WHAT KIND OF ENTITY SHOULD I SET UP FOR MY PROPERTIES???
Part I...
I am going to tell you a story this morning about an event that occurred in the 1970s but is still very appropriate to discuss today. When you start a business or purchase real estate you have to set it up in a proper entity to protect that asset and all of your assets. This story has to do with a business and not real estate but the moral of the story is universal!
When I was a young lad, in 1969, I moved from New York to Los Angeles to work in accounting. I wasn't even a CPA yet, I was all of 23 years old. I got a job in New York for Los Angeles with an international accounting firm and the name of the firm was very long but their initials were L K H & H. I was a staff assistant the first year, I was out of college for 1 year and taught high school in New York when I graduated college for one year. So, I started working at this firm and they had many clients. I might add that in the accounting profession there are different levels. I started out as a “Staff Assistant” where everyone starts out. I am proud to say that I was one of only two people ever in the Los Angeles office, with over 100 employees, to skip a level and make “In Charge Senior” in only one year where everyone else did it in two or three years.
They had one particular client that they had an ownership interest in. It was a glass contracting company of all things. The first lesson here is do what you know and don't get involved in projects or businesses that you have no knowledge of. That is called absentee management and, although, you get to see the financial reports and have monthly meetings and wonderful dinners and drinks after the meetings, and I have seen this, when there is a problem, maybe a BIG problem, you cannot contribute to the solution because you are not trained in this industry.
Back in 1969 there were no Limited Liability Companies (LLCs). There were Corporations, Subchapter S Corporations and Limited Partnerships that gave the owners limited liability. This international CPA firm, who works with so many attorneys, was in a GENERAL PARTNERSHIP with this glass contracting company. General Partnerships have no limited liability and all of the assets of all of the partners are subject to seizure if the company goes bankrupt. Just keep that in mind as I continue the story.
This glass contracting firm had three different partnerships and, since it was so long ago, I really do not remember the reason for this. But all three entities were general partnerships. That means that we had three “In Charge Seniors” on the job at the same time. I was one of those In Charge Seniors at this point in my career. In Charge Seniors in an international CPA firm are all Certified Public Accountants, have at least 3 years accounting experience or more and supervise a staff of two to four assistants below them.
The partnership between the CPA firm and the glass contracting company had been going on for many years and at the end of each year’s assignment the In Charge Seniors would submit the financial reports and a list of recommendations to the glass contracting company and the CPA firm, their bosses. The glass contracting company could not be audited because of a lack of independence between the two entities due to common ownership. One of those recommendations from the In Charge Seniors to the glass contracting company and the CPA firm EVERY YEAR was that the company should incorporate and afford themselves the benefit of LIMITED LIABILITY. But they never did it!!!!! This is the second lesson to take note of.
One day the glass contracting firm got a job to put all of the outside glass on the MGM Hotel and Casino in Las Vegas, Nevada. By the way, the outside of that building is all glass. Everyone was thrilled because they were all going to make millions of dollars. The rest of the story is all down hill.
The glass contracting company could not complete the job and they were all sued by the MGM Company and they lost the lawsuit. Everyone had to declare bankruptcy. The Managing Partner of the International CPA firm went from driving a Rolls Royce to driving a Toyota. The CPA firm broke up into many different firms and many of the partners just started their own CPA firms. Remember, there were hundreds, if not thousands, of partners who had nothing to do with this company but they were all affected by the bankruptcy.
The moral of the story is to always set up any entities that you create, whether they are involved in real estate, glass contracting, doctors and dentists and every other business to protect yourself and all of your assets that you worked so hard to get. There are Corporations, Subchapter S Corporations, Limited Partnerships, Limited Liability Companies or Partnerships or Limited Family Partnerships that you could set up to protect your assets. PLEASE seek the advice of a competent attorney and CPA before you set up your entity.
These days most individuals investing In Real Estate automatically set up LLCs for each property or for groups of properties. With the current tax laws, you should definitely seek the advice of a competent Real Estate CPA before making that decision. Then there is the question, are you a Real Estate Professional or are you a Real Estate Investor. That question could have a big effect on your tax returns as well.
My name is PAUL LEVINE and I am a Commercial Realtor in Southern California from Santa Barbara to San Diego. I help my investor clients build, buy, and sell Multifamily Housing. I also help investors and realtors throughout the United States and Canada with commercial transactions if they need my expert help. I can always be reached at (818) 298 – 4000 or at PLevineRealtor@gmail.com. I was a practicing CPA for over fifty years before becoming a Commercial Realtor and I was an Associate Professor of Accounting for six and a half years.