Category: Finance, Real Estate.
As a real estate investor it is important to choose a business structure that gives you the maximum asset protection as well as the best tax advantages.
Sole Proprietorship. Although I can t advise you as to what type of entity you should structure your company as( you should consult with attorney) I can give you a brief overview of the different types of entities. A sole proprietorship is basically a one person company and is simply" you doing business" . If you a using a fictitious or trade name you must file a" d/ b/ a" or doing business as with your state, city or locality. There isn t any filing requirement to start you business using this structure unless you are using a fictitious or trade name. The only types of fees associated with being a sole proprietor are the licensing fees that your city or state or locality charges for doing business. The income made by a sole proprietorship is income earned by its owner.
Tax Consequences of a Sole Proprietorship. In addition, as a sole proprietor, you report your income, profits and losses, expenses on schedule" C" on your federal income tax return. Disadvantages of Sole Proprietorship. This income is subject to a self- employment tax. One of the disadvantages of a sole proprietorship is there is unlimited liability. There is really nothing shielding your personal assets. If you got sued everything you have personally is at risk.
If your business goes bankrupt, you must file for personal bankruptcy protection to avoid the business debts. A general partnership is an entity that is formed with two or more parties. General Partnership. No paperwork needs to be filed to create a partnership. However, it is better to have a partnership agreement that spells out the terms of the partnership. In fact it can be formed with a simple handshake.
If there is no partnership agreement then the partnership is governed by state law. S. have adopted the Uniform Partnership act which consists of a set of rules of how partnerships should act if they don t have a formal agreement. The majority of the states in the U. Liability of a General Partnership. Partners are jointly liability for any acts of negligence. A general partnership has no liability protection for partners. So whether or not a person in a partnership committed a negligent act he or she is still personally liable for that act.
The general partnership itself doesn t pay taxes it simply files an I. Tax Consequences of a General Partnership. This is only an informational form that summarizes income, expenses and profits and losses of the general partnership business. S. 1065 form. A general partnership is treated as a" flow through entity" which means that the profits and losses of the partnership" flows through" to the partners who report their share of income or losses on schedule" E" of their personal income tax returns. The way that this works is that the partnership would send each partner an I.
Limited Partnership. K- 1 form that states their share of the partnership profits or losses. In order to form a limited partnership, the partnership must file a" Certificate of Limited Partnership" with the state in which it is organized. There are the general partner and a limited partner. There are two types of partners in a limited partnership. The general partner controls the day to day operation of the partnership and is liable for all business debt where as a limited partner is not responsible for business debts and/ or claims. The general partner in a limited partnership have unlimited liability and if a judgment is rendered against the limited partnership and that partnership doesn t have enough assets to cover the claims, the creditor can go after the general partner s personal assets.
Liability of a Limited Partnership. Sounds risky doesn t it? Now unlike the general partner a limited partner has no liability beyond what they initially invested in the partnership. Well it is! Creditors can t go after limited partners for the debts of that limited partnership. Tax Consequences of a Limited Partnership.
In addition, limited partners unlike the general partner are not personally liable for acts committed by the general partner unless they participate in management decisions. A limited partnership is also treated as a" flow through entity" for tax purposes. This is the case whether they receive those net profits or not. I must point out to you that in" flow through" entities, the owners pay individual income taxes on all net profits of the business. Corporation. Its primary advantage is to provide owners with limited liability against business claims.
A corporation is a business entity that carries its own legal status, separate and distinct from its owners. A corporation requires a filing of an articles or" certificate" of incorporation with the state. An" S" corporation status must be elected. There are two types of corporations" C" corporations and" S" corporations. Tax Consequences of a Corporation. The primary disadvantage of a" C" corporation is double taxation. A" C" corporation files an IRS form 1120 and pays taxes on its net income.
Profits are taxed first at corporate tax rates and then again at the individual level. when owners receive profits from the corporation in the form of dividends. It files an information IRS form 1120- S and the profits and losses" flow through" to the shareholders. An" S" corporation is taxed just like a partnership. The S corporation sends each shareholder an IRS K- 1 which states the shareholder s share of profits or losses. A corporation provides liability protection for its owners( the shareholders) . Liability of a Corporation. If the corporation was sued, the owners are not personally liable.
A limited liability company( or" LLC) " is a hybrid cross between a corporation and a partnership. Limited Liability Companies. To form a LLC the requirement is that you must file an" articles of organization" with the state. Liability of a Limited Liability Company. An LLC is owned by its members or partners and it is governed by its operating agreement. A limited liability company provides protection for its members.
If the LLC is not able to meet its debts, the members are not liable for these obligations. The members are not liable beyond their contributions to the company. In addition, if the LLC is sued the members are not personally liable. An LLC is also a" flow through" entity and for single member LLC the tax reporting requirements are basic. An LLC can be" member managed" or" manager- managed" Tax Consequences of LLC. All you have to do is attach an IRS form Schedule C which is a Profit or Loss from a Business to your Form 1040 individual return. On this schedule you will calculate the amount of self- employment tax owed.
You will also have to file IRS form Schedule SE which is a self- employment tax form. This self- employment tax is a combination of Social Security and a Medicare tax. Like I mentioned previously that requires the LLC to file a form 106Income, deductions and credits, losses allocated to each owner for the year are reported on Schedule K of form 106A schedule K detail is given to the respective members of the LLC detailing their specific shares of profits and losses. If there are two or more members of LLC, then that LLC generally must file its taxes as a partnership. They would then use this information and attach the K- 1 to form 1040 of their personal tax return and use it to calculate their personal income tax owed. LLP s are a special type of partnership designed to provide individual partners with protection against malpractice by other partners in the business.
Limited Liability Partnerships. In some states this is known as a registered LLP, or RLLP. So there you have it, an overview of the different types of business entities in which to choose from. LLP s are primarily designed for professions such as doctors, lawyers and accountants. In running your real estate business, it is imperative that you to choose the entity that works best for you. As a rule of thumb you want the best assessment of the business structure that will allow you to keep a significant amount of income that you made from your deals while minimizing the taxes that you have to pay to Uncle Sam.
Furthermore, you should also seek the advice of a competent attorney and an accountant before choosing a specific entity. It makes no sense to make the money as a Real Estate Investor and to give a great deal to the IRS just because you didn t choose the appropriate business structure.
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