Should You Incorporate a Real Estate Business?

Real estate businesses — especially those involving investments — represent a substantial amount of risk. There are a lot of “what ifs” in real estate investment, including: What if someone gets hurt on my property? What happens if I fall behind on the mortgage for one property but stay current on the others? What are the tax obligations if I take out a mortgage under my own name?The primary reason to set up a business entity like an LLC or corporation is to protect your personal assets against a lawsuit. Incorporating your real estate business offers several other advantages, however.Personal Liability
If you operate your business in your own name, you will be financially liable if someone files a lawsuit against your business, or if you face expenses you can’t pay. When you incorporate, your personal assets will be protected if the business runs into trouble.Rather than obtaining a mortgage for a property under your own name, you can get a loan under the name of your business from the bank. This offers even further protection as the LLC or corporation will own the property — not you — especially if you form an LLC or corporation for each property you purchase for rental purposes.For even greater protection, you can take the further step of holding each property in its own corporation or LLC. This further limits liability to the specific investment. If someone sues you for an injury on Property A, the liability ends with that LLC and it will not involve companies that hold Property B, C and D.Business Deductions
As a sole proprietor, you can deduct many business expenses associated with your real estate company, including mortgage fees and interest, building materials, maintenance and more. There are many operating expenses you cannot deduct, however, unless you form an LLC or incorporate. This includes employee salaries and many types of insurance you will need. When you turn your real estate business into a corporation, you can deduct 100% of these business expenses from your profits before allocating income to yourself and any other owners.Professionalism
If you sell or rent properties, the people who do business with you will want to know they are dealing with a legitimate company. As silly as it may sound, the word “incorporated” or “LLC” in your name makes your company appear more reputable and attracts higher-quality customers.You Can Sell Your Business
Once your business is profitable, you have the option to sell it if you like, but only if incorporate. If you operate as a sole proprietorship, you are the business. If you plan to ever sell your company, you must set up a separate entity that can be transferred or sold and continue to do business.Income Splitting
If you operate your business as a sole proprietor, you will be taxed on all profits, even if you choose to reinvest them into the business. If you incorporate, the company is now a separate taxpayer that pays a lower tax rate. You can choose to take a small salary and leave the rest of your profits in the company to lower your income tax rate.Multiple investors, such as investment clubs, should also consider forming an LLC or incorporating. If you do not incorporate or create an LLC, all investors in the project are considered partners, which means all will be liable for the actions of the others. If you form a limited liability company, you will have greater flexibility in management, too, as the operating agreement can grant and limit obligations, powers and rights for each owner.The Bottom Line
Real estate is a tricky business. Why increase your risk any more than you need to? Consult with a corporate service company and an attorney to determine if forming a business entity is the right decision for you.