Legal Structures for Real Estate Investments. Real Estate Boot Camp July 18-19, 2014

Transcription

1 Legal Structures for Real Estate Investments Real Estate Boot Camp July 18-19, 2014

2 Introduction 2 1. Overview of Legal Entities 2. Limited Liability Companies 3. Virginia Business Trusts 4. Tax Considerations 5. Multiple Entity Structures 6. Out of State Properties

3 Types of Legal Entities Corporation LLC Partnership Business Trust ( Series Entity ) Sole Proprietorship (Not a Legal Entity) Land Trust (Also Not a Legal Entity) 3

4 Why Use a Legal Entity? Many people concentrate on taxes Better reason: reduction of risk In the event of liability, protect personal and other business assets Insurance is important, too When you jump out of an airplane, wear a belt and suspenders. 4

5 Requirements of an Entity By Law (Corporation) or Agreement (LLC) the entity must do certain things. Failure to do these things may wipe out liability protection the entity provides Piercing the corporate veil 5

6 Formalities of the Entity Corporation annual meetings, annual report, by-laws, stock certificates statutory requirement LLC Operating Agreement is the Contract that governs entity (along with Articles of Organization and statute) Business Trust similar to an LLC (Declaration of Trust instead of Operating Agreement) Renew annually with the State Corporation Commission Each Entity needs a Registered Agent 6

7 The Importance of Formalities To ensure your legal entity is respected: Sign in the name of the entity - Complete and exact, including LLC or Inc. Officers use titles when signing Keep separate bank accounts Keep separate books and records Document transactions Transactions between entity and owner at arms length 7

8 Limited Liability Companies Flexibility Low Maintenance Liability Protection 8 Virginia is one of 13 states that protects the assets inside an LLC from a charging order Judgment creditors of a member (owner) are only entitled to the member s distributions Creditors cannot foreclose on the LLC s property

9 Virginia Business Trusts A cutting-edge entity for protecting multiple real estate investments Not like an estate planning trust or land trust Separate legal entity like a corporation or LLC Multiple liability baskets ( Series") within a single entity Each property is isolated from the others for protection, unlike an LLC or corporation Similar to Series LLCs (Delaware, Nevada) 9

10 Business Trust Formation Articles of Trust filed with the SCC (like LLC or corporation) Governing Instrument - the contract that controls the trust (like an LLC Operating Agreement) Governed by Trustees (like a corporate board of directors) Owned by Beneficial Owners (like shareholders) Trustees may appoint officers, (like corporate officers or the manager of an LLC) Series are authorized in Articles and Governing Instrument 10

11 Business Trusts Series To help ensure liabilities and claims are isolated, make sure each series: Is adequately capitalized Has its own name to put creditors on notice Has separate financial statements for each series Signs all contracts, deeds, notes in the name of the series Transactions between series are arms -length, at fair market prices and properly documented Do not comingle funds of different Series (banking issues) 11

12 Business Trusts Risks The Series Entity not yet widely used Tax treatment has not been fully resolved Its effectiveness has not been tested judicially More predictable asset segregation with multiple entitles May be suitable for those who have decided that the costs to file and maintain multiple entities are not justifiable 12

13 How it Works Business Trust Form Business Trust (Articles, Governing Instrument) Locate target property Form new Series (a Series Addendum to Governing Instrument) Purchase Contract S/B in name of the Series, be assigned to the series or deeded in later Close in name of Series Main Street Series of ABC Business Trust Contracts involving property in name of Series (construction contract, lease)

14 Tax Considerations - Corporations C-corporations pay double tax, which can be a serious problem when appreciated assets are distributed S-Corporations have limited flexibility in making special allocations of profits, losses and liquidation payments 14 But S-Corp pays owners a salary (subject to Social Security Tax) and pay dividends (income tax only) IRS requires the salary to be reasonable or dividends will be subject to Social Security Tax too ($1/year won t cut it)

15 Tax Considerations LLC & VBT LLCs and Business Trusts are Disregarded Entities for tax purposes 15 Multiple owners - taxed as a partnership, C- or SCorporation Partnership taxation is usually recommend for most real estate holdings Business Trust with multiple can be taxed a partnership, but this is not 100% clear in all cases If one owner or married couple, Form 1040 Sch C or E (no separate tax return for Entity)

16 Taxation of Investors and Dealers Taxation of Entities holding real estate depends on level and type of activity. In general: 16 Investors income considered passive Gains are capital gains Operating losses not deductible against other income No Social Security Taxes Dealers (Flippers) treated as a trade or business Gains are taxed as ordinary income, not capital gains Operating losses offset other income Social Security Taxes on all income

17 How it Works Buy & Hold For a small investor with only rental property, one Legal Entity may be one too many Deed property to a legal entity triggers lender s due on transfer clause Up to 5 properties with conventional mortgages can be held under your individual name Buy an umbrella insurance policy! But understand your personal assets are exposed and weigh the risks! 17

18 How it Works Fix & Flip For Flippers, you have a Hot business Lots of activity concentrated in a short time period different risks than investors One Legal Entity for all transactions? Protects your personal assets but all assts in the entity are exposed to claims But beware of ghost liabilities Separate LLC for each flip? 18 Can get out of hand and eats at profit margins Virginia Business Trust can isolate risks in separate Series

19 Multiple Entity Structures Owners of multiple properties can obtain additional liability protection Only assets owned by a specific Entity are subject to claims against that entity Separate business liabilities and claims (hot) from high-value real estate (cool) Have arms-length agreements in place between entities and individuals ( rent from yourself ) 19

20 How it Works Integrated Business Some investors flip, rent, manage renovate, and hold a realtor or broker license Isolate separate risks in multiple separate Entities Make sure you follow formalities Separate Contract books and records with correct Entity Arms-length 20 intercompany agreements

21 How it Works Integrated Business Joe Blow Jane Doe Blowdoe Management, Inc. (S Corp) Management Agreement (Bank Account) Blow Contractors, LLC Blowdoe Investments (VBT) Doe Real Estate Sales, LLC Blowdoe Properties (VBT) Rehab Contracts (Pay Rents) 123 Main Street East Avenue 789 South Dr. 987 Fixa Way 654 Flip Lane

22 Land Trusts A Land Trust is another way to hold real estate: Agreement between Trustee and Beneficiary creates Land Trust Privacy Trustee holds legal title on the Deed, Beneficiary s name can be disclosed only by court order Beneficiary: Has power to direct the Trustee regarding the property management, sale, lease, operation Beneficial Interest is personal property Creditors of Beneficiary cannot place liens on the property (but can reach beneficial interest if known) Beneficial interests can be transferred easily 22

23 Land Trusts Opportunities 23 Beneficiary has tax advantages of property ownership Opportunities to acquire properties anonymously Legal entities can be Trustee or Beneficiary to further shield them from liability May be used creatively to create co-tenants, JVs or subdivide properties

24 Out of State Property Need to register Entity in other state (e.g., Florida) if you are doing business there (collecting rent) Additional expenses every year (VA and FL) VA law may not be the same as other states (Series Entities) Usually safer and no more expensive to form a local Entity (may cost less) Business 24 Trust Series owns Florida LLC

25 Summary Become familiar with Entities and pick best Follow the formalities Separate risks from valuable assets Watch the tax considerations Manage, don t do hire professionals 25

26 Questions? 26

27 My Background DAVID J. STOYANOFF has over 30 years of business experience, most recently in the positions of Assistant Vice President of Compensation and Benefits, and as Senior Tax Counsel, both for CSX Corporation. He was admitted to the Nebraska State Bar and the Virginia State Bar, and the U.S. District Courts of Virginia and Nebraska. David is a graduate of Wayne State College and received his J.D. from the University of Nebraska College of Law. He is also a CPA. 27

28 Contact Information David J. Stoyanoff Torus Law, PLC 3741 Westerre Parkway, Suite D Richmond, Virginia Phone: Fax: David@Toruslaw.com 28