Best Legal Entity for Real Estate Investing

the best legal entity for real estate investing is hi I'm Phil outs with freedom mentor calm I'm a full time real estate investor real estate mentor I've been a part of a whole lot of deals over the last ten years and in this video I am going to share with you what is very helpful to know when contemplating the idea of setting up an LLC or a corporation if you're gonna be real estate investing and one big disclaimer I am NOT giving you legal advice in this video nor might giving you accounting advice either I am going to recommend prior to you setting up anything that you speak with a qualified attorney as well as accountant to make the best decision on if and when and what type of entities you need to create if you're going to be real estate investing but since I'm not an attorney I'm not an accountant I'm probably to tell you stuff they wouldn't tell you and what I'm going to share with you comes from the school of hard knocks comes from a lot of years of making good and bad decisions and this is the kind of stuff that I didn't read in books in fact I'm going to probably and in this training here I'm going to probably contradict some things you may have read in some other famous books because it is interesting what happens in the real world with this stuff so let me put myself in your shoes for a moment maybe you're first getting started or you're contemplating becoming a real estate investor and maybe you're trying to consider what you need to do as far as an LLC to set one up when do you set it up they even set up an LLC what is an LLC do you set up a corporation I mean so I'm gonna try to answer some of those questions pretty briefly and then I'm going to get into more of what it means to a real estate investor okay the first thing I think this is extremely important is that in business if you do not set up an entity and you start doing business you are by default a sole proprietor Pro oh boy I'm about to embarrass myself because I don't know if I spelt that right or sole proprietorship spell check that can do wonders right so this is your if you're doing business any kind of business real estate mission or otherwise you're automatically a sole proprietorship that's just with a law works and so when I was living out of my truck and I was flat broke and homeless my first few real estate deals I did them as a sole proprietorship now I'm most attorneys and accountants they freak out and they gasp when you mention the idea of doing business in the sole proprietorship because of one main missing element what you're missing from a sole proprietorship is what they call liability protection okay liability protection we break that down for a second it's not that scary to understand the concept the concept is this if if you do something in business and you're operating as a sole proprietorship which you could you could have a business name you could name your business you know of successful investments but if you don't have a legal energy setup you're still operating as a sole proprietorship and if something goes wrong you know somebody Sue's you something happens they can sue you personally and take all of your personal assets along with whatever happened the business now when I first got started I was homeless broke whatever uh I didn't have anything to lose so you know I mean if somebody sued me well they gonna get nothing right so when you're first contemplating this if you are absolutely flat broke and have nothing at all just keep in mind that yes is it's still important to consider getting a legal entity set up yes but it's not the end of the world because you don't have a bunch of things to protect however what if you are already have a pretty significant set of assets and you're looking at getting a real estate investing so let's talk about the different kinds of entities and what can what can happen well here's the first thing on what some investors do is they continue to operate in a sole proprietorship huh let me explain but what they do is they get liability insurance okay so they would talk to an insurance broker and they would get an insurance policy that protects them up to say two million or three million so they get a liability protection policy and they continue to operate the sole proprietorship why why would any real estate investor in their right mind operate like this interestingly enough in most cases you actually do better from a tax perspective if you operate out of a sole proprietorship I bet you didn't know that because you file all your expenses on the schedule see any accounting people would know what I mean but so I for example there's a gentleman I know that he owns over uh over 350 single-family home rentals he owns them all free and clear and there are a lot of Murray kind of Junkers in the ghetto but he owns all of them in a sole proprietorship why because in his state if he owns real estate in a sole proprietorship he doesn't have to pay an excise tax estate excise tax however if he owned that real estate in an LLC or a corporation he would have to pay an excise tax does that make sense so certain taxes can get triggered on a state level not a federal level but at the state level if you own real estate in certain entities and that's one of them is LLC's or corporations so this particular gentleman owns all his property the sole proprietorship and he protects himself in the case of a tenant trying to file a lawsuit against him with a liability insurance policy some of you may be watching this you may be from Canada and many Canadian of all state investors do the same thing and that's because in when it comes to Canadian legal entities in most cases if you want to set up a corporation you have to have five employees well shoot most real estate investors never get to the point of five employees you don't need employs really so this is a great option also I know people that do a lot of short sales or they buy short sales these days when you make an offer on a short sale banks want to see a personal name so a lot of my offers in their own personal name and their offering as a sole proprietorship and they have a liability insurance policy that makes sense all right that what I gave you here that wisdom you'll hear nowhere else but it's true and it's very accurate and it can be an easy way to get started you have to set up immunity the only thing though is liability insurance policies aren't always cheap in some cases it's actually cheaper to go with a legal entity so that's the first one and so by default if you're operating in business you're already a sole proprietorship the next thing I want to mention is something called an LLC LLC that is a limited liability company limited liability company ah this is what is used most often for most small businesses most small businesses are set up with an LLC it's because they're flexible they're a lot easier to set up there's a lot less minutia that has to be dealt with as far as like corporate paperwork and those sorts of things they can be filed easily set up I mean it's just ease of use okay now the cool thing about an LLC is that it can be taxed as a sole proprietorship or it can be taxed as an S corporation so so I'm going to say so P or a or an S Corps so I have I have LLC's that are set up that are taxed as sole proprietorships and I am as taxes S corporations and that can be nice when it comes to eliminating self-employment tax one of the problems with operate as a sole proprietorship or as your LLC being taxed as a sole proprietorship is self-employment tax so it can get kind of expensive once you start making a lot of money so that's why we go back to what I said beginning the video and that is before you set anything up I want to recommend you talk to both an attorney and an accountant because they may have competing views the attorney is going to talk and focus on liability protection and the in the accountant is going to going to focus on how to save you the most in taxes so if you can set up an LLC tax as an S corporation that can be pretty sweet although if you're not making much money at all it's not it's not helpful so there's there's a balance there and for most cases you'll probably be setting up an LLC and and if you want it to be taxed as an S corporation you can do that and the the final thing is is certainly some people set up it's called a corporation I'm going to call an S corporation because you're probably never going to be big enough to set up like a real corporation with Atle those big big big things because those are a lot more expensive they get taxed at the corporate level whereas s core the the tax still flows back down so um so this right here you may use this as well and again your accountant your attorney may bring this up as an option I still vote that you go with the LLC escort but again I'm not giving you legal advice or accounting advice and this I'm going to give you an incredibly important tip here okay so real estate investing can be broken up into two activities active and passive okay active is you buy a property fix that up resell it you talk to motivate sellers and flip properties you're wholesaling you're moving and grooving you're you're doing deals and then the passive side is where you buy a property and lease it out and you get rental income that's your passive income this is the rule of rule of rules okay here's the rule now I'm going to put it in red get it's so important okay this is it you want to separate those two activities separate passive and active and the reason why is for tax purposes okay because it is potentially possible that if you own rental property in the same entity which could have been your sole proprietorship if you were doing it you know just your own personal name if you're both flipping properties and owning long-term rentals in the same entity then what can happen is the IRS can say that all of your rental income is going to be taxed at the ordinary income level which is a nightmare because rental income can be taxed a lot less because it's rental income or passive income so you separate the two so anytime you own a rental property put that into a legal entity that is separate from what you're doing with your active stuff so maybe you're doing your active stuff in your sole proprietorship but then you set up an LLC for your rental income or vice versa you know maybe you set up an LLC for all of your flipping and wholesaling and then you do all your rental income out of your sole proprietorship with your liability insurance or maybe you do all your activity out of the S corporation this is all your active stuff and then all your long-term stuff is out of your LLC but you got to separate the two does that make sense huge huge huge detail because if you don't separate the two you're going to really get hit on taxes all right so this right here really encompasses the majority of this whole concept and I would I think another question a lot of people bring up is where to set up the where to set this thing up you set it up in your own state you set it up in some wonderful state you know halfway across the country I'll say this in most cases you're better off putting it in your own state because that's where you're going to be operating in your business now I'm some people like to set up their LLC's in Wyoming that seems to be like the favored state these days because the non-disclosures and some other things that you can do and you can go through all those headaches and hassles and again talk to an attorney about that but in most cases you're probably just it's probably a lot simpler to set it up in your own state one thing to keep in mind is especially when you're doing a lot of active investing it's not always a good idea to set up your entity and you know like Wyoming if you're doing business and say you know Texas because when you're working with sellers and they try to look you up they hire an attorney maybe a look you up and they see that you're not even in business in Texas then all of a sudden you're a bigger heap of trouble and you need to have filed some documents to be able to do business in Texas and also their next mess so my vote is just set up the entity in your own state and make sure you talk to a local accountant local attorney to make sure you set it up correctly I know in Tennessee when I was on a bunch of real property up there what I did was I set up an LLC and the two treated me I set up a yeah I set up a partnership and the two partners were LLC's and that's how I avoided paying the excise tax in Tennessee so there's some cool creative things you can do there as well but also keep this in mind the simpler the better because the more entities the more you have to pay each year for the annual fees and those sorts of things I get the question sometimes Phil how many rental properties should I put into an entity before I setup a new one well I got this point to make once you start bringing in some real rental income from Rome properties you'll be able to answer that question yourself you put five into one LLC do you put one property per LLC my vote is actually depend on which state you're in move the property and do a land trust with a different name and in that way you can throw them all in the same LLC and when any time a somebody was trying to search to see how many assets you had and they were they were going through the county records they wouldn't be able to figure out who you know what you own because every single property is owned in a different name of a trust that's going into a different realm there as you can see but there's ways to get around that I think you should keep it simple with your entities because you're me filing tax returns on each one which does cost money I mean all these things are going to be expensive if you keep piling up too much complication that make sense but at the very very least you if you're going to both own rental property and be flipping make sure you have two entities that way you can avoid your rental property income being taxes ordinary income all right so having said all this what is the best legal entity for real estate investing obviously it depends it depends on what state you're in it depends on your you know what your situation is and how much money you're actually making that thing but in most cases for most real estate investors you can set up an LLC that's so easy to darn set up and by the way as it relates to paying people to set up your entities you want to talk to the attorneys and the accountants to get the information on which entity is set up the actual physical setting up sure you can hire somebody they're going to charge a three five nine hundred bucks I have set up so many in these over the years now you can just go online you just go to the Secretary of State I'm not giving you legal advice here but you can and you can just set this thing out pay the filing fee and be done with it I mean there's only like three checkboxes and a couple of fill in the blanks I mean it is so simple to set these things up and you get an EIN number from the from the the irs.gov website that takes you of all of three minutes I mean setting up entities is so simple knowing which entities to set up and use that's the part where you need these professionals because they just they know all the different angles okay all right well I hope this helps on understand which legal entities to set up if your first gain started you may just go the sold prior ship get you some liability insurance or you may set up your first LLC you know and and then you can always start as being taxed as a sole proprietorship and then change it to be taxes in this quarter later if you don't know which one to elect and you just get started and try something the nice thing actually we say one more big problem with the LLC the S quarrel was fun stuff if you're a traditional real estate investor which we don't talk about that much in my videos but you might be one of those on you have a very very big problem if you're going to a bank to get a mortgage banks are going to give you a mortgage but they're going to expect you to own the property in your personal name because if your name is the one that's on the loan they want that to match what's on the deed so there they won't even let you own the property in an LLC they'll make you own it in your personal name so I mean this happens all the time and it drives real estate investors nuts because you're like what I want to be in business in an LLC and so then they say well what I'll do is after I buy it I'll deed it into my LLC and now it'll be a mat well you can do that but then you just breached it the deed of trust anti oh that that clause in there that talks about not being able to change title not that the bank may do anything about it but I think the bigger lesson here is this if if you're going to be a traditional real estate investor you're gonna be using normal bank loans and they're going to expect you to become the owner well then just put everything in your in your personal name get liability insurance and then do all your flipping stuff out of an LLC or become a creative real estate investor whereby since no banks are necessarily involved you can move anything into an LLC which is that I've always done I've never gotten a bank loan to buy a rental property in my entire business career so I just always move on into an LLC and I take it over subject to I I do owner financing I become the owner but I can own it in an LLC right there I don't have to do any trickery I don't have to worry about owning a sole proprietorship all right well I'm Phil Bustillos with freedom mentor.com you can learn more about me and my website but also check out some more of my videos I hope you really like them I try to share what I've learned in the real world about this stuff and if you'd like to consider working with me more on a one-on-one basis I also have an apprentice program on my website you can apply it's an entire interview process and I work with some people across the country one-on-one I I I do deals with them and all that fun stuff all right I'm Phil I'll feel free to mentor thanks so much for watching

Channel: Phil Pustejovsky

Views: 298,679

Rating: 4.8949261 out of 5

Keywords: real estate investing, real estate investment, legal entities, Limited Liability Company (Organization Legal Structure), S Corporation (Organization Type), Sole Proprietorship (Job Title)

Id: VAv_jZWUL3I

Length: 18min 14sec (1094 seconds)

Published: Tue Dec 24 2013