I’ve set up a number of entities in my career, and here are 6 pitfalls to avoid when setting up your real estate entity.
Mistake #1: Not Educating Yourself About the Pros and Cons of Different Entities
In many cases, setting up an LLC will do just fine for real estate investing.
But not in ALL cases.
Do you know the pros and cons of LLCs, C-Corps, S-Corps, LPs, or LLLPs? No?
Well, you should.
Because not every situation is the same.
Maybe you’re the sole owner in your business for the foreseeable future. Or perhaps you want to create an entity that includes different investors. Or that can own multiple other entities. Or that will have employees and provide maximum tax savings and benefits.Each of these situations and objectives may require a different entity.
Mistake #2: Not Setting up the Entity From Day One
Should you set up the entity now even though you haven’t done a deal yet?
My answer is YES. You should set up your umbrella real estate investing entity now. Here’s why:
- You can reduce your taxable income IMMEDIATELY with any business-related expenses.
- You get the benefits of asset protection from day one.
- You look more professional if you’re acting as a business.
For these three reasons alone, it’s worth setting up your entity immediately. It’s cheap and easy to do if you know how.
Mistake #3: Not Maintaining the Entity
Most real estate investors who set up an entity fail to properly maintain the entity.
“Huh, you mean I need to do something to maintain the entity?”
Yup. You need to do things like have an annual meeting with minutes (even if it’s only with yourself) and document major decisions (like buying or selling a house) with resolutions (even if they’re only signed by you). Also, make sure you don’t do things like co-mingle business with personal funds, and make sure you sign documents as an officer of the company.
This is important to maintain the corporate shield that your entity provides to you. Otherwise, if you don’t and you ever get sued, it’s possible that the “corporate veil” can be pierced and you become personally liable (that’s very bad).
Mistake #4: Not Setting Up the Entity Yourself
Don’t pay an attorney $1,200 to set up a single member LLC. Buy a course or book that shows you how, and do it yourself. Keep your operating agreement to just a few pages.
Keep it simple.
Mistake #5: Not Knowing When to Hire a Professional
Having just said that, the opposite is also true. Don’t try to set up the entity yourself when an attorney should really do it for you. This gets back to mistake #1, not knowing about the different kinds of entities, what’s involved, and when to hire a professional.
For example, if you’re going to do something a bit more complex (like have investors in the deal), definitely have the attorney involved in crafting the operating agreement.
Mistake #6: Setting Up the Entity Too Early
If your plan is to purchase apartment buildings, for example, you’ll most likely want to have each property in its own entity. Many newbie multifamily investors make the mistake of forming “123 Main Street LLC” too early, and then the deal never goes to closing.
Time and money are wasted.
Instead, sign a contract with “Entity TBD” or “Your LLC Name or Assigns.” When you’re done with due diligence and you’re sure you’re going to move forward, THEN have the attorney create the LLC.
The first step in avoiding mistakes when setting up your entity is to educate yourself about the pros and cons of the different entities.