Latest / Cash Flow for Life / Chapter 21: Business and Legal Formation
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- 00;00;00;05 - 00;00;24;16 Chapter 21 Business and Legal Formation. Now, before we get started, I want to be very clear that we are not tax or legal experts. We're going to give you some general guidelines and things to think about when you work with your tax and legal experts. Always, always get the proper tax and legal advice, no matter what you read out there, anywhere on the internet and including this book. 00;00;24;19 - 00;00;47;12 This isn't a long chapter, but it's an important one. You're serious about building your real estate investing business, as evidenced by the fact that you're reading this book and consulting with us. And heck, you've made it this far. Congratulations will be just as serious about how you structure your business entity. Our natural tendency is to want to keep things simple. 00;00;47;14 - 00;01;21;20 A simple business structure is a sole proprietorship with everything under our personal umbrella. It's okay to start this way, but you'll want to adapt as your business grows. Moving to some type of corporate structure is usually the goal for dealing with taxation issues. Reducing liability, protecting personal assets, and creating holistic retirement plans. The decision should be based on discussions with both your lawyer or attorney and your tax professional. 00;01;21;22 - 00;01;46;04 Putting off the decision or discussion for too long could result in higher costs. When you pass your properties to the new business entity, you can't really just wake up one day and wave a wand to convert all of your properties you've purchased as a sole proprietor to assets owned by your corporation. I mean, you can, but there's going to be sale transactions and there's going to be fees involved. 00;01;46;06 - 00;02;12;09 So be thinking about this corporate structure decision from the time of your very first property purchase. You don't have to do it. You don't have to actually have a corporation, but you have to think about it. And you have to understand the plan with your tax advisor. Yes, there's more paperwork and reporting involved in a corporate entity. So you may want to wait until you have a couple of positive purchases and know that you're going all the way with this business. 00;02;12;11 - 00;02;49;17 Let's look individually at the reasons for incorporating taxes. Corporations are taxed differently than individuals are and usually at a much lower tax rate. You can somewhat control how you pay yourself and how you take profits out of the company to minimize taxes. Liability. If you remain a sole proprietor and an accident at one of your properties results in a lawsuit by a tenant, your personal assets are at risk, including your personal residence, your personal bank account, retirement accounts, everything. 00;02;49;19 - 00;03;21;19 Incorporating can sometimes change that. The tenant can sue the corporation, but can attack only the assets within the corporation, not the actual shareholder, which is you. Your personal assets will not be involved or at risk. Retirement plans. There are certain retirement account types available to you as an individual and they're not bad. However, with the corporation, some of the corporate income can be put into matching funds for retirement accounts for employees. 00;03;21;20 - 00;03;51;09 Namely, you create a company and buy in the company name. Get the facts about available corporate structures that you may want to adopt. Go over all of the characteristics of each with your accountant and attorney. Do a comparison chart or t chart to make comparisons easy, especially in the area of taxation. Compare the management and reporting requirements and costs for each as well. 00;03;51;11 - 00;04;19;29 Look at how money can pass from the corporation to you from a tax perspective, as some can be dividends and some may be able to be salary. Look at the ways in which the corporate structure can create and contribute to leverage retirement plans. Keep in mind that corporate protection from liability for debt is slow to evolve. A brand new corporation will not be able to get mortgages without your personal guarantees. 00;04;20;02 - 00;04;49;04 So while you can protect your assets from lawsuits and accidents, you will still be standing behind the early debt of the company financially. One thing to always remember about corporate status is to not pierce the corporate veil. As they say, the protection afforded you in the corporate business structure is at risk. If you mix assets or don't purchase everything in the corporate name, you want to keep things completely separate. 00;04;49;07 - 00;05;18;16 In other words, if you're signing any document or opening accounts to purchase building materials, open them in the corporate name. Do this even if you have personally guaranteed the debt, because the corporation must do the purchasing. Also, all income in the form of rent checks must be made out to the corporation. If you take rent checks in your personal name or in other ways, mix personal identity in corporate transaction. 00;05;18;21 - 00;05;49;09 You risk piercing the veil and losing the protections of the corporation. The law considers the corporation and entity into itself, like a person. Getting the corporation confused with you personally. Can be misleading to those with whom you do business. Let's keep that in mind. Insurance. Regardless of whether you have a corporation or a sole proprietorship, you'll want to always purchase good insurance coverage for your company and properties. 00;05;49;12 - 00;06;14;25 Consult your lawyer or attorney and insurance agent to determine the types and amounts of liability insurance you need. This is very important. Property insurance is easy because you want to cover your company for the value of the property. Liability is a little trickier. You need to determine your risk exposure and try to buy enough coverage to protect you without going broke on the premiums. 00;06;14;27 - 00;06;41;23 Taxation. Your accountant must be involved here. Using a corporate structure allows you to allocate functions, income, and expenses to take advantage of the corporate structure to lower tax rates. The property management company can build a holding company for management services in the amount that creates the best tax result for each. Now be careful with this. You've got to still be within industry standards. 00;06;41;25 - 00;07;10;12 The acquisition company gets financing from the holding company, but picks up closing costs and other acquisition costs. How much might be passed upward to the holding company can be structured for tax advantages. Lawsuit protection. Visualize the lawyer your tenant hires to sue you because he sprained his ankle while running up and down the stairs chasing his. He'll have to hire help to sort through your corporate structure to see which entity has the assets. 00;07;10;14 - 00;07;36;02 Consider that it might not be the same entity that has the liability. When do you create a corporate structure? You may never go this far. Some investors don't, but we suggest that you consider it when you surpass about 15 properties or a certain level of income, as directed by your tax advisor. It's expensive to start and manage corporations, so you'll want to have enough in the way of properties and incomes to justify it. 00;07;36;03 - 00;08;05;14 Action steps. Learn about the corporate structures and the advantages and disadvantages of each. Make an appointment to discuss them with your accountant and also with your attorney. Take action when the timing is right. What's next? You're on a roll now, getting to the point where you're thinking about all those properties you'll own and manage. It's time to look at systems and methods to keep your business humming along without stressing you out.