In the 2020/2021 financial year the value of the managed real estate market carried on its trend of growth, reaching $10.5 trillion, despite the adverse effects of the COVID-19 pandemic; this is more than 1.5x the size a decade ago. The reassuring resurgence of this market in the wake of the COVID-19 pandemic appears to be attracting plenty of new entrants searching for lucrative returns on their investments.
Many will be unfamiliar with the best practices for engaging with this market. For instance, in order to deal with the unique risks of the real estate market, one popular precaution is to establish a holding company. These are used to minimize risk, provide a veil of privacy and help save on taxes. This article discusses what real estate holding companies are, their advantages and disadvantages alongside how to form one.
What Is It?
There are two popular definitions for a holding company, either: an entity created for the purpose of holding an asset, or a parent company designed to contain subsidiaries. Most people will opt to establish their holding company in a state that is optimal for small businesses such as Wyoming or Nevada.
From here, owners will then create subsidiaries to this holding company that are assigned on an individual basis to each real estate property they own. Each subsidiary will be formed in the state in which the property is based. By assigning a property to each subsidiary it helps contain the damage from an accident/lawsuit within one property from spreading to the others.
The purpose of these companies is twofold: to separate each subsidiary’s business assets from one another and to put a wedge between personal assets and the risks of the business. This is the case because the parent company’s only responsibility is to own its subsidiaries. By granting ownership of individual properties to each subsidiary and precluding the parent company from engaging in any other duties associated with running the business, the parent company remains protected.
On top of these minimizations to risk, the structure of a real estate holding company grants its owners both tax savings and privacy. Furthermore, establishing an anonymous LLC as the parent company hides the assets you own from the public eye. This structure facilitates tax savings as it entitles the owner to the incentives the government provides business owners.
Furthermore, the purposes of a real estate holding company can be summarized briefly: for the sake of asset protection, privacy around business asset ownership, and taxation benefits from government incentives. On top of all this, it portrays a more professional image of you.
Advantages and Disadvantages
The main advantages of using a real estate holding company for your properties are innately linked to their purpose, which has been explored in detail above. It is worth noting that there are some slight downsides to their use, though nothing that would warrant abandoning any ideas of using this business structure in favor of another.
The process associated with forming the holding company and all its associated subsidiaries will be quite dear, especially those related to registration. On top of these initial costs, there are also notable continual costs that carry on throughout the lifespan of the holding company, such as any annual fees the taxes your businesses are liable for.
Of course, holding companies cannot run themselves and have to be managed by someone, which may be a little overwhelming for business owners with little or no experience. This does give rise to the additional cost associated with hiring a professional with experience running holding companies before, such as an attorney.
Despite these downsides to the operation of a real estate holding company, it is still considered far more favorable to do so rather than opting for another business structure such as a sole proprietorship.
While the ostensive simplicity associated with these other business types can seem appealing (i.e. less forms and fees), this is definitely outweighed by the fact these other business formations can be completely jeopardized by a single event as there is no delineation between business and personal assets, let alone the individual businesses.
How To Form One
To set up the protection of your properties with a real estate holding company, you need to establish an LLC. Thankfully, the process of doing so is quite straightforward, it involves: selecting a state for the business, choosing your business’s name, choosing a registered agent, filing Articles of Organization, and finally, creating an Operating Agreement.
It is good practice to have an attorney handle the paperwork associated with the formation of your LLC in order to confirm that it is done without error; even better if they specialize in holding companies and real estate.
Once the LLC has been formed in your state of choice, business bank accounts will need to be set up in order to create a demarcation between your personal and business assets. On top of helping with asset protection, it is also useful for making the process of bookkeeping easier.
If you need financing in order to purchase properties, business credit will need to be applied for in the name of your holding company. Finally, when you purchase a property, this will be done in the name of your holding company.
Whilst all of these steps could be done unaided, it is significantly simpler and less stressful for the business owner to delegate it to an attorney they have hired, despite the increase in upfront costs this will incur. Ironically, this often ends up being in the company’s best interests financially as it can increase its efficiency and result in savings in the long run.
On balance, real estate holding companies are an extremely powerful tool for those in the real estate market, it allows a person to distinguish and protect their assets from one another, remove the ownership details of their assets from the public eye and receive the taxation benefits of government incentives.
For more information on this topic, please see this resource for a helpful guide on not on the foundational knowledge but also reputable attorneys to help you set up your holding company.