If you’re thinking of getting into the flipping business, make sure you do your homework before you get started. The way you structure your house-flipping business should be different than for other types of REI, both financially and legally.
One of the most important things to get right is to ensure you have a solid asset protection strategy in place that will defend both you and your business against potential lawsuits.
Related: How An S Corp Election Helps Flippers and Airbnb Landlords
Things to consider when choosing your business entity
If you want to ensure maximum asset protection, you’ll need an asset protection plan that is specifically tailored to your business’ needs. When selecting a legal entity structure for your business, you should consider how the structure fits within both your asset protection strategy and your overall business plan.
Here are a few things to keep in mind when deciding which business entity is best for your house-flipping business.
If you are actively engaged in flipping real estate, it’s essential that you limit your liabilities by forming a business entity that keeps your personal assets safe, such as a Limited Liability Company. LLCs are legally separate from their owners, so this means if your business is sued, the plaintiff can’t access your personal assets to cover the judgment.
There are several alternatives to the traditional LLC that can supercharge your asset protection. The Series LLC, for example, lets you create a veritable labyrinth of mini-LLCs (called “series”) that not only protects your personal assets from business liabilities but also protects each property from your other properties’ liabilities.
Using a two-company structure
I’ve helped many of my house-flipper clients benefit from a two-company structure that pairs a traditional LLC with a series LLC. In this model, the traditional LLC serves as a shell company that manages day-to-day operations like collecting rent and paying employees.
While the traditional LLCs runs the business, the series LLC exists simply to hold the business’s assets. The series LLC should not participate in your daily business operations at all. To maximize this structure’s effectiveness, you should create one series for each property so that each asset is isolated from your other assets.
What is the benefit of this type of two-company structure? The traditional LLC becomes the would-be litigant for potential lawsuits, but since it doesn’t own any of your property, your assets remain untouchable. The series LLC has limited exposure to liability because it doesn’t engage in business operations. By keeping these two functions structurally separated, you can avoid many lawsuits before they are filed because it’s much harder for a plaintiff to recover with this structure in place.
Related: LLC or Umbrella Insurance: Which Is Better for Investors?
Another reason LLCs are a favorite among flippers is the benefit of pass-through taxation. This means that the business itself is not taxed, but its profits and losses are reported as the members’ personal income, avoiding the double-taxation that comes with a corporation.
With an LLC, you can choose to be taxed as a partnership or sole proprietorship or as an S corporation (S corp). While an S corp can significantly reduce taxes for some flippers, others won’t benefit from this structure. I strongly recommend seeking advice from a CPA or attorney with significant real estate investing experience if you’re considering electing for an S corp.
Additional considerations for flippers
Here are a few more topics to discuss with your lawyer when choosing the legal entity for your flipping business:
What percentage of your business will be flipping?
If your business will focus exclusively on flipping houses, your approach will likely be different than that of a real estate investor who only flips some properties and holds other properties long-term.
How often will you conduct transactions?
Some business entities are better than others for frequent transactions, so it’s essential that you determine how often you will be buying or selling properties.
How active will your business be?
By its nature, flipping is a much more active investment than other real estate investing strategies. You should discuss how many properties you intend to invest in and flip when deciding how to best structure your entity for your business plan.
Do you need a real estate license?
Even though a real estate license might not be legally necessary, some flippers may benefit from having one or employing someone who does. No matter what works best for your business plan, you should consider this factor in the decision-making process.
Anonymous trusts: Another layer of asset protection
If you want to add another level of asset protection to your plan, you should consider forming an anonymous trust to serve as the owner of your LLC.
Make sure to seek help from an experienced real estate investment attorney in the formation process. This will not only guarantee that things are done properly, but also that your business is structured as advantageously as possible.