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How to Organize a Real Estate Business

Instructor: Ian Lord

Ian is a real estate investor, MBA, former health professions educator, and Air Force veteran.

When a real estate agent sets up a business, he or she can choose from a variety of business structures for tax purposes. These legal structures include sole proprietorships, corporations, partnerships, and limited liability companies.

Sole Proprietorship

Alex is a new real estate broker. He is ready to set up and run his own business. But how does he organize his business? That's going to depend on a number of factors. Will he operate his business alone or does he want to bring in business partners? Does Alex need to protect significant personal assets like his home from the risk of business debts or lawsuits? Does he need to raise money from investors to accomplish his goals? Let's look at some of the possible business structures available for tax purposes.

Partnerships

If Alex just starts going to work with his real estate license in hand, he is by default running a sole proprietorship business. In this structure, the owner and the business are legally one and the same entity. The advantage of setting up this type of business structure is that beyond a real estate license (or other type of business license), no formal action - or paperwork - is needed. Additionally, there are no complex tax returns. Alex's profits from real estate would be included on his personal income tax return. One disadvantage, however, is that if Alex gets sued, his personal assets could be at risk.

Let's say Alex would like to take on another agent, Bob, as a business partner. A general partnership would divide ownership in the company according to an agreement Alex and Bob make. To create a general partnership, they would need to check with their state government to file any necessary paperwork. Additionally, as in all business arrangements, it would be best to have the details of the business structure drawn up in case there is ever a dispute. In a general partnership, each owner has the authority to commit the company to legal agreements. However, one disadvantage is that each partner is liable for the actions of the other partners. This concept is called joint and several liability. When things work well, the partners share in the business profits. Unfortunately, if Bob were to run up significant business debt and then disappear, Alex would be responsible for the debt.

A limited partnership is a more formal business structure with state specific registration requirements and different classes of partners. In a limited partnership at least one partner is a general partner. These partners are responsible for the management of the company. Other partners may be limited partners, also known as silent partners. These partners enjoy limited liability from the debts of the company. With limited liability a business owner is only risking the assets they have invested in the company, and are not personally liable for business debt. In exchange for waiving the right to manage the property, they are not held liable for business debts but still see profits from the company in the form of dividends. In both types of partnerships the business profits pass through to the owners who in turn pay the taxes on their personal returns.

Corporations

If Alex was worried about limited liability and business taxes, forming a corporation business structure might be the best option. A corporation is a legally distinct entity from Alex the person. While acting in his capacity as an employee of the company, Alex enjoys limited liability from business debts. All he risks financially is the money he has invested in the business. Corporations can be organized in two ways.

If Alex makes $100,000 as a sole proprietor, but plans on taking half as salary and keeping the rest in the business, he still pays taxes on the entire $100,000. In a C corporation he could draw a salary of $50,000 and save the rest of the money in the corporation for future expenses. Although he would pay federal corporate tax rates on any year end profits, this is likely less than taking the money home and paying personal income tax rates plus Social Security and Medicare taxes. C corporation share owners pay taxes on the dividend profits from the stock on their personal returns. Most of the larger companies in the United States are C corporations. They can be privately held or have shares which are traded publicly.

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