Structure of the Real Estate Property You Manage in Fayetteville, North Carolina
Today we going to discuss the difference between a corporation and a limited liability company when you are thinking about which structure to use for your real estate investment company, in Fayetteville. As a Fayetteville property management company, we get asked a lot of times by individual home owners, as well as investors with multiple properties, which kind of company should they form to manage their own property.
There’s a ton of information about forming either one of them, and which one is better. To be honest, this can get really confusing to the average person. Even with your own independent research, it still can lead you to have doubts about which structure is best for your real estate investment company.
You may constantly ask yourself if you should form a real estate company for rental property investment. As property managers in Fayetteville, we will tell you, unequivocally, yes you should. What it boils down to exactly, is what do you want for your company, how you want it to be managed, and where do you see your growth happening.
Let’s start off with how you would like to have your company controlled. First, we’ll talk about the corporation.
In a corporation, you have directors and officers that form the basic leadership structure. These two parties work as the administrative heads, that will run the business. If you are an individual investor, then you will be the one responsible for filling all of these roles. In a corporation, as an individual investor, you are constantly deciding which hat you are wearing, and whether you need to make a resolution to make a particular decision in order to enact that particular decision.
Conversely, in an LLC you have managers, and sometimes members who also serve in a management role. With an LLC, the management of the company is clear. If you are listed as the manager in your LLC, then the control and decision making is centralized with you, and the decisions you make are as the manager of the business. In terms of ease of running a business during day to day operations, an LLC is going to have a definite advantage over a Corporation from a control and execution standpoint.
Operationally, in a corporation, everything is driven by bylaws, and resolutions. These documents explain what each party can do, and also lays out their responsibilities. They also explain how shares are issued out, how you hold meetings, and the operations of the company. Everything within running the corporation should be extremely detailed.
Conversely, in an LLC, you use an operating agreement. The operating agreement can more or less be thought of as a contract between two real estate investors. You set up the expectations of each member of the real estate group, and if a party doesn’t meet those expectations, it is laid out in the operating agreement what the remedy is to the other party.
For example, let’s say you spell out the work requirement of one of your partners. She has to bring in 5 properties a month for evaluation of purchase potential. Your job is to facilitate the rehab of the properties. If your partner does not meet their requirement, how do you address this?
With an LLC, you can get to the micro of the terms of the agreement. If your partner doesn’t meet the terms of the agreement, then there is a reduction in the ownership or the profits. This fluid nature is what makes it best for the way a small real estate investment group should operate. You simply don’t have the same flexibility with a corporation, with the documents used in the formation and management. The corporate structure, although it does have many pros, makes it much more difficult to structure a business around expectations, especially when bringing in outside parties.
An LLC is a much better way to go, especially when it comes to profit sharing. With an LLC, you can spell out in your operating agreement how profit splits are going to take place. With a corporation you aren’t going to have the same structure. Profits will either be paid out as a salary, or as a dividend. The end result may appear to be the same, but it is much more complicated to achieve the same result.
In terms of actual ownership, in a corporation you have shares, in an LLC you have membership. In a corporation, you have shareholders, which mean they own “stock” in the corporation. The shareholder in a corporation has relatively no rights aside from a fiduciary duty to the corporation.
When you are a member of an LLC, you have certain duties that are given to you in your operating agreement, which spells out exactly what you are supposed to do. Your operating agreement also spells out conditions that require member approval. For example, if you are going to sell 35 percent of the assets of your LLC, then it might require member approval. This gives members some degree of control over how the business is managed in order to protect their interests. Conversely, in a corporation, shareholders are not going to have the same level of control.
Where ownership decisions really come into play, is when you are looking at bringing in outside people for a capital investment. When you bring outside individuals on, you want to make them feel as comfortable with their investment as possible. You can create a separate LLC from your parent LLC, with the sole purpose of bringing in investors for a particular deal, or deals, and structuring the operating agreement to make the investors at ease. Once the deal is done, you can keep the LLC in place for future deals, or dissolve it.
The next topic is asset protection. In a corporation, shares are not protected from creditors. In an LLC, assets can be protected by way of charging order protection. What this means is that if you are sued individually, your shares in a corporation may be taken from you. As a result, you could lose all your shares, and by necessary consequence, your assets.
In an LLC, if it is set up correctly, and in the right state, you could have full charging order protection. What this means is, if you get sued individually a creditor cannot take your interests from you. Your assets are protected from creditors. This protection is a huge advantage of an LLC over a corporation. Why would you possibly want your assets exposed. You can run your business, and not worry about potential creditors.
The next issue is taxation. With a corporation, you can elect to be taxes as a C or an S Corp. A C Corp acts as a standalone taxation entity, meaning that entity is taxed in it’s own tax bracket. An S Corp has a tax flow through tax structure. With an LLC, you can choose to be taxed as C, S, Partnership, or disregarded, so you can decide the best way to set up your LLC for tax purposes. The biggest benefit being the flexibility you get in formulating and choosing how exactly you want your business entity taxed, whereas in a corporation you are limited to either a C or S Corp.
There are many advantages to choosing an LLC over a corporation when you are structuring your business. There are also some advantages to choosing a corporation, which we will dive into fully in our next blog.
Until then, if you have any questions for us, or need assistance managing your property, don’t hesitate to reach out
The Team at Linchpin Property Management
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