Invest Like a Pro: Setting Up a Business Entity for Real Estate
When you start applying for your first loans as a new real estate investor, you’ll hear a lot of advice. One piece to seriously listen to is to create a business entity — an LLC or a corporation — to hold your investments.
Why? Because setting up a business entity helps protect your personal assets. When you start applying for loans for your real estate project — like a hard money loan — having a business entity is a great way to establish credibility with potential lenders.
How to set up a business entity
Here are some basic steps in setting up a business entity to apply for a hard money loan.
1. Choose an entity type
Limited liability companies (LLCs) and corporations are the most common entities you’ll find to create.
Benefits of choosing an LLC
An LLC offers the same security from legal liability as a corporation but with the tax advantages usually found with partnerships or single ownerships. LLCs are a popular choice for small businesses because they provide personal asset protection and tax benefits while also allowing for more flexibility and control over the company's management and operations.
Members of an LLC are not held personally responsible for any financial obligations or debts incurred by the business. This means that your personal property and assets are typically protected if your business gets into any legal questions or debt.
LLCs are also easier to set up and maintain than corporations. Taxation will depend on your needs and goals: LLCs be taxed as a partnership, an S corporation, or a C corporation.
Benefits of choosing a corporation
Like LLCs, corporations provide limited liability protection to shareholders, meaning personal assets are typically protected if the corporation faces legal action or debt. Corporations can exist in perpetuity, meaning they can continue to operate even if the ownership or management changes in the future.
One benefit to a corporation is that you can raise capital by selling stock, which can be an attractive option if you are seeking alternative ways to raise a significant amount of money to invest in your real estate portfolio. In addition, corporations often have a more formal structure and are more widely recognized than other types of business entities. Depending on your size, this can lend credibility to your company and make it easier to do business with other companies, customers, and investors.
When it comes to tax advantages, corporations can deduct certain expenses, such as salaries and employee benefits, which can reduce their taxable income. Additionally, certain types of corporations, like S corporations, can avoid double taxation by passing profits and losses through to shareholders' personal tax returns.
Keep in mind that corporations may involve more administrative and legal costs than other types of business entities, so it's important to consult with a lawyer and tax professional to determine if a corporation or LLC is the right choice for you.
2. Register your entity
You must register your entity and new business name with your state's business registration office. Registration typically involves filing articles of organization — also known as articles of incorporation — and paying related fees. The fees vary from state to state and can range from $50 to as much as $650 for an LLC or up to $900 for a corporation.
3. Obtain a tax ID number
Your entity will need a tax ID number, also known as an Employer Identification Number (EIN), which you apply for through the IRS. The good news is that applying for an EIN is free!
4. Open a business bank account
Once you have your tax ID number, you can open a business bank account in your entity's name. If you find a bank separate from where you do your own banking, you can keep your personal finances separate from your business.
5. Find a hard money lender
Hard money lenders like Kiavi offer short-term loans secured by a property’s value and equity instead of your personal assets and credit profile. Hard money loans are great for business entities because they help new investors establish creditworthiness.
Why hard money? Here are three benefits.
Hard money loans are typically used to finance real estate investments by developers, rehabbers and house flippers. Investors looking for investment properties love hard money loans for a few key reasons:
Faster funding
Hard money loans are usually approved and funded faster than traditional bank loans, which can take weeks or even months to process. Hard money lenders make decisions quickly based on a property’s value and income potential.
Flexible terms
Hard money loans typically have more flexible terms than traditional bank loans. The loan amount, interest rate, and repayment schedule can often be negotiated, making it easier to customize the loan to fit your needs.
Short-term financing
Hard money loans are typically short-term loans, usually lasting one to five years. This can be beneficial if you need financing for a short period, such as for a renovation project or to bridge the gap between purchasing and selling a property.
Final Thoughts
Setting up a business entity such as an LLC or a corporation for your real estate investments is crucial to safeguarding your personal assets and establishing credibility with potential lenders. LLCs and corporations offer unique benefits, so it's essential to consider your specific needs and goals before making a decision.
Once your entity is registered and operational, hard money loans provide an excellent financing option for real estate investors, offering faster funding, flexible terms, and short-term financing suited for various projects. By investing in real estate through a business entity and leveraging hard money loans, you'll be well on your way to investing like a pro and growing a successful real estate portfolio.