If you own real property or properties, you should seriously consider holding title through an entity. There are various business, asset protection, tax, estate planning, and real property law issues that make holding title in an entity beneficial.

What is a Legal Structure or entity?

When it comes to the legal and financial side of real estate investments, protecting yourself and the real property and avoiding  needless taxation are critical objectives. While you have the choice to operate your real property as a directly owned sole proprietorship—filing income and expenses on your personal tax return—this is far from the best approach.

You should consider some layer of protection between your business and your personal assets.

A failure to establish legal safeguards in the form of a documented business structure could put your own personal assets—home, car, savings, etc.—at risk if you were to be sued or fall behind on debts. On the other hand, the right type of entity owning real property can offer protection of the entity and its real property from your personal creditors.

A legal structure or entity is simply some legal documentation that you wrap around your real property  to protect it. Assuming that you choose the proper one, you still have all of the freedoms to operate the real property as you see fit. And, another consideration is to have ownership of your real properties by different entities in order to protect your other real properties if there is a lawsuit involving one of them. If you put all of your real properties into one entity, whatever happens in that entity on piece of property exposes all other real properties owned by that entity.

The Entity Structures You Should Consider

Notice: Every situation is different, and you’ll have to think about your specific needs and goals. But when viewed through a general, big picture lens, here are some of the best legal structures for real estate investors to consider.

1. LLC

For long-term investors, a limited liability company (LLC) is a great option. It’s suitable for buy-and-hold investments where you’re looking to accrue steady income and long-term capital appreciation. LLCs offer limits the liability of the investor.

Another benefit of an LLC is that it’s a pass-through entity. In other words, earnings and losses are passed through to your own personal income tax return. This makes it simple to manage. But if you do go this route, you have to be careful not to mix any personal and business expenses. Doing so will pierce the LLC veil and leave you personally liable.

Notice: There is a California Property Tax Benefit to owning real property inside of an LLC. If the LLC is the buyer of the property from a third party, the property will never be reassessed due to change in ownership as that term is defined under California property tax law, UNLESS one person acquires more than 50% ownership of the LLC.

2. S Corp

“The S corp is a pass-through entity for tax purposes, similar to the LLC,”  “This means that the income generated by an S corporation will flow through to the personal income tax returns of the shareholders, and the S corp itself generally does not owe any tax liability.”

By structuring your real estate investment venture as an S corp, you get the flexibility to manage the ownership of the company.

However, S Corporations have the following problems:

• S Corporation stock can only be owned by certain persons, under the tax law
• S Corporation stock is easily seized by creditors of a shareholder
• Taking real property out of the S Corporation is a taxable event.
• There is no step up in basis when you die for the inside basis of the real property. By contrast, real property inside of an LLC can get step up in income tax basis if an election is made on the LLC tax return
• S Corporations are subject to a California state income tax of 1.5% on S corporation net income each year.

3. C Corp

A C corp is very different from both LLCs and S corps in the sense that it is a separate tax paying entity. C corporations operate as true corporations that pay their own taxes. The biggest benefit is that there’s no cap on the number or types of owners (like an LLC). This makes it ideal if you’re pooling investors together for large real state investments. And because the earnings of the company don’t flow to your personal tax return, you don’t have to worry about income tax liability. However, this means there’s double taxation when you want to pull cash out. I usually do not recommend having real property owned by a C Corporation.

4. REIT

Real Estate Investment Trusts (REITS) are not common. However, it is possible to establish a non-publicly traded REIT.  A REIT is efficient and secure, but there’s one issue that stands out. In order to qualify, the entity must distribute at least 90 percent of annual income to shareholders. This makes it difficult to continue growing.

Take the Long View

Whether you’re starting with a single property or have plans to accumulate hundreds of properties, it’s important that you think long-term when setting up a legal structure for your business. It’s far easier to set up a structure and grow into it than to reach a point down the road where you need to reincorporate. The latter can be expensive, time-consuming, and hard on a business.

Choosing an Ownership Structure for Your Real Estate Investment

When people jointly invest in real estate, whether with a friend, family member, or business partner, they frequently don’t think much about how they take title. Yet, real estate ownership structure can play a key role in meeting the investor’s economic goals.

Various Ownership Structures

Some popular ownership structures for real estate investments include:

Tenancy in common (TIC)
Partnership
Limited liability company (LLC)
S Corporation (S Corp)
Grantor Trust

Each of these has advantages and disadvantages. As a result, the choice of structure depends upon the owners’ investment, estate, financial, tax, business and asset protection goals. A few key factors to consider when selecting an ownership structure are as follows:

Who are the Investors. Federal tax law places significant limitations on who can own shares of an S Corp. Generally, S Corp owners must be individuals, estate, and certain types of trusts. All owners of an S Corp must be US citizens or permanent residents. If any of the owners will be business entities or are not US Citizens or permanent residents, a different ownership structure must be used.

Up Front Cost. Up front formation costs can be a factor for some investors. LLCs and S Corps are formed by filing paperwork with the state, which involves a filing fee. Although the fee usually is nominal, LLCs, S Corps, and grantor trusts all require preparation of organizational documents by an attorney, and an S Corp also requires the filing of a federal tax form.

As a practical matter, an attorney should prepare a partnership agreement for any partnership. Unless Tenancy in Common (TIC) owners are spouses, it also is advisable to have an attorney prepare a TIC or Co-Ownership Agreement for TIC structures.

The costs of these legal documents will depend upon the complexity required to meet the owners’ unique needs.

Annual Costs. Many ownership structures require ongoing costs due to required tax filings and/or state entity maintenance costs. For instance, LLCs and S Corps require annual state filings and fees. Corporations require annual minutes. Annual minutes are recommended for LLCs to evidence business purposes each year for tax requirements.

Most of the ownership structures also will require paying a tax preparer to file annual federal and state income tax returns. Partnerships, LLCs, S Corps, and grantor trusts all typically are pass-through entities, meaning that taxes on their income are paid by their owners. However, they all are required to file annual federal and state income tax returns. On the other hand, TIC income also is paid by the owners, but TICs are not required to file tax returns.

Owner Protection from Personal Liability. Although real estate investors typically purchase liability insurance to protect their investments from common risks, insurance doesn’t cover everything. In particular, insurance doesn’t cover mortgage loan and contract liability. Insurance also may not provide the coverage or defense when the time comes: the insurance contract may exclude claim coverage, or the insurance company may be out of business.

Investors who own their real estate in a TIC or general partnership structure will be personally liable for all obligations associated with their investments. However, by selecting an Limited Partnership with a corporate general partner, LLC or S Corp as their ownership structure, investors will not have liability beyond the amount they invest unless they sign personal guarantees or are found by a court to be the ‘proximate cause’ of an injury.

Probate Considerations. Investors also may be concerned about their real estate investments being “tied up in probate.” Although any structure will be subject to any applicable federal or state estate tax, it is possible to structure an investment so that it is not part of the probate estate. The best way to do this will depend upon the investors’ individual estate planning needs and the use of a living trust, or provisions in an LLC or Partnership Agreement that indicate what happens to an owner’s interest.

For example, in a TIC structure, multiple owners can own jointly with survivorship (actually called Joint Tenancy) so that when one owner dies, the others take ownership of his/her interest. However, this only works where the investors are spouses or want to leave their investment to their co-investor upon their death. This is not usually the case.

A grantor trust is commonly used to avoid state probate, and it can be used when two unrelated real estate investors each want to leave their investments to their heirs. However, the cost of preparing the trust instrument in such instances can be significant.

Although sometimes possible, survivorship rights are not common with LLCs, partnerships, or S Corps. Owners electing to invest through these structures should expect that their investments will be part of their probate estates unless owned by their living trust.

Deferral of Tax on Gains Upon Sale. Many real estate investors rely upon Section 1031 exchanges to defer taxation of their gains upon sale of their investments. Any of these ownership structures can do a Section 1031 exchange if certain technical requirements are met.  Should the owners want to go their separate ways after they sell the real estate, only the TIC structure enables them to do so while preserving the ability of one (or all) of them to do a Section 1031 exchange. This can be overcome by merely buying out a departing member, partner or shareholder, who would then have taxable gains.

These are just highlights of the factors involved in structuring a real estate investment. Although not every real estate investment is successful, with careful planning and the advice of an attorney experienced in real estate investments, real estate investors can position themselves and their heirs for long-term real estate investment success.

Holding the title to a commercial real estate property can be managed in several ways that differ quite a bit from each other.

From tax advantages to liability pitfalls, each type of commercial property ownership brings unique benefits and drawbacks, therefore it is important to understand each clearly before you take over a new real estate asset.

Types of Property Ownership

When looking to purchase commercial property, it is always wise to consult with a lawyer who specializes in the following:

Real Estate Law (naturally)
Business Law
Estate Planning
Asset Protection Planning; and
Tax Law

Different types of ownership may be preferential for commercial property owners in different locales due to varying laws and other factors.

Following is a detailed look at seven of the most common types of property ownership:

• Sole Ownership
• Joint Tenancy
• Tenancy in Common
• General Partnership
• Limited Partnership
• (LLC)
• S Corporation
• C Corporation
• Trust

Sole Ownership

In this scenario, the full ownership of the real estate asset belongs to a single individual.

The biggest appeal of sole ownership is that decisions about the property, are simplified and involve such issues as how best to use it or when to sell, do not need to be approved by tenants or any other party aside from the owner. Below, you  will see, this is not the case with property ownership formats such as joint tenancy and tenancy in common.

A major drawback of sole ownership however, is the added complexity for a property owner’s heirs. In order to transfer the title, a sole owner’s heirs will need to probate their estate, which can be a costly and time-consuming process.

Though flawed, clients come in having real property owned through Sole ownership. Sole ownership is commonly used for multi family rentals like duplexes and triplexes, small retail properties, as well as land. As you read below, you will see how this could be a mistake.

Joint Tenancy

With a joint tenancy, two or more tenants own equal shares of a property. The tenants are entitled to equal rights, income, and use of the property, and can also benefit from sharing the mortgage and tax payments.

A joint tenancy is one of the most common types of land ownership.

One of the most important aspects of a joint tenancy agreement is the right of survivorship. This means that if one or multiple tenants die, the ownership passes on to the surviving tenant. Unlike probate, right of survivorship allows for ownership to be passed on easily after the death of one party.

In order to enter into a joint tenancy agreement, the property conveyance or deed need to specifically state that a joint tenancy and rights of survivorship have been created.

Joint tenancies however also come with a number of drawbacks, which can add a certain element of risk. For example, if one of the tenants has unpaid debts, a creditor is legally entitled to collect what they are owed through the forced sale of the asset.

In addition, each tenant must agree to the sale or transfer of the property, which can be very limiting.

Joint tenancies also have tax consequences. For example, estates exceeding the applicable estate tax exemption at the time of death are subject to state estate and federal taxes.

Lastly, joint tenants are liable for their share of property maintenance and repair costs.

Tenancy in Common

A tenancy-in-common property is owned by two or more persons at the same time. This type of ownership however can be split into different percentages among the tenants, hence it does not provide equal use, rights, or income.

Survivorship rights are not included under a tenancy in common. In the event of death, the decedent’s share is acquired by their heirs or beneficiaries though will probate or if owned by living trust, through that device, who then enter into the tenancy-in-common agreement with the other surviving owners.

A tenancy in common is another pretty popular type of commercial property and land ownership.

Tenancy in Common vs. Joint Tenancy

While they may look similar at first glance, these two types of property ownership differ in several ways.

In both scenarios, the asset is co-owned by two or more parties. Unlike a joint tenancy however, a tenancy in common does not include rights of survivorship.

Furthermore, a tenancy in common does not provide equal use, rights, or income, whereas a joint tenancy does grant equal shares to all owners.

Partnerships

The title to a commercial real estate asset can be held through a partnership, general or limited.

LLCs

For example, if two investors share the ownership of a warehouse building through an LLC and a worker suffers an injury on site, the LLC would protect their personal assets in the event of a lawsuit.

In addition, owning partnerships offer tax benefits as they are subject to pass-through taxation. The LLC’s members pay the business taxes through their personal tax returns and the LLC itself pays no taxes.

Corporation

Corporations are separate legal entities that can also hold the title to a real estate asset, as in the case of an owning corporation.

The major downside to this form of ownership is liability. For example, if someone suffers an injury on the premises, the owning corporation can be sued, and an asset can be acquired and sold by a creditor.

While the risks can be mitigated with liability insurance, asset owners are still vulnerable due to policy limits.

Trust

The last type of property ownership we will discuss is an owning trust.

In this scenario, a designated trustee manages real estate assets under the direction of a trustor, who has also designated one or more beneficiaries. Either an organization or an individual can act as the trustee.

In the event of the trustor’s death, their interest is passed on to the designated beneficiaries.

When discussing trusts, it is also important to explain the difference between irrevocable trusts and revocable trusts.

An irrevocable trust can only be modified or terminated with the beneficiary’s permission, as the grantor of the trust has effectively relinquished all control.

In contrast, a revocable trust still allows the trustor to make changes to the trust. Additionally, the trustor must pay tax on the income generated by the property.

What is the main benefit of owning land or property through a trust? Most significantly, commercial property owners enjoy the privacy that a trust provides.

When land or real estate is owned through a trust, the actual individuals behind the trust can remain anonymous. Their personal ownership is not recorded in public real estate records and this can help them avoid the risk of litigation.

However, anonymity is not guaranteed. A court can unearth property owners’ identities, such as in the case of any suspected criminal activity.