WHEN IS A REAL ESTATE HOLDING COMPANY REALLY NEEDED?

When real estate investors decide if it is necessary to form a separate holding company or “ownership entity” to own their real estate, there are several questions they should ask themselves. The ultimate goal in making your decision should focus on what impact an ownership entity will have on your bottom line.

While there are several aspects of formation to consider when determining when to form an ownership entity, this article will address five (5) of the most important considerations that you should contemplate:

1. Do you have enough equity in the property to warrant the formalities associated with forming an entity?

When viewing the different aspects of holding a piece of property in your own name versus an ownership entity such as a partnership (limited or general) or a limited liability company (LLC), you should consider how much equity you have in the asset vs. your liability. If you have little to no equity, it may not be worth forming an ownership entity as you may have plenty of insurance coverage that offers you the same protection you could obtain from an ownership entity. Additionally, you’ll want to consider the formalities associated with the formation of an ownership entity and the formalities associated with keeping the entity in compliance with the law. Such formalities include paying annual fees based on gross revenues and minimum taxes. If the benefits of forming the entity do not outweigh the hassle of formation, you may not be ready to form an entity.

2. What are your tax objectives of ownership?

You must determine what your long-term goals are for your property. How long will you hold your property? Do you intend to hold your property long term or liquidate it right away? If you intend to liquidate the property in a fast turn around, you may not be able to maximize the tax benefits of formation. However, if you intend to hold the property as a long-term investment or turn the property as part of an exchange, it may be an appropriate property to place in for an ownership entity.

It is also important to consider whether your property is generating profits or losses. The more profitable your property is, the more fees you will be required to pay.

3. Does your lender have specific requirements for lending?

Some lenders require an ownership entity to own a single asset for a single purpose. For example, some lenders require that if you own an income property via an LLC, that the LLC own only one property. This keeps the debt to income ratio manageable and the liability known to and controllable by the lender. Therefore, it is important to know the requirements of your lender prior to holding more than one property per ownership entity.

4. Can an ownership entity provide a collateral agreement between co-owners to prevent future uncertainties?

Buy-Sell agreements are agreements used when multiple owners own property together and form an ownership entity. Buy-Sell agreements can take away the lack of control and surprise that can arise due to the death, disability, withdrawal, and possible expulsion of co-owners of property. This may be one reason for forming an ownership entity and may be a basis for securing an agreement to hold property with a co-owner. While co-ownership agreements may be an effective tool for handling agreements between co-owners, Buy-Sell agreements, are an effective tool to control activities between co-owners in an ownership entity. These agreements can also avoid the infiltration of outsiders into the ownership of your property.

5. Can an ownership entity provide better protection for multiple owners?

Ownership entities can often provide better protection for multiple owners of a property. While there are certain protections that can be provided by a well-drafted co-ownership agreement, certain protections can also be achieved by way of an ownership entity. An ownership entity such as a partnership or LLC can provide limited powers for co-owners so every owner knows exactly what the other owner can and cannot do. This protection allows each owner the comfort to know that a co-owner is not able to leverage the property without the others knowledge.

Your considerations may change once you begin to own multiple properties. When you own multiple properties, you may compartmentalize your liability by forming multiple ownership entities. Forming multiple entities, each with a single property provides a cap on liability at that equal to the value of the property owned by the individual entity.

If you own investment property and you are concerned about or would like to discuss your potential liability, contact your legal professional to investigate an ownership entity that will be right for you.

This web site is designed for general information only. The information presented at this site should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.

Law Office of Cristi L. Michelon | 132 E. Figuero Street | Santa Barbara, CA 93101 | (805) 882-2226 / (805) 882-2227 (fax)