A real estate holding company is designed to reduce an investor’s personal exposure to the risks and liabilities inherent with owning investment property. Commonly referred to as real estate LLC’s, holding companies also isolate income from a property or specific properties, simplifying bookkeeping and taxes. Starting a real estate holding company is recommended for most investors.
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How to Start a Real Estate Holding Company in 6 Steps
Starting a real estate holding company is generally pretty simple and inexpensive. While a number of business structures are appropriate for a real estate holding company, (S corp, C corp, sole prop, or LLP) a real estate LLC is the most common. It doesn’t require a lot of administration, and you can manage it yourself as a managing member of the LLC or you can designate a manager. You can set up the real estate LLC online or with the help of an attorney.
Here are the six steps to starting a real estate holding company:
1. Set Up the LLC for Your Real Estate Holdings
You need to set up the LLC that you’re going to put your properties in. Part of this setup process includes choosing a name for your holding company. You also need to register it with your state, register it with the IRS, and receive an employee identification number (EIN).
Keep in mind that the name of your business can’t be the same as any other LLC on file in your state. The business name must end in LLC, Limited Liability Company, Ltd, or some variation that shows the type of entity it is. Each state has its own LLC office, and it’s generally associated with the Secretary of State’s Office. You can call them, or it may be possible for your lawyer to check online to see if a name is already being used.
File Paperwork for Your LLC
We recommend working with a real estate attorney because specific paperwork is needed for an LLC. However, if you use Rocket Lawyer, they will give you a list of paperwork to file with instructions on how to do so. Generally, you need to get your EIN number first; the order in which you create articles of incorporation and an operating agreement doesn’t matter.
You will need the following documentation when you form an LLC:
You can apply for an EIN number online on the IRS’ site. It gives you directions for applying. Basically, you can apply online if your business is located in the United States or its territories. You usually get your EIN number immediately, as soon as you apply. You will then need this EIN number for the rest of the LLC filing process.
Articles of Incorporation
The articles of organization are generally filed at the Secretary of State’s Office, sometimes referred to as the state’s LLC filing office. You can find the office information on your state’s website. It’s a simple document that usually lists the company’s name and address. Some states also list the members of the LLC.
An LLC can have one member or multiple members, and these members will be listed on the LLC operating agreement. This operating agreement defines the roles of each of the members, and should be signed by each member. You can get the sample form from an online legal form service like Rocket Lawyer, your attorney, or an office supply store.
An LLC operating agreement should include:
- Ownership and operations rules
- Members percentage interests
- Members rights and responsibilities
- Management duties
- How profits and losses are handled
Once you have your business entity established, many people assume the next step is to transfer ownership of a property to it. But to reap all the benefits of a holding company, there are actually a few more steps you can’t afford to miss. This is especially true if you’ve yet to purchase the real estate that will be held by your new real estate LLC.
2. Open Separate Checking Accounts
It’s important to have separate personal and business checking accounts to keep your real estate LLC funds separate from your personal funds. This better protects the owner’s assets and helps with bookkeeping. It can also help you track your business purchases.
Another benefit of opening a separate checking account for your real estate LLC is budgeting your funds and preparing for tax time.
3. Choose a Professional to Work With
You may want to hire a professional to help you set up the LLC, especially if it’s your first one. This helps cut down on time and limits your liability, since a professional is doing it for you.
Usually, investors use a real estate attorney in their state to set up the real estate holding company. However, some investors prefer to do it themselves.
Pros and cons of working with an attorney to set up your holding company include:
- Streamlined process
- Professional who knows the state laws and is familiar with the filing process
- All paperwork is filed for you and you don’t need to purchase templates
- You don’t need to worry about paying separate fees
- Less time consuming since the attorney handles the entire process
- More expensive; an attorney is usually three times or more expensive than setting up the LLC on your own
- You have to spend time finding a reputable attorney
- You’re depending on someone else to correctly do everything for you within IRS and state guidelines
If you choose to work with a real estate attorney, ask a friend, family member or other real estate professional for a referral. Ask for the professional’s credentials and look at their website (including their customer reviews) and make sure they’re familiar with real estate law in your state.
4. Find a Property & Get It Under Contract
The main goal of establishing the real estate holding company is to use it to protect your personal assets and your properties, so it’s important to know how to find and purchase investment properties. You want to find a property that fits in with your investment goals and your budget.
Once you have a real estate LLC set up, you can fix and flip a property. Generally, a fix-and-flipper usually wants something that they can fix up and build sweat equity in by rehabbing the house and updating kitchens, bathrooms, etc.
However, a buy-and-hold investor looks more at the long-term earning potential of the property and wants to know how much they can get for renting out the property. They also want to choose an up-and-coming or stable neighborhood, where property prices continue to steadily increase and the value of their real estate investment goes up.
Before you get too deep into the property hunt, you will want to choose a lender and get a pre-approval letter. This pre-approval letter is needed to look at properties with a real estate agent and is needed before you can make an offer on a property (unless you’re paying cash).
For more information on choosing a neighborhood and narrowing your property search down to one property, check out our guide to buying a multifamily property. It also outlines the steps for choosing your lender and getting pre-approved.
5. Secure Financing for Your Rental Property
You’re already pre-approved, so now you need to finish the lender’s application process. During this time, the lender will carry out something called underwriting, where they thoroughly check the information on your loan application as well as your supporting documents.
Some of the required documents include:
- Complete mortgage application
- Purchase contract
- Documentation showing where down payment is coming from (e.g., a gift letter)
- Property details
- List of current assets and liabilities
- Rent roll, copies of leases
They will also verify the property information and order an appraisal, which you pay for out of pocket and is generally $300 to $500. An application fee is another cost that some lenders charge.
Lenders generally have different funding times depending on the type of loan, but usually, a hard money loan funds within 15 days, a conforming loan closes within 30 to 45 days, and a commercial loan can take up to 60 days to close.
6. Close on the Property
The last step to starting a real estate holding company is closing on the property.
This closing is when the deed to the property switches names and the new owner gets the keys to the property at something called a settlement. This usually takes about 60 to 90 minutes and is generally conducted at a title company or real estate agent’s office.
Prior to closing, you will have your financing in place and the mortgage company will give you a copy of your closing costs, so you know what to expect at settlement. You will be required to bring certified funds, your identification, proof of property insurance if you’re financing the property, and your checkbook for any additional expenses.
A closing is the same regardless of whether you are purchasing the property in your name or an LLC’s name. The proceedings are the same but the required paperwork is different. For example, the title company will need a copy of your articles of organization and your operating agreement to verify the members of the LLC. This is mostly done to prevent fraud.
The deed and all of the closing documents will be in the LLC’s name. This means that when you get the utilities switched over, they will also be in the LLC’s name. Keep a copy of your LLC documents handy because you will need them and your identification to show that you are authorized to sign on the LLC’s behalf.
How a Real Estate Holding Company Works
A real estate holding company protects investors by legally placing the real estate property contract, the deed, and the mortgage in a separate entity (usually an LLC). The investor then owns the LLC and the LLC owns the investment property. Done correctly, this ownership structure protects the individual against legal liabilities related to the properties.
There are multiple ways to structure a real estate holding company. These entities include an LLC, an S corp, a C corp, sole proprietorship, or a partnership. An LLC is the most popular entity to use for a real estate holding company because it’s simple to administer but still gives you all the liability protection and personal separation a corporation can give you. It’s also easy and relatively affordable to set up.
When you purchase a property, the real estate contract, the deed, and the mortgage will be in the LLC’s name. The LLC owns the properties and the investor(s) own the LLC. If the investor owns the properties in his/her own name, they’re exposed to more liability. They’re also mixing personal and business funds, which makes tax time more difficult and they’re not entitled to the tax breaks an LLC receives.
For example, if a tenant slips and falls on one of your investment properties that’s in your personal name, the tenant may sue, win and be entitled to a settlement from your personal funds. However, if that property was in an LLC, the tenant may sue the LLC and it won’t affect your personal finances.
It doesn’t matter if you’re a fix-and-flip investor or a long-term investor, it’s a good idea to put all of your investment properties in an LLC for that added protection. Some investors use one LLC for each property, but that can get costly and time consuming, so it’s generally fine to have multiple properties in one LLC. However, if you own properties in multiple states, each state should have its own LLC because laws and taxes vary per state.
Real Estate LLC Taxes
You will need to pay taxes on your LLC; if it’s a one-member LLC, the IRS treats it differently than an LLC with two or more members. A one-member LLC is generally treated as a sole proprietorship for tax services. Assuming that there are more than two members in your LLC, then the taxes pass through the LLC onto each member’s personal tax return in the format of profits and losses.
The LLC doesn’t pay any federal income taxes, but some states do apply annual LLC taxes. Instead, the members fill out a Schedule E on their tax returns. Each member is also taxed on their share of the LLC’s profits as outlined in the operating agreement. Taxes surrounding an LLC can be complicated, so we suggest consulting with a tax professional.
Who a Real Estate Holding Company Is Right For
A real estate holding company is generally right for both long-term and short-term investors. It’s generally recommended for all real estate investors because it protects your personal assets from the liability of owning property and it keeps your real estate income separate. It’s a fairly inexpensive company to start and doesn’t need much management, so the benefits outweigh the costs and commitment.
A real estate holding company is right for:
- Fix and flippers
- Buy-and-hold investors
- Residential real estate
- Commercial real estate
- First-time investors
A real estate holding company usually isn’t right for you if you are just purchasing a home as a primary residence. An LLC can be costly to set up and maintain, so it’s generally fine to keep your primary residence in your personal name.
“A real estate holding company is right for investors who want to have legal protection for their assets and tax write-offs for their properties. As you structure your mind and business, you can become more organized as a result, which leads to more successful business operations.
— Joshua Lybolt, President & Co-Founder, Prime Real Estate
Costs of Setting Up a Real Estate Holding Company
The costs to set up an LLC for your real estate investments vary by state. The costs also depend on if you’re setting it up yourself or if you’re using the services of an attorney. The average state filing fee to set up an LLC is $127 if you’re doing it yourself. The average cost to set it up with an attorney is $1,000 or more.
Typical costs to set up an LLC include:
- State filing fees: $10 – $800 as a one-time fee
- EIN number: Free
- Annual LLC fees: $0 – $800, depending on the state
- Operating Agreement: $20 or more for a template
If you choose to hire an attorney, they will charge you one fee that will include the state filing fees and all documents. Attorneys generally charge $1,000 to $1,500 to set up an LLC. Keep in mind the annual fees are still your responsibility.
Instead, you can choose to use a contract provider like Rocket Lawyer. They offer packages that may cost a few hundred dollars depending on the state you’re in. If you register the LLC in a state that you don’t have an address in, you will need to pay a registered agent, in addition to Rocket Lawyer, and this can cost $300 or more per year.
Pros and Cons of Starting a Real Estate Holding Company
There are many advantages to starting a real estate holding company. The main advantages are limiting your liability and tax benefits. However, there are some disadvantages as well, including additional costs to form and maintain the LLC.
Pros of starting a real estate holding company include:
- Business write-offs
- Limited liability
- Establish business credit
- Separate business finances
- Business seems more professional with an LLC at the end of the name
Cons of starting a real estate company include:
- Costs to start the LLC
- Annual costs in some states to maintain the LLC
- Financing costs may be higher using an LLC
Frequently Asked Questions (FAQs) About a Real Estate LLC
What Is the Purpose of a Real Estate Holding Company?
The purpose of a real estate holding company is to protect your personal assets from the liability of owning real estate as an investment. Its purpose is also to provide tax benefits for the properties and to keep the property’s finances separate from your own personal finances.
Can My Personal Debt Affect My Real Estate LLC?
This varies by state and also depends on what type of debt it is. However, in most cases, the assets of an LLC can’t be used or taken to pay off the personal debt of one of the members of the real estate LLC. This can be a complex topic, so it’s best to consult your tax professional.
Do You Have to Be a Real Estate Agent to Manage Your Own Properties?
No, you don’t need to be a real estate agent to manage your own properties. However, depending on the location of the properties, you may need other licenses, such as a business license and rental property licenses. You can check with your local municipality to see what is required.
Now that you know how to start a real estate holding company, we recommend incorporating as an LLC to protect your personal assets. It can also keep your business and personal assets and finances separate. Starting a real estate holding company can be completed in six steps, including one step on choosing the right professional to work with.