Hello my friends and welcome to another episode of Ask Marco where I answer your investing related questions.
Today’s question comes from Lorenzo and this actually came in through our website blog. It wasn’t through the contact form where you click on the Ask Marco link at the top of the website and his question is basically around asset protection for my real estate empire. So Lorenzo goes on to say, I am in the process of building my real estate empire. Congratulations Lorenzo! I’m trying to do it the right way so it would not cost me later down the line. My questions are, and then he lists out five questions. So I’ll take these one at a time just to keep things in a good flow and clear and really there could be an entire episode on really just some of these questions, let alone all five. But I’ll give you a good overview of what the answer to the questions are.
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So the first question is what type of entity should I form if I want to hold properties development or flip? Okay. There’s no one answer to this question because the type of entity you would use for buying hold properties, in essence, your real estate portfolio would be different in almost every case. Uh, if you are doing a development and or a flip because one is a transactional business versus buying and holding properties where you’re just having income-producing assets that you want to hold for asset protection purposes. So before I go any further, I just want to make clear to everybody that I am not an attorney, I not an asset protection attorney. I’ve just learned this through my own personal experience and working with real estate attorneys and studying asset protection on my own. And really it’s just years of experience. So my answer to your question is not necessarily the right answer for you specifically, but in general terms, it’s what a lot of real estate investors use or do and what most asset protection attorneys would set up for most real estate investors.
So I say most because again there are exceptions to every rule. So in terms of the type of entity at a high level and generally speaking, properties are held in the US in LLCs, a disregarded entity. The LLC is not set up as a partnership. It’s not set up as an S corporation. It’s set up just plain and simple as an asset holding entity. It’s an LLC in the state, typically in the state where the property is held and it is not run as a business. It’s simply held as a disregarded entity for tax filing purposes, but you title over the property or properties depending on how many you want to hold in that entity. You title the properties over and they are held and you just maintain the books and you file a return. A, it’s actually a form with the IRS every year just stating that you know, this is the status of that entity and it will not pay taxes.
It’s a flow-through entity. So any income that is generated from that entity holding your real estate property or properties flow through to the owning member that has the interest in that LLC. So that was a mouthful, but I hope that made sense. Now that is different with an active business such as a flipping business where you have many transactions and you have income and expenses could be a lot of expenses and there’s a profit and loss statement. So anyway, that’s about as deep as I can get into that. Lorenzo. Second question is, would this be considered a holding company? To a large degree, yes, because it’s holding your asset or assets the property. So yes it is a holding company, but the way people use the term holding company in most cases is it’s a top-level entity that actually holds title to one or more of your other entities or businesses.
So you have like at the top of a pyramid you have a holding entity and that holding entity is what has title or interests in your other entities that hold assets and or run businesses. That’s really the simplest way to think of that. Um, but yes, it is a holding entity. I wouldn’t say a holding company. Third, he says, should I use a management company for out of state? Yes. 99% of the time. I’m going to answer yes to that question because if you are not actively managing your own properties or your portfolio, then somebody should be and probably needs to be and especially if you’re not a seasoned real estate investor where you have the time or experience or knowledge to manage that portfolio from a distance. And I’m not saying it’s difficult or hard or even impossible. A lot of investors do self manage their properties from a distance and there are resources, tools, and websites out there to help you with all that as far as finding tenants, screening tenants to some degree placing tenants and that’s becoming easier as technology is coming out to help real estate investors self-managed.
But for the most part, most of the time I would say just hire a professional full-service property management company to manage and oversee your portfolio. The biggest thing you want to avoid is turnover. So you can’t completely eliminate it, but whatever you and your management company can do with your properties to minimize the turnovers that you have, meaning keeping the tenants in for as long as possible will go a long way in preserving your cash flow on the property. And of course, you know over time you build equity through amortization and appreciation and that’s what creates your true wealth for how would tax work out with this form of company? I’m not exactly sure what you’re asking here, but I think I touched upon that with my answer to number one, and that is these asset holding entities are flow-through entities. When you set up the LLC, you will elect it to be a disregarded entity.
So it doesn’t actually hold a profit at the end of the year. And that’s why it doesn’t pay tax. Whatever income is generated, it flows through to your actual holding company or whatever the entity is that holds that particular LLC or, or holding company. So I don’t want that to sound confusing, but essentially a disregarded entity doesn’t pay tax. You elect it to just be a title holding entity. Not an active business. And finally, number five, which is better form an LLC on each individual property or have them all under one LLC. Again, like most attorneys answer questions, it depends and it depends on the amount of exposure you want from one LLC. So if you have an LLC holding a property and there’s no equity, there’s nothing to go after if there ever was a lawsuit. But if you have a lot of equity in that property or if you have multiple properties and they all have equity, then you have increased exposure and depending on what your tolerance level is, and this is just a subjective question and it’s a matter of you know, what you’re comfortable with and maybe what your attorney, asset protection attorney suggests.
You may want to limit the number of properties or in dollar terms, the amount of equity that you have in a particular LLC. So you have to define that criteria and where you’re going to draw the line as far as when do you actually have a second LLC or a third LLC and so on. So no, I wouldn’t probably put all my properties in one LLC, especially if there’s a lot of equity. And the other thing too is as a general rule of thumb, if you have properties in multiple states, you’ll probably want LLCs in each of those States holding title to the properties in those specific States. So don’t put a property from Atlanta, Georgia and Indianapolis, Indiana in one LLC because you have to pick one state to set up that LLC. And it’s best to just keep those all the same meaning Indianapolis properties are in an Indiana LLC.
And then that LLC is held by whatever holding entity or holding company you have. Okay? So hopefully that’s going to help you Lorenzo in your real estate empire. And, uh, I’m hoping that we can help you build that portfolio and that empire. So that is it for this episode. If you have a question about investing finance or real estate, of course, then let me know. Click. Ask Marco at the top of passiverealestateinvesting.com, remember to subscribe, share this show with your friends and other likeminded people who can benefit from it as well. Leave us an iTunes review. I read every single one of them and I appreciate them all. Thanks for listening. I’ll see you on our next episode.
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