How to Choose the Right Business Structure for Real Estate Ventures

So you’ve got a hankering to establish a real estate business, but you’re not taking action because you aren’t sure how to structure such an endeavor. There are so many options it can paralyze the uninformed with indecision.

Rather than resign yourself to letting this remain a pipe dream, stick around and learn about a few key routes, from FLPs and LLCs, which are worth exploring.

Understanding Family Limited Partnerships (FLPs)

If you’re eager to both invest in real estate and make this your business, the first notable structure to consider in your quest to build a successful real estate operation is the Family Limited Partnership (FLP). Let’s break down what makes FLPs an appealing choice.

What Is a Family Limited Partnership?

An FLP consists of two types of partners:

• General Partners: These individuals manage and control daily operations.
• Limited Partners: These individuals have no managerial authority but hold ownership interest.

It’s equivalent to running a family-owned restaurant where parents make decisions, while children own shares but don’t handle day-to-day tasks.

Key Advantages

Why should you consider an FLP for your real estate venture? Here are some compelling reasons:

Tax Benefits

FLPs offer significant tax advantages:

• Gift Tax Exclusion: Transfer property interests as gifts without triggering hefty taxes.
• Valuation Discounts: Real estate holdings within an FLP may qualify for valuation discounts, reducing overall tax liability.

In simpler terms, it’s adjacent to getting items on sale at checkout, as your total decreases even though you’ve bought substantial assets. There are other approaches to saving taxes on property deals, but FLPs still make sense for some.

Asset Protection

With FLPs, you can protect family wealth effectively. This is chiefly achieved by ensuring that creditors face challenges in seizing partnership interests due to the aforementioned limited partner restrictions. With the median household having $166,900 in assets, this is no small sum to defend.

Practical Implementation

Here’s how setting up and maintaining an FLP typically works:

1. Draft a Partnership Agreement: Clearly outline roles and responsibilities.
2. File Formation Documents: Submit necessary paperwork with state authorities.
3. Maintain Compliance: Keep detailed records, and adhere strictly to regulatory requirements.

Challenges

No structure is perfect, so you need to be aware of potential downsides too. The biggest stumbling block is the complex setup process. Initial formation involves intricate legal steps that will require professional assistance.

The Benefits of LLCs in Real Estate Ventures

Limited Liability Companies (LLCs) have become increasingly popular among real estate investors. They blend flexibility, protection, and simplicity, making them a go-to choice. Let’s explore why understanding the differences between an FLP and LLC will help you settle on the right structure for your real estate endeavors.

Flexibility in Management

Unlike more rigid structures, LLCs provide management versatility. There are two main options here:

• Member-Managed: All members participate in daily operations.
• Manager-Managed: Designate specific managers to handle business activities.

With more than 2.4 million LLCs nationwide, it’s obvious that this selling point of managerial flexibility is a major one.

Strong Liability Protection

Another significant perk of forming an LLC is shielding personal assets from business liabilities. The basic idea is that by ensuring that the owners’ personal finances remain distinct from company debts and obligations, entrepreneurs and investors will be more willing to innovate and take risks, rather than making conservative business decisions.

While plenty of LLCs fail, with BLS data showing that this fate befalls 20% in the first year alone, the idea is that the economic benefit is a net positive in the long term.

Favorable Tax Treatment

LLCs offer beneficial tax options that can suit different investment strategies:

• Pass-Through Taxation: Income generated by the LLC passes directly to owners, avoiding double taxation. Profits are reported on individual tax returns.
• Elective Tax Status: Choose how you want your income taxed based on business goals. You might for the default option, being taxed as a Partnership or Sole Proprietorship, which allows for a simplified filing process. Alternatively you can opt-in for S Corporation Status for potential self-employment tax savings.

Easier Formation and Compliance

Forming an LLC usually involves fewer hurdles compared with other entities such as corporations. These are the steps:

1. File Articles of Organization: Submit basic formation documents with state authorities.
2. Create Operating Agreement: Outline governance procedures.
3. Annual Reporting: Maintain simple yearly compliance tasks.

LLCs are a lot more common than FLPs in part because there are fewer hoops to jump through to get them off the ground, as you can see.

Read more: What is a personal real estate corporation

Decision-Making Power and Business Structure Choice

Choosing the right business structure for your real estate venture can significantly impact decision-making processes. The level of control and decision authority varies across different structures. Let’s dissect how these dynamics play out in various setups – introducing some new options while reinforcing what we’ve already learned about FLPs and LLCs to give more context.

Sole Proprietorships: Absolute Control

In a sole proprietorship, one person calls all the shots. With complete autonomy, you can make decisions swiftly without consulting partners or boards.

Partnerships: Shared Decision-Making

Partnerships split responsibilities among partners, influencing how decisions are made:

• General Partnership: All partners engage actively in daily management.
• Limited Partnership (LP): General Partners handle management while Limited Partners contribute capital but don’t manage.

Family Limited Partnerships (FLPs): Family Dynamics at Play

FLPs involve family members sharing control based on their roles:

• General Partners: Typically senior family members lead operations.
• Limited Partners: Younger generations owning shares without active participation.

LLCs: Flexible Management Structures

LLCs offer customizable management frameworks suited to specific needs:

• Member-Managed: All members have an equal say, ensuring collaborative decision-making. This is suitable for smaller ventures where everyone’s input is valuable.
• Manager-Managed: Designated managers oversee operations, providing streamlined leadership. Managers execute daily tasks while other members focus on strategic aspects, so it’s ideal for larger enterprises needing clear hierarchical oversight.

Corporations: Hierarchical Decision Authority

Corporations establish structured governance with defined roles that influence decision power distribution significantly:

• Board of Directors: Elected by shareholders to make high-level decisions.
• Officers/Executives: Handle day-to-day operations under board guidance.

The Last Word

It’s all well and good to have information on FLPs, LLCs, and other business structures at your fingertips. Now you need to act on what you’ve learned, ideally with the guiding hand of a legal professional with relevant business experience behind them, so that the foundations of your real estate venture are built firmly as opposed to being prone to erosion.

Written by Billy Guteng. June 20, 2024

Billy is a content writer for Kukun. He was born in France, and has lived in multiple cities around the world ever since. He loves art, design and architecture as well as construction and real estate.