Corporations

Corporations are a legal entity owned one or more shareholders. They can be private or public like Ford, Microsoft, Federal Express, etc.

As a real estate investor, you can create your own private or closely held corporation by filing articles of incorporation and bylaws with the appropriate state agency.

Requirements for incorporation will vary from state to state.

The primary advantage (among others) is limited liability for share holders. Since the owners of a corporation actually own stock and not the real estate, the most shareholders can lose is their equity investment.

The disadvantage of a corporation relates to initial expenses:

It costs money to have an attorney draw up the organizational documents. There are also costs to cover extensive reporting requirements at state and federal levels for maintaining corporate status. If these requirements aren't meant or if there's lack of capitalization, creditors or lien holders can seek personal liability from individual shareholders.

There are two types of corporations:

C corporations One advantage of this type of corporation is that it has continuity (it continues in the event a shareholder dies). It has two disadvantages: The major disadvantage of a C corporation is that it's taxed twice--once when the business makes a profit and then a second time when those profits are distributed to shareholders. Another disadvantage is that if the corporation has losses, it has to carry them over to the next tax year because the shareholders can't use C corporation losses on their personal returns. S corporations This type of corporation has the advantage of avoiding double taxation by passing all tax liabilities onto shareholders. As such, S corporations are only taxed once.

However, they're seldom used in real estate ownership because their primary disadvantage is that the liquidation of an S corporation is a taxable event. This means that even if the shareholders agree to an equitable distribution of assets, the Internal Revenue Service will consider the liquidation as taxable. The shareholders will then be forced to pay capital gains taxes and possibly sell some of the assets.

In addition, there's the issue of material participation. This is an IRS term that indicates whether an investor worked and was involved in a business activity on a regular basis. It has a series of tests to determine material participation which affects the tax benefits you may or may not receive.

Generally speaking, incorporation is an expensive choice for holding real estate assets if you're an average real estate investor. You must be willing to pay for the professional, legal and accounting advice not only at the beginning but also on a continual basis. These expenses can mount up. You also have to deal with the hassle of ongoing technical requirements and the possible expensive possibility of double taxation.

Key Point: Know your investment objectives and state and federal laws concerning title holding; then, select the form that best meets your investment needs. Do seek out the services of an attorney first.