Real Estate is, some might argue, where wealth is grown. People buy and sell real estate all the time. Most successful people hold a substantial portion of their wealth in real estate. If you have experienced any success in your business, it may be time to consider the investment in real estate yourself.
The first place to start is in the building where you operate your business. This is a place where you can benefit from the success of your business and to experience the benefits of limited liability and what legal entities can really do for you. Today, let’s talk about the Real Estate LLC.
It makes sense that you would want to own the building where you work everyday. For many entrepreneurs, it is the business equivalent of home ownership. You own that real estate. You can use it for your business. But, it isn’t quite the same. When you purchase real estate as a business owner, you do not want your operating entity to purchase the real estate. It is a wonderful investment to make as an entrepreneur, but like so many things there are legal pitfalls and doing it wrong can lead to serious liability (and penalties).
To begin, it is important to create an entity that will own the new Real Estate. For now, we can short circuit the legal entity discussion and assume the LLC is the safest way to own Real Estate. So, we can short circuit the entity discussion for now.
Formation of a New Entity To Own Your Real Estate
Owning Real Estate has tax benefits and brings with it certain liabilities. The option that protects you the best and opens up the most possibilities for you moving forward is to own the commercial real estate in an LLC and to rent the real estate to your operating company. For this, you will need a legal entity to own the real estate. Once the purchase is completed, you will be your own landlord. To create your Real Estate LLC, you will need, at least the following:
- Certificate of Formation – A new company is created by a certificate of formation which outlines the owners, and other required elements of the new entity. The name for the entity must be registered with the state prior to formation to ensure availability.
- Operating Agreement – The Operating Agreement is a legal requirement and it outlines the agreements between the owners of the business and outlines many important issues that should be determined at the beginning of the business. As a single member investment entity, this document should be rather simple, but is important nonetheless.
- FEIN – The FEIN is like the Social Security Number for a business. With any new entity, a new FEIN should be secured.
Purchasing The Real Estate
The Process of purchasing the real estate involves the following:
- Real Estate Purchase Agreement – The real estate purchase agreement should be drafted by the purchaser. That gives the purchaser more control over the process. This agreement should outline the terms and purchase price for the agreement. Note, if the seller is financing the purchase of the Real Estate, you will also need a promissory note.
- Warranty Deed – Make sure, when you purchase any real estate, that you are purchasing a Warranty Deed. This will help protect you from any claims that you do not own title to the property. This document will be filed with the Probate Court where the property is located. In addition to a warranty deed, you want to get Title Insurance (if you are mortgaging the property, it will be a requirement).
Being Your Own Landlord
Once you have formed your Real Estate LLC, you need to properly document the relationship between the two companies. Legally, this is an arms-length transaction and to get the tax benefits of having this set-up, you need to make sure the relationship is properly documented.
The beginning of this relationship, like any landlord-tenant relationship is in a quality commercial lease. You need to ensure that your lease is legally enforceable and outlines the relationship between the two companies. One of the most important aspects of owning the real estate you use in your operating company (which you also own) is to make sure that there is a legitimate, legal, relationship between the landlord and the tenant. It must be treated the same a lease between two entities that do not have the same ownership (also called an “arms-length” transaction).
Separation of Funds
One of the most important legal components to this type of relationship is that you treat your Real Estate Company like you would a (separate) landlord. That means writing checks for rent (on time according to the lease), reimbursing expenses, and making sure the fees and expenses are properly outlined between the companies. That is how you will benefit from the tax savings of owning the building yourself. One of the benefits of being your own landlord is that you can control your expenses, but once you determine how those expenses will look and which entity is responsible for what, you must abide by the lease (or amend it).
As with any major acquisition, there are many tax and legal consequences to consider. This is an overview of what the process might look like for you to purchase your own building to rent to your operating company, but the way this type of scenario would play out for your business in your circumstances may be different. So, make sure to involve the professionals on this one (even if it is all cash – maybe especially if it is all cash).