LLC vs. Corp Entity: Real Estate Investing Business Structure: Expert insights on LLCs vs. Corp entities. Uncover the nuances of liability protection, tax strategies, and efficient exit plans. This engaging discussion with attorney Clark Washington navigates the complexities, offering valuable guidance for investors seeking robust legal frameworks in the realm of real estate. Explore the best fit for your goals, whether choosing a LLC, C-Corp or S-Corp, learn the art of strategic profit distribution and the flexibility each structure offers. Mr Washington discusses the vital considerations, from handling mortgages during property transfers to crafting effective exit strategies. Elevate your real estate journey with expert advice on financial planning, tax implications, and the critical decisions that shape success in this engaging and informative conversation.
Brett
0:00:43 – Today we’re going to be talking to Mr. Clark Washington. I apologize, Attorney Clark Washington, who came to us by way of Tyler Jernson, escrow, and Clark’s going to be discussing a big question we get from a lot of our new investors, and that’s whether I should buy my properties personally, put them in a corporation, LLC, or whatever other entities that are out there. So stay tuned. We’re going to talk to Clark here in a minute and hopefully answer a lot of questions for you folks that are interested in understanding where to place your properties. It’s our first episode of 2024. Before we get into all that, I want to real quickly mention the Memphis market where our investment team works and we specialize in investment properties in the Memphis market and we deal with investors around the world, across the country. So Jeff, real quick, you’ve got a new builder. We have a brand new construction program where we’re building these brand new 42 rental properties that are renting MHA and producing 1% or better with a one-year building warranty. Your builder that you now have, I’ve got two and now you’ve got one. How many this year in 2024 is he building?
Jeff
0:01:45 – Our goal is 50 this year.
Brett
0:01:48 – 50? Well, I’m going to do 51. Maybe even 52 if I’m lucky. Yeah, so we’ve got a brand new program. Well, it’s not brand new. It’s been 2023, it was very successful. We have builders that are building brand new for two rental properties not building homes for individuals anymore they’re building rental properties and they’re running in a chair and they are producing one percent are better with a one-year bill the warranty brand new from the ground up you can reach out to us at 901-692-7401. Also I’ve got a builder who’s got not a building new properties and we’ve got currently 19 completely turnkey rehab properties rented MHA producing 1% or better as well all over the city of Memphis. Now he plans on doing 40 to 50 of those this year. So we’ve got plenty of inventory. If you’re interested in investing in the Memphis market, we are the team you need to talk to. We are the boots on the ground, our ears to the ground. We know this market well and we can guide you to your ultimate goal. Price ranges are running for new bills anywhere from 155 up to 185 depending on the market but if it’s a hundred eighty five thousand dollar house you can probably pick it up for a hundred eighty and it’s renting for nineteen hundred dollars a month so it’s getting twelve thirteen percent gross out of the gate on the turnkey properties anywhere from ninety thousand to a hundred thirty thousand completely renovated with a warranty on them with a tenant in place and it’s a hundred thousand dollar house you can probably pick it up for ninety five it’s renting for a thousand fifty a month so the numbers are good on both sides. So we are sponsored by Title Assurance and Escrow, one of our title companies that does all of our closings. They are Chris and April, 901-737-3332. If you have any questions about escrow or closing or you’re looking for a title company. Also the Stamps Real Estate Company Investment Division, which is us, is also a sponsor of this show. Just get in touch with us, 901-692-7401 or MyMemphisInvestmentProperties.com. All right, Mr. Washington, Attorney Clark Washington, welcome to the show. Thank you for being here.
Clark
0:03:46 – Well, thank you very much. Thank you for the invitation.
Brett
0:03:48 – Yeah. I’ve been talking to Chris and April at Title Assurance and Escrow about, we’re going to have them on to talk about LLCs because I get a lot of calls from young investors and old school investors that are changing their strategies and they always ask me this question, is it better for me to keep these properties in my personal name? Should I set up an LLC? Should I set up a corporation? Do I need to set up an LLC for every state where I have properties? And you know, I’m not qualified to answer those questions. I can give them kind of a what my other investors are doing and let them kind of figure it out on their own. I try to guide them as best I can, but obviously I don’t want to give bad advice or tell people to do something that ends up being detrimental to them, so I try to stay away from that. So I pick Chris’s brain and April’s brain a lot about that. They are not versed enough in that. They know how to set those companies up, but they don’t really understand the implications. So with that, I want to bring up the first type of entity that a lot of my investors use, probably 90% of them, and that’s a limited liability corporation, LLC. In our phone conversation, you mentioned possibly that the limited liability corporation has its limits with liability protection, which is the reason I think most investors put properties in LLC is because they feel like it gives them some personal protection from the oh s*** moment.
Clark
0:05:09 – See, most people love LLCs, and the reason they love LLCs is because of the name, you know, Limited Liability Company. They think, oh my goodness, this is the greatest thing I’ve ever seen. It limits my liability. So the name itself…
Brett
0:05:23 – Limits but doesn’t eliminate.
Clark
0:05:25 – You are exactly right. Well said. Most people, when they hear the name, they say, that is what I need. And they just exclude every other option or every other opportunity to have entities. Limited Liability Company, that’s wonderful because it’s going to limit it, it’s going to make the world so much better, make my life so much simpler. It’s not always the best entity to own anything, but it does attract a lot of people because of its name. In some cases, you may want to be a corporation. Let me mention four different entities, but before I do that, let me mention what entity. If you’re a person, I’m a person. An LLC is a person for legal purposes a corporation is a person So the ownership can be in the name of that person you may own your property solely I may own my property solely but you have a corporation you have an LLC a limited liability company You may have a proprietorship which most people call sole proprietorship or you may have a partnership. Now, there can be all kinds of different partnerships, but if you look at what your goal is, and that really should be the first question anybody asks, what is my goal? Because what do I want to accomplish? Let me give you a simple one. You have a couple. They want to buy a house. They want to live in it. Typically, they’re going to buy the house as a husband and wife, which is a special ownership, and they’re one, their tax returns are one, so it’s not a sole proprietorship, but they’re going to own it together. Makes perfect sense. But as you move forward, or in some cases, even before you start, a couple may say, well, I’ve got this and that and other things going on in my life. Is it really best for me to own our residence as husband and wife, or should we own it in some other entity? Right. Sometimes a corporation, many times a trust. It depends on what they want to accomplish. And it’s not hiding assets. That’s not what I’m talking about. It’s really planning, because if you plan what’s best for you individually, whether you’re an individual person, whether you’re a couple, whether you’re an investor, whether you’re in business, what do you want to accomplish? And when you determine what you want to accomplish, and sometimes sitting down with other people who deal with this will help you define the answer of, you know, what do you want to accomplish? They can help you answer that question. And once you define what your goal is, then you can determine what type of entity is going to best suit that goal.
Brett
0:07:50 – Okay, makes sense. Let me ask you from an LLC standpoint, which a majority of investors put properties in LLC, my question to you would be, take all the other what-ifs off the table. And I’m an investor, I’m just buying my first property and I come to you and I would like to put my property, I need to know if I can keep it in personal name of Brett Bernard, if I should open up an LLC and slide it into that limited liability corporation or whether I should put it into a standard corporation. What would you say the pros and cons of all three of those are?
Clark
0:08:23 – If you came to me and said, I want to buy this piece of property and I want to put it in an LLC, what do you think or is that a good idea? I would turn around and ask you a number of questions to see what you wanted to accomplish. If you’re an investor and you own a bunch of properties or maybe you’re wanting to be sure that the profit, now you’re doing it to make a profit.
Brett
0:08:42 – Right.
Clark
0:08:43 – And hopefully everybody does it to make a profit.
Brett
0:08:44 – The majority of what the reason I’m doing the LLC or determining how to put it there is to protect my personal life, my personal home, my personal cars, my personal wealth from any potential liability of those properties. Second to that is yes, I might want to see if there’s any tax benefits to me putting it in an LLC to increase profitability or get more write-offs or to the subject we talked about the other day on the phone about losses. What would I need to know to differentiate those three, the proprietorship, the limited liability corporation, and corporation. What would be the pros and cons of each one of those for me personally?
Clark
0:09:21 – As a proprietorship, you’re not going to protect yourself from your liability. If you own the property solely as a proprietorship, then anything and everything that you own as far as other assets is subject to whatever attachment if you have a problem. So it doesn’t protect you individually. An LLC would protect you individually, and a corporation would protect you individually. Because they’re separate entities. Whereas a proprietorship, you are who you are. And I would probably recommend, if you’re an investor, don’t buy property in your name individually.
Brett
0:09:53 – And if you have to buy in your name because you get a mortgage and they won’t do it in LLC, then you buy it and swing it to an LLC via quick claim deed or something, just moving into that?
Clark
0:10:03 – You can do that very quickly, but if you’re borrowing money to do it and you want to put it in an entity, if you tell the lender, the bank, the mortgage company, whoever’s doing the financing for you, if you explain it to them, they will probably understand that it needs to be in an entity. Now, they may require you to personally guarantee the debt, so you’re personally guaranteeing that debt, but you’re not personally guaranteeing everybody else in the world that may want to file a claim if something happens in the world. Okay. So you’re still better off putting it in the name of an LLC or a corporation.
Brett
0:10:31 – Okay, that makes sense. So the name Limited Liability Corporation, explain what that means, the limited liability portion of that.
Clark
0:10:41 – Well typically when you say limited, it is what you have invested. So what does the LLC own? So if there’s something that goes sideways or upside down or whatever, and then the company has to be liable for it, whatever the LLC owns is the pool of assets to satisfy that liability claim. Not your personal assets, just the assets of the LLC.
Brett
0:11:05 – Okay. So, you have no personal link, I guess, or personal liability in that LLC should everything go belly up and you bankrupt the LLC and your houses get foreclosed on.
Clark
0:11:17 – You do not have the personal liability beyond what’s in the LLC. Let’s use you and me as an example. If the two of us decide to be members of an LLC, we’re going to be equal members, so we’re going to contribute whatever equally. So our personal liability is whatever we may have contributed to the LLC. For example, if we go out and buy a $200,000 a piece property and you say, well, we’re not going to borrow the money, we’re just going to contribute $100,000 a piece to the LLC, that is our contribution to the LLC. So, we put at risk $100,000 each. And if things go sideways, that’s what’s exposed, but not everything else in the world that we may own.
Brett
0:12:04 – Well, then that makes sense because your limited liability is to whatever you have in that LLC, contributions, equity, assets, but your personal home, your boat, you know, your vacation home and all that’s not up for grabs should that LLC fold and assets be dispersed.
Clark
0:12:21 – And what you just said is a good explanation. Your liability is limited as to what you put in the LLC.
Brett
0:12:26 – Okay, well that makes sense. So would it be better for someone to maybe put everything in a corporation versus an LLC? I mean, is there more of a protection in a corporation or is it more about profitability and tax write-offs?
Clark
0:12:40 – Your liability is limited with the corporation also because in a corporation, your personal liability or personal exposure is only as to what you have contributed to the corporation. So it’s very similar to the LLC. Again, if you and I decide to go into business, and instead of being an LLC, we’re going to be a corporation. We contribute $100,000, so you own half and I own half, or $10,000, $10,000, whatever our agreement is. So our exposure is our individual commitment to the corporation. So our liability is also limited because it’s only as to our contribution. Now whatever the corporation may own over a period of time, that’s what is in that pool of assets to solve any liability claims. In a corporation, you can be what a lot of people call a regular corporation or a C corporation or C corp. Or you can be an S corporation when there’s a relatively small number of members. And what the S Corporation does, it allows the profits or losses to flow through individually to the shareholders based upon their ownership interest. If you and I are 50-50 and we make $100,000 profit in our S Corporation, then $50,000 of that profit is going to go to you, 50 to me, for tax purposes.
Brett
0:13:58 – Okay. Regardless of whether you take it or not.
Clark
0:14:01 – That’s exactly right. Whether you take it out or not, you’re going to get one of those pieces of paper that says you’ve got the responsibility to pay taxes on $50,000.
Brett
0:14:09 – On S Corporation. And a C Corp is one that has more members?
Clark
0:14:13 – Not necessarily that. A C Corp or an S Corp, it just depends on how you want the corporation to be treated for tax purposes. Okay. Now, LLC, when an LLC finishes the end of the year, it’s going to do the same thing as far, you don’t have a pretty much a choice there. You’re going to be taxed as a member based upon whatever your membership interest is.
Jeff
0:14:33 – Brett, let me chime in here and go back to this LLC for a minute. I’ve got a question for you, Clark. When you transfer a property from an individual to an LLC, but there’s a mortgage on it, is there any chance that that could like trigger a due on sale clause at closing where the mortgager will demand total payment?
Clark
0:14:52 – Anytime you have property where there is a mortgage or some type of bank lien or whatever, if you transfer it from that owner to another owner, you always run the potential risk that there’s a due on sale or there’s a complication with the lender. Because the lender is looking to whoever signed that note. Now in many cases you may tell the lender, well, okay, I bought this property individually, something that we talked about earlier, but I want to put it in an entity. And you explain to them what they’re doing, they may say, well, that’s fine, but you’re still liable for the debt. And so we understand, so our knowledge there of the transfer is fine.
Brett
0:15:30 – So at the end of the day, you can transfer it to an LLC if the bank’s okay with that, but, and this is something that I believe it or not, a lot of people don’t realize. Just because you transfer it to the LLC doesn’t relieve you personally of that debt. Never, never. So that brought me back to my last question. Jeff, I’m sorry I interrupted you. If you personally guaranteed that debt, the LLC folds, the bank comes after you personally now for that debt, now your personal assets could be up for grabs if there’s a judgment of some sort?
Clark
0:15:59 – If you personally guaranteed the debt, anything and everything that you own personally is subject to being used to satisfy any debt.
Brett
0:16:08 – So the only protection you’re getting is, you’re not really getting protection, but you may get some tax benefits from an LLC then, in that scenario possibly.
Clark
0:16:15 – Again, go back to the questions, because if you, say you’re an LLC or you’re a corporation, and you borrow money from a bank for one piece of property, okay, you owe that debt personally if you personally guaranteed it. Now the corporation of the LLC may be the original maker of the debt, but you’re the guarantor. That’s the only answer to that debt, but you march along and months later the corporation of the LLC gets sued for some million dollar claim. That doesn’t mean you’re personally liable for it. You’re just personally liable to the bank who loans you X amount of dollars for that transaction.
Brett
0:16:49 – Gotcha. Okay.
Clark
0:16:50 – f you have a loan and you want to transfer the property from one entity to another or from an individual name to an entity, as long as you talk with the lender and be sure they know what’s going on and so that they don’t find out later on and all of these unknowns create problems or perceive problems. So typically if you talk with them, explain what you’re doing. Most lenders are business savvy enough, they understand what you’re doing, you explain it, so you can work out a smooth transition without having any default with the lender.
Brett
0:17:20 – If you’re doing an investment loan, typically the lender understands that you’re probably going to move this from one entity maybe to another entity out of your personal name. So yeah, I agree with that statement. Jeff, I didn’t mean to interrupt you, but I wanted to get that point across.
Jeff
0:17:33 – No, that’s fine. I want to shift gears a little bit. I’m kind of all over the place. I want to talk about taxes a little bit. I understand if you’re a corporation, you file a corporate tax return, you pay corporate taxes, but how does the tax benefits differ from an LLC to maybe an S-Corp? The only thing I know about an S-Corp is you kind of avoid the double taxation because you’re just paying on the profits that pass through as personal income. Is that correct?
Clark
0:17:58 – Well, let me explain a little bit more than that, but a sort of a statement, just a sort of foundation statement. When I go back to earlier, when you’re talking about what do you want to accomplish and you need to define your goals, sometimes in defining your goals, you may have to talk with your CPA, your financial advisor about what your goals are, because not considering the tax simplifications about what you may create by your venture is foolish because you need to say, okay, where am I going to end up at the end of the year or the end of the road? So a lot of times in getting a legal opinion or legal assistance in forming your entity or completing the transaction, it also involves sitting down with your CPA to be sure that you’re not going to sort of stumble or trip along the way when some planning on the front end, you could avoid that. But going back to your question about a corporation, you form a corporation and then the corporation is its own person, its own entity. You make a profit and if you leave the profits in the company, the corporation is going to be taxed at whatever the rate is for those profits. And usually it’s better not to do it that way. If you’re going to be a regular C-Corp, zero out the corporation. Bonus it out, do whatever. Because if you leave the money in the corporation, say you leave $100,000 in the corporation for profit, you’re going to pay taxes. And what’s left in there, if you take that out later, that’s what you call the double tax. Because you dividend it out later, you’re going to pay taxes on the net dollars that you’ve already paid taxes on before. So if you bonus it out, distribute it out based upon legitimate ways of doing it, The corporation is zeroed out. Now, if you need $50,000 in January for cash flow purposes, you could loan it back to the corporation.
Brett
0:19:44 – So you would pay it out. So there’s no fund, no account in your corporation you could set up for future growth, expansion, without you’re going to be taxed on it either way?
Clark
0:19:55 – Well, the profit, if the corporation has a profit, you have to deal with the profit.
Brett
0:19:57 – You would tax some of that early on as growth money or expansion money? Because you’re going to invest that money in the growth of your company, so is it taxable?
Clark
0:20:08 – Well, profit is taxable.
Brett
0:20:11 – Okay. So buy a hot tub, put a swimming pool in the back, build a gym for your employees, all the stuff you need to do.
Clark
0:20:17 – Well, those are capital improvements.
Brett
0:20:20 – Yeah, all right.
Clark
0:20:21 – But yes, what are you going to do with the money? So to only look at the financial situation once a year is foolish. Because anybody, whether you’re an LLC, corporation, proprietorship, whatever, watch your financial situation as you move through the year. And hopefully you’re making some plans and adjusting as you move through the year about what you need to do. But at the end of the year, if the corporation or LLC or whatever the entity is, if it’s made money and made a profit, we have a duty, IRS is going to expect us to own up to that duty to pay our taxes. But as far as a corporation, if you say, well, I’m going to pay my taxes and leave it in the corporation, usually that’s not the wisest thing to do because you’re creating, if not definitely, at least potentially a second tax later on on those same dollars.
Brett
0:21:07 – So take it out, loan it back to the corporation if it needs it.
Clark
0:21:10 – That’s right. Loan it back. And if you loan it to the corporation for six months or a year, two, three, or whatever, because then whoever loans it is a creditor. It’s different. But money’s already been taxed. You loan it back for cash flow purposes or for capital improvements or whatever the financial need is, and you treat it as a debt or a loan. So the individual may be just like a bank. But again, you know, I would, for example, I could draw less of a salary and just pay the rest of it out in dividends. Well, if you’re an S-Corp, and that’s the deal. So if you elect to be an S-Corp, so at the end of the year, the $100,000 example, at the end of the year and you’ve got two owners who are 50-50, the corporation is not going to pay any taxes on the $100,000. The owners are going to have the responsibility to pay the taxes because that’s automatic.
Brett
0:22:05 – Whether you took it out or not.
Clark
0:22:07 – That’s right.
Brett
0:22:08 – And there’s… You get a K-1 and it says you made $50,000 and you’re like, yeah, that only took 20. Well, that’s SOL. You owe for 50.
Clark
0:22:14 – And there’s different ways of creating a tax where you may not have a profit without getting a lot of details, but, you know, that’s a financial question. Sure. But if you’re an S-Corp and you want to be treated as an S-Corp, the profits or the losses are passed through to the individual owners.
Jeff
0:22:30 – But at the end of the day, you don’t want to just drain your corporation like Britt said earlier and buy boats and swimming pools and beach houses and all that. I mean, because, you know, at the end of the day…
Brett
0:22:41 – Why not? That sounds like fun to me.
Jeff
0:22:43 – At the end of the day, you want to build an income and invest it and retire. So if you’re just taking tax write-offs for the fact of not having to pay taxes, that’s not always a good idea either, I’m assuming.
Clark
0:22:53 – Well, you know, there’s profit and then there’s cash flow. You want to make a profit. Everybody wants to make a profit, so why go into business except to make a profit? Well, there’s another reason, because it’s fun. Well, if you’re making money and you’re having fun at the same time, I mean, that’s the best of all worlds. And hopefully that’s what people, they enjoy what they’re doing, they make money as they go through that process.
Brett
0:23:14 – That’s why Jeff’s so happy he’s joined this team. He’s making money and having fun.
Clark
0:23:20 – That’s great. He’s a happy man.
Clark
0:23:22 – But, you know, even after paying the taxes, if you’re in business, you know, hopefully every year you won’t make money every year. So even though if you elect to be an S Corp and you distribute the tax obligation, you might not necessarily distribute the cash, you may loan it back. Then the next year you’re going to make some more money, you’re going to make some more money. So you create profit every year. But there’s also the cash flow because sometimes, you know, the cash flow may not be necessarily what you want it to be for operating purposes. So you may have to borrow some money for that. And in different businesses, whether they’re industrial type of businesses or whatever, depending upon how their accounts are paid, whether they are late paying or whatever, most companies will have a working line of credit or they’ll have working capital, which keeps their cash flow available to operate the business, pay payroll and things like that. But that’s one thing, that’s cash flow, but still at the end of the day, they want to make money.
Brett
0:24:24 – All right, well, let’s go back to the LLC then because the majority of my investors who don’t have a personal name have been LLCs. What do you believe would be the biggest misconception of an LLC when they put things in an LLC? What are some of the alligators there that maybe these guys don’t realize or that investors don’t see putting it in there? What could be a potential issue for them down the road?
Clark
0:24:48 – Most people jump to be an LLC because they think it’s the best. Again, it goes back to the name, Limited Liability Company. But an LLC may not be the best thing for you. You can typically get just as much flexibility with a corporation as you can in an LLC, even when you consider whether you’re going to be an S-Corporate or C-Corp for tax purposes. But in an LLC, of course, you’ve got an operating agreement among the members about how you’re going to operate. But when you look at what is your goal, are you going to be the only person there, you’re doing it yourself? So you can be a sole member or single member LLC, or you can be a single member corporation where you’re the only one that owns the stock. I think that corporations typically provide more flexibility and different options about doing different things than an LLC does. You go back to what your goal is. If it’s one person or if it’s several people, it’s going to be in this venture together. But on LLC, the money is going to go out just like it was a partnership. It’s going to be distributed to the members or at least the obligation will be distributed.
Brett
0:25:50 – Okay.
Clark
0:25:51 – So on the front end, what do you want to accomplish? Is this just a one-time deal for one piece of property or one venture or is this a long-time venture? Are you going to have multiple owners? Do you want to be treated as an S corp or a C corp? But when you define what is, what’s the goal on the front end and you answer that question, that’s going to help you determine what is the best.
Brett
0:26:09 – Which one is best for you?
Clark
0:26:11 – What’s the best? I like a corporation because of flexibility, but if you tell me that, okay, I like an LLC because of ABC, I can probably match you corporation ABC plus a D and an E and an F.
Brett
0:26:24 – So in your opinion, in your opinion, professional opinion, I know you can’t give legal advice, but if it were you and like you said, we go into partnership and we decide, you know what, over the next 10 years, we’re going to buy 50 rental properties and create a nice rental portfolio and a big bank of assets, what would you recommend we do as far as setting that company up?
Clark
0:26:45 – I would probably recommend a corporation. But again, go back to the goal, because sometimes there may be a financial or tax benefit to be an LLC. But if you’re an investor and you’re going to buy a bunch of properties, and you’re going to always be buying and selling, always buying and selling, whether you’re flipping them or whether you’re just buying them and selling them for a profit.
Brett
0:27:05 – So it makes a difference in whether you’re going to be buying, fixing up, flipping, or whether you’re buying and holding for 10 to 15 and building asset wealth. So that could determine the difference between LLC and a corporation.
Clark
0:27:16 – Oh, yes. You and I may sit down and I want to buy a bunch of properties and I want to rent them. I want to hold them for long-term and rent them. And you say, well, Clark, I want to buy a bunch of properties and I want to sell them. We may hold them a few months. We may hold them 18 months and just keep on buying and selling. That’s what you do. So those are two different goals. So if you determine what’s going to be the best for you, that would determine whether you should be a corporation or LLC. I would typically start out with the assumption that a corporation is going to be the best in sitting down and talking with someone. But through that discussion, that Q&A back and forth, I think that would refine, is it really going to be a corporation or does it need to be an LLC? I would probably cancel out before the question even starts. Don’t be a proprietorship. Don’t be a partnership.
Brett
0:28:06 – Okay.
Clark
0:28:07 – Because, again…
Brett
0:28:08 – You don’t want any personal liability in the real estate investment world.
Clark
0:28:11 – That’s right. And using you and me as an example again, if we say, okay, let’s just be a partnership and we’ve known each other forever, we know how each other thinks, we’re going to be a partnership. Both of us are individually liable for everything.
Brett
0:28:27 – Personal assets. Personal bank accounts, everything.
Clark
0:28:29 – That’s right. If I go out here and I do something weird or strange or just make an innocent mistake, you’re liable for that, even though it’s me. But we’re partners.
Brett
0:28:38 – Okay. Understood.
Clark
0:28:40 – So I would cancel the sole proprietorship and partnership, probably take that off the table right away. Now, there’s some unique examples where you could be like limited partnership, and in the past people have been in real estate limited partnerships where their exposure pursuant to the partnership agreement is only as to the amount of money they’ve invested. So they have a limited involvement because it’s a limited, they are a limited partnership. Limited liability partner. But that gets to be a little more complicated and it’s it’s hard to sort of keep on going year after year after year.
Brett
0:29:13 – Because you’ve got to redefine the limitations for that one partner.
Clark
0:29:16 – And you have to revisit that question all the time.
Brett
0:29:19 – Yeah, okay, got it. Understood.
Jeff
0:29:20 – Corporation it is. Let’s go one more time, C Corp versus S Corp. Would the S Corp be more for a smaller guy like me or?
Clark
0:29:21 – Not necessarily because if you look at the corporation, you say, okay, an S Corp, you’re going to pass out. Essentially, there’s no floor. All of the tax obligation just goes out to the owner. Owner are owners. But you can accomplish pretty much the same thing if you’re a C-Corp. You just zero out the bottom line every year. So you’re going to get the same protection whether you’re a C-Corp or an S-Corp. The election is just how you want the profits to be treated as going to the individual shareholders or let the corporation deal with it. If the corporation deals with it, I’d recommend that you bonus it out, pay it out, so that you don’t have a dollar left.
Brett
0:30:06 – Well, I got a question for you. What if, so we have a corporation, and we’ve got $300,000 profit for the year, and we’ve decided that we’re each going to take a $50,000 bonus for the year, and we got $150,000 left in the corporation that we’re in turn going to turn around and buy another one or two rental properties with for cash. How does that change the tax liability? Because that investment or purchase, is that $150,000 taxable?
Clark
0:30:39 – Yes. If you have $300,000 profit and you do not pay it all out, whatever you leave in the corporation, the corporation is going to have to pay taxes.
Brett
0:30:45 – You got to pay it out, not invest it.
Clark
0:30:46 – But if you pay it out and then let the shareholders pay their own taxes. If you say, well, okay, our cash flow is down to almost zero, so we need 150 to go buy this piece of property. So one, two, or however many shareholders can loan the money to the corporation just like a bank. The cash is there, and the corporation goes and buys the property, and then as the corporation makes money, makes profit, you pay those lenders back.
Brett
0:31:14 – Okay, gotcha. All right.
Clark
0:31:15 – And let me go back to a question a moment ago about, you know, C-Corp versus S-Corp. And we’ll use three owners versus two, just to give you a little different. Let’s just say at the end of the year, if you’re an S-Corp, you’ve got three owners, they’re all equal owners. So in an S-Corp, you made money. So each one of those three will get their tax allocation equally, a third and a third and a third. So that’s the way the profits are going out. But let’s assume you’re a C-Corp. And again, you’re equal owners. But one of the three of us may have done less. And let’s just say we sit around and say, okay, we got $300,000 profit at the end of the year. Collectively, we may decide, instead of distributing it a third and a third and a third, we may distribute that in some other proportion besides, say it may be 50%, 25%, 25% and you bonus it out. You don’t get that option if you’re an S-Corp. It’s going to go out in the direct proportion of your ownership.
Brett
0:32:13 – But a C-Corp, you can decide how you divvy that money up.
Clark
0:32:16 – Based on whatever criteria you may have. You may say, okay, it’s going to be based upon how you perform, it’s going to be based upon how much time you spend in the company, or you may have a whole laundry list of criteria, but you have the flexibility of deciding how to pay it out. If you’re an S-corp, you don’t. If it’s a third and a third and a third, that’s your obligation. Another reason why you can accomplish the same thing plus if you’re a C-corp, you can still pay it out or distribute it out, but it doesn’t have to be equal. It can be based upon performance or some other criteria.
Brett
0:32:52 – Well, I think that’s a lot of good information. I take away from this, Jeff, that corporations probably the best bet, a C-corp for someone, but obviously you said talk to your accountant. There may be some tax benefits on the LLC side for an individual versus a C-corp or whatever, so it’s going to come down to your personal financial situation and your personal goals.
Clark
0:33:12 – You’re right. You want to limit your liability, obviously.
Brett
0:33:14 – So we know proprietorship, partnership, any other ship, boot it out the window.
Clark
0:33:19 – Typically, yes. You eliminate that right away.
Brett
0:33:21 – Gotcha. Okay.
Clark
0:33:22 – And the question about whether you’re going to be a corporation, LLC, or whatever, typically is not a simple question. You don’t want to make the decision too quickly without thinking it through and talking to the right people.
Richard
0:33:33 – Do you typically recommend that people isolate liability by having one or two properties within a corporation and then having multiple corporations?
Clark
0:33:41 – Great question. In many cases yes. For example if you’ve got three different locations, they’re commercial properties and you may be renting those properties or you may be operating through separate businesses. It may be beneficial for you to have three separate entities or three separate corporations. Keep them isolated because A is A, B is B, and C is C. It also, as an owner, it gives you the ability to analyze each one of those properties separately. It’s a lot easier to see which one’s doing better, which one’s doing worse.
Brett
0:34:15 – I think that’s the reason why a lot of investors who have rentals in multiple states, they have one particular rain tree, he has a rain tree Memphis, he’s got Raintree, Orlando. He’s got these LLCs set up in different states for those holdings, for those specific properties. His answer to me when I asked him the question why was because some states have income tax, some states give different tax breaks for certain types of rental properties or in what they call the opportunity zones. So they set them up separately because they have to handle them all differently.
Clark
0:34:48 – It sounds like he’s done his homework and his answer is yes because every state has different nuances, taxes, property laws, things like that. But that’s a good example of someone who’s evidently just thought about the question, analyzed it before he made the decision and then did the thing that’s going to be best for the business activity.
Richard
0:35:07 – When it comes to my exit strategy, should there be consideration of what entity I select? And is this something that would be part of your Q&A on the front end?
Clark
0:35:17 – Yes, because that’s part of what the goal is. You’re going to hold it short term or long term. And one of the things, it can be a little more cumbersome to try to exit from an LLC versus exiting from a corporation. You can have a stockholder that’s going to exit out of a corporation. That can take place pretty smoothly as long as you have the right paperwork on the front end. But it doesn’t mess up or interfere with the operation of the corporation. It just keeps on keeping on. It’s a good question. Yes, you should decide that on the front end because even if the plan is we’re going to be doing this forever, nothing is forever. You need to plan for those things.
Richard
0:35:57 – And before proceeding with anything, presumably it’d be wise to discuss estate planning?
Clark
0:36:02 – Yes, because so many people go into a venture with somebody else and things happen. It could be a death, whatever. How are you going to treat that if someone becomes disabled or someone passes away? I could sit here all day and talk about examples that I know about where unfortunate things happen because you always want to have business insurance, liability insurance, but in many cases just plan a life insurance for a key member is important. But yes, what’s going to, if someone exits because of disability or death, do we want to be owners with that person’s heirs or do we want to buy them out?
Brett
0:36:42 – Judging from experience, buy them out. Get them out of the way as fast as you can.
Clark
0:36:48 – Typically it’s the case because the heirs are typically not committed just like the owners are. You’re just dealing with a whole different set of facts.
Brett
0:36:56 – They see dollar signs. So I guess the easiest solution is to give out your contact info because here’s my recommendation. If you’re going to start investing in Tennessee, there’s a lot of questions as to how to appropriately approach that. There’s a lot of questions you need to answer and goals you need to figure out. My team can help you with the acquisition, the management, the rehab, the renting, all that in the market, but it looks to me like there’s a lot of legal questions that a lot of young investors should ask themselves and try to get answers to. So start off, talk to your accountant or CPA, and then the next call should be to Attorney Clark Washington, which, how can they reach you?
Clark
0:37:32 – Well, whether it’s to me or whether it’s, there are always legal questions. If you’ve got an attorney that you deal with, obviously you’re already tied in with someone that can give you some legal advice. And usually if that’s not what they deal with, they’ll refer you to someone that they know that can deal with that. But if you have an attorney that you’re dealing with, that’s good. Not every attorney deals with these kinds of things, and probably not every attorney deals with multiple states. But sometimes you have investors that deal with properties in various states. estates. But again, you talk with your legal advisor, your attorney, and you talk with your accountant to be sure. I’m in Memphis, Tennessee, and the best thing that I would say to anybody is not necessarily call me, but be sure you talk to someone who can give you some legal advice about what’s best for you when they understand what your goals are. And if they don’t have an attorney? Well, my name is Clark Washington. I’m in Memphis, Tennessee, and my contact information is 901-371-9197.
Brett
0:38:31 – Got it. Clark, thank you, man. It’s been very insightful. These questions have been haunting us for the first year of our podcast. You’re the first person to come on and try to get some clarity to that. I’ve learned a lot. I know Jeff’s learned a lot. Hopefully, my listeners and our new investors will learn a lot from this as well. Thank you. Appreciate you being here.
Clark
0:38:47 – Thank you very much. Happy New Year.
Jeff
0:38:49 – Well, happy New Year. Thank you, Clark.