Flipping is just different than other investing strategies. In terms of both the financial aspects and legalities of running this type of business, there are a few things flippers should know about organizing and defending their real estate portfolios. Chief among the things every flipper should understand is how to construct an asset protection strategy that adequately defends against lawsuits and forms a sound structure for active real estate businesses. Here’s how.
Do Your Homework Before Forming Your Entity: Special Concerns for House Flippers
House flippers’ asset protection strategies should reflect their actual needs. Here’s a short checklist for you to consider before you start with entity formation.
When you form your real estate entity, consider how it will fit both within your asset protection and broader investment strategy. Here are some critical issues to consider:
- Tax issues. Do you want the flexibility of the LLC, which may be taxed as an S-Corp or more similarly to a partnership?
- The best kind of entity for an active business. The active nature of flipping is clear when we compare this REI tactic to say, buy-and-hold investing where investors hold properties for years–such investors are relying on passive income and assuming a more passive role generally.
- How frequently you plan to make transactions. Many flippers will have a property bought and sold inside of a year, and certain entities are superior for frequent transactions vs. rarer ones.
- Licensing and other operations issues. There may be reasons for a savvy house flipper to also acquire a real estate license (or work with a team member who has one), even if doing so isn’t legally necessary. What’s best for you in terms of daily operations will come down to many factors, including personal preference.
- What percentage of business is your flipping activity? If you are exclusively a flipper, you will almost certainly require a different approach than an investor with only minor flipping activity or who doesn’t rely on flipping transactions for profit.
If you have specific questions about these concerns in your life, speak with a qualified real estate attorney as well as an advisor you trust familiar with your investment market(s). Let’s shift gears and dive into the decision-making process you’ll use to select the entity for your flipping business.
REI Entities for House Flippers: What’s the Best Choice?
We’ll talk about a couple of popular choices for house flippers. Ultimately, the only way to know for sure what will be best for your business, portfolio, and plans will be the product of conversations with personal advisors. But feel free to use these rules of thumb as a starting point for your research and discussions about forming an entity for flipping real estate.
We’re going to talk about key strategies for house flippers with the understanding that flipping is a form of active trade. LLCs and S-Corporations are popular options. Learn more about the entities you can use and the key questions you’ll need to answer below.
The Limited Liability Company: How to Flip Houses With an LLC, Series LLC, or Both
It’s vital that those engaged in active real estate flipping businesses find a way to limit the many liabilities that can accompany this investing method. For many flippers, the Limited Liability Company helps square both the issue of liability and how to formalize the flipping business.
Now, the Limited Liability Company comes in a few variants. You’ve got your Traditional LLC, an affordable classic; the Series LLC, which allows you to quickly create an infinitely scalable network of mini-LLCs, as well as ways to use both types of LLC together for a formidable asset protection structure.
We hope to help you make the best decision for you by explaining how these companies protect your assets, how you can use them, and ways to approach some of the choices you’ll have to make whether you establish one Traditional LLC or a two-company structure. One of your unavoidable decisions is how your LLC will pay taxes, and yes, you get to choose.
The Tax Choice: Should You Consider Taxing Your Real Estate LLC as an S-Corp?
One reason flippers like LLCs is because you have options for taxation. LLCs may be taxed like partnerships or as S-Corporations. Making the S-Corporation judgment can be difficult for any investor, and we strongly recommend involving an REI-savvy CPA. But here are some things you can discuss with that professional, or anyone else assisting you with forming your real estate LLC.
S-Corporation makes sense as a tax savings strategy for some investors, but of course we all know there are no legal silver bullets for tax minimization. One huge benefit of using the LLC in general is pass-through tax treatment, which is still available if you’re taxed as an S-Corp. LLCs are beloved pass-through entities for investors, meaning profits and losses are simply recorded on the company members’ respective personal income returns.
There are certain advantages of S-Corp taxation for house flippers:
- S-Corporations are legally separate from the members of LLCs for liability purposes.
- S-Corporations and LLCs offer easy ways to add and account for new members.
Be aware you may hear discussions of the S-Corp vs. the LLC as if this is an either-or proposition. Resist the temptation to listen to such reductive views, because you truly can have it both ways. One could in theory form a separate S-corporation entirely, but for most investors, opting to use an LLC taxed as an S-Corporation is a simple choice that preserves the beneficial features of both entities. Even better, the LLC taxed as an S-Corp is easier to run than a fully separate S-Corporation (complete with its many legal requirements). Not every flipper will even benefit from S-Corp taxation, but enough do that you should consider all options.
Combining Entities for Greater Protection: How to Use a Traditional and Series LLC Together
Some investors may be happy with a single entity, but many of our flippers and other investors love the tried-and-true method of pairing the Traditional LLC with the Series LLC. Under this model, the Traditional LLC serves as your operating or shell company. It manages day-to-day activities like collecting rent, paying employees, etc.
Meanwhile, your Series LLC functions as an asset-holding company. This company must never interact with the world, because that’s what the Operating Company does. To maximize the Series LLC’s effectiveness, all you do is create as many Series as you have assets, direct your attorney to help you make the appropriate transfers so each asset is in its own Series, and ta-da. You’ve got yourself a basic two-company structure. Use it correctly, and it can protect your real estate assets for life.
Using your entity correctly means ensuring liabilities go where we want them. In the case of the two-company structure, that Traditional LLC is the company we actually want a would-be litigant to come for. It doesn’t own anything. The company that does own all your assets, the Series LLC? It hasn’t ever been exposed to those liability-magnet business operations. By separating these functions structurally, you prevent many lawsuits before they even begin simply because it’s harder to sue this structure than a person. The system works, and your assets stay under your control.
No matter what you decide, trust your experts, be transparent, and fearlessly gather information. We’re here to help you while you learn the best way to establish your flipping entity and protect your new business.