Real estate holding companies are the best way to protect your personal assets from the liabilities associated with buying and selling real estate. A holding company is the legal entity that holds assets, collects profits, and assumes liability for you.
While you absolutely should create a holding company any time you plan to invest in real estate as a form of business, there are different kinds of companies that you can establish to best serve your needs and protect you from loss. It all depends on your unique situation and what you plan to do with the real estate you purchase.
Parent-Child Holding Company
Depending on your business needs, you might find it beneficial to set up multiple companies to purchase and manage your investments. A parent company is the primary company that owns one or more smaller companies or businesses. The parent company assumes control of smaller companies by either buying them outright or owning a majority of the smaller companies’ stock.
The companies that are owned or otherwise controlled by the parent company are known as child companies or subsidiary companies. Child companies are usually somewhat related to the parent company as far as a specific industry is concerned, but it’s not uncommon for the relationship between parent and child companies to go undisclosed. That’s because child companies are separate legal entities from the parent company.
Child companies operate as their own business, and are related to the parent company only insofar as they are legally owned by the parent company. However, parent companies do receive tax benefits and enhanced legal protections from investments in child companies.
Sister-Sister Companies
When a parent company owns multiple child companies or subsidiaries, those subsidiaries are referred to as sister companies. Just like child companies can act independently from their parent company, sister companies are often unrelated. In fact, sister companies can even act as competitors on occasion.
There are cases, however, when sister companies will act together. If they operate in the same market or industry, sister companies can negotiate deals on product pricing, share marketing budgets, or even share vendors and supply chains.
Scenario 1: Individual LLCs Own and Manage the Property
When it comes to real estate, your holding company needs to pull double duty. Not only do you need a legal entity under which to buy, sell, and manage property, but you also need to protect yourself from liabilities. The simplest way to organize your holding company is to create an LLC that does it all.
That means your LLC is a single holding company that conducts all the business associated with your real estate investments and endeavors. Your holding company is the entity that applies for financing, owns the property, manages the property, performs repairs, sells the property, and assumes all risks associated with that process.
Having an individual LLC that owns and manages the property creates an adequate barrier between your own personal finances and those associated with your real estate investments. You’re only responsible for reporting income for one company, and any legal ramifications only affect the holding company itself.
Scenario 2: Individual LLCs Own Property That’s Managed by a Property Management Company
While it’s perfectly acceptable to have a single LLC own and manage a property, there’s another way to create even more risk protection in real estate investment. That’s where parent-child holding companies and sister-sister companies come into play.
A parent holding company would purchase and sell real estate. The holding company would be responsible for applying for financing, owning the property itself, and selling the property. The child company would assume all management responsibilities for tenants, repairs, and maintenance. This arrangement creates another layer of asset protection between the child company and the individual behind the LLC.
For even more protection, an LLC in the form of a real estate holding company would create two child companies or subsidiaries. These subsidiaries would act as sister companies, supporting the interests of the parent company. In this example, one sister company would be responsible for purchasing and selling real estate, while the other sister company would maintain and manage the property.
The Bottom Line
When embarking on your real estate endeavors, it’s important to structure your business ventures in a way that protects your assets while meeting your goals and abilities. You don’t want to create multiple subsidiaries and sister companies if you don’t have the business experience or available funds to support multiple businesses. Overcomplicating your holding company’s responsibilities won’t make your investments any more solid. Instead, allow your holding company to work with you, fulfilling your needs and protecting your assets as you grow your business.
Holding Company Examples
The easiest way to demonstrate the advantages of a holding company are through examples. Setting up a holding company, and accompanying subsidiaries, is popular for investors in industries as diverse as real estate, trucking, finance, e-commerce and more.
It’s commonly understood the benefits of creating a Limited Liability Company or a Corporation. They are asset protection, lower taxes, increased professionalism and (sometimes) privacy.
Less understood are the reasons to create a holding company, or how to go about structuring your business in the most efficient manner. Just as a business entity provides benefits unavailable to a sole-proprietorship, so too does a holding company provide benefits unavailable to a single business entity.
Holding Company Advantages
A holding company may be set up with a parent-child or a sister-sister relationship. Each has their intricacies, but here we will cover the general benefits of a holding company before moving to specific examples.
- Better Asset Protection
- Potentially Lower Taxes
- Enhanced Privacy/Anonymity
- Easier to Buy/Sell
Asset Protection
A single entity creates a separation between the assets of the owners and those of the business. This is called the corporate veil and prevents an accident with the company from affecting you personally. For example, if someone slips and falls at a rental home, then they can sue the company which owns the home – but they cannot personally sue the owner.
The limitation of the corporate veil is that it does not prevent business creditors from pursuing business assets. For those with real estate, intellectual property, valuable equipment, large bank accounts, etc. this means much is still at risk.
Fortunately, holding these assets in a separate company can help. For example, a distribution company could hold their warehouse and trucks in one company, with another managing operations. The operational company manages employees, schedules deliveries and signs contracts with customers.
If there is an accident, then the operational company (which does not hold assets) is the first line of defense. Similarly, a real estate company may hold property in one company and use a separate company for property management.
Lower Taxes
The simplest method for lowering taxes is the fact the new tax law provides additional write offs to businesses that sole-proprietorships do not have. This is available to all business owners.
Having multiple companies allows you to flow money through in the most efficient manner possible. For example, many use a corporation at the top to enjoy the low 21% federal tax rate. Others, in more advanced scenarios, use an offshore company to hold assets in a low or no tax jurisdiction.
One scenario is forming a Wyoming Corporation may own your trucks and your operating LLC, in a higher tax state, can pay it for the lease. This would work in any state that has no corporate tax rate. This diverts money from a high to a low tax area in a legal way. This is referred to as transfer pricing.
Enhanced Privacy
Some states allow anonymous companies and others do not. Some allow anonymous LLCs and Corporations, whereas others allow just LLCs. The most common anonymous states are Wyoming, Nevada and Delaware. New Mexico is rising in popularity, but only allows anonymous LLCs.
Individuals in states such as Florida and California are required to disclose significantly more information. Fortunately, through using a “Double LLC” this can be avoided.
Florida requires the owner of an LLC be listed. To avoid listing yourself, you may form an anonymous LLC in New Mexico and list it instead as the owner. This satisfies Florida’s disclosure requirements without sacrificing your personal privacy in the process.
As identity theft, and aggressive creditors, become more common so too does this strategy. It is not simply for those with “something to hide”, but can be effectively used to minimize your digital footprint and the chance you become a victim of circumstances.
Buying/Selling Companies
Those with many lines of business, such as e-commerce stores, will find they may want to buy or sell existing brands. This is made easier when each revenue stream was maintained as a separate company. The company can be spun off, and the account more easily valued, when separate books and records have been maintained.
The alternative is one company with many different revenue and expense streams that cannot be easily separated. This scares off potential buyers and makes valuations more difficult.
Separating accounts in this way also provides asset protection as mentioned above. Why let one line of business potentially affect another? For example, candles or kids toys are high risk, whereas selling t-shirts and hats is not. Separate them at the beginning to avoid any issues later on!
Examples
What follows is a cursory overview of several industries which commonly use holding companies to further their business objectives.
Real Estate Holding Company
Real estate investors commonly use holding companies because their assets are simultaneously valuable and inherently risky. Each property can be easily put into its own silo to avoid the liabilities of one property from affecting another.
Generally, there is a master company at the top with children LLCs at the bottom. Each LLC is owned by the master and holds a single property. That LLC is in charge of hiring contractors, signing agreements with tenants and maintaining the property.
Investment Holding Company
Those with diverse financial interests often bring them under a single umbrella company. This simplifies finances and brings the ability to move funds between companies more easily.
Only the holding company must file a financial return. This is referred to as a consolidated filing since all the subsidiaries “consolidate” their filings into one at the top.
If one entity is generating significant cash flow, then it can be moved to the company at the top and optionally to another subsidiary as needed. This both moves money away from a subsidiary, which could experience a credit event, and allows funds to be moved towards companies which may need it more such as a start-up company.
E-Commerce Holding Company
E-commerce companies often represent a diverse collection of brands and interests. You may wish to keep the relationship between these entities hidden. One revenue stream may also be riskier than others and pose a risk to the whole organization if lumped together, e.g. children’s toys or candles.
