Holding Companies in Industrial Real Estate
Find out four steps to creating your own LLC for your next industrial property investment.
- What Are Holding Companies?
- Key Advantages of Holding Companies
- Different Types of LLCs Used as Holding Companies
- How to Set Up an LLC as a Holding Company
- 1. Pick a name.
- 2. Designate an agent
- 3. Prepare and File Articles of Organization
- 4. Create an Operating Agreement
- Other Considerations
- Related Questions
- Get Financing
What Are Holding Companies?
One classic way to reduce a commercial real estate investor’s risk profile is by isolating properties from an investor’s other assets through the use of holding companies, most commonly limited liability companies, or LLCs. A holding company essentially protects investors by placing everything related to the ownership of a commercial real estate asset — the deed, contract, and any mortgages — under its name instead of yours.
Key Advantages of Holding Companies
Using a holding company can be extremely beneficial from a liability standpoint. If someone trips and falls outside your warehouse, they could potentially file a lawsuit against the owner of the property. Should they win, the owner would need to compensate the victim. If a holding company is the legal owner of the asset, any payment would come from the holding company — not from an investor’s personal wealth.
Using a holding company also presents tax advantages. For starters, holding commercial real estate under a separate legal entity makes it significantly easier to separate business from personal finances when it comes time to file taxes. Beyond this, holding companies often enable investors to take a significant business income tax deduction, and many aspects of commercial real estate ownership — including asset depreciation, property taxes, and insurance — are also tax deductible. Even standard business expenses like travel and advertising can often be deducted.
Different Types of LLCs Used as Holding Companies
There are three main types of LLCs that you as a commercial real estate investor may be interested in. Each has its own tax implications.
Single member LLCs — e.g., a limited liability company where you are the only member — are not taxed directly, but instead taxation passes through to the sole member. You would file taxes on your personal federal tax forms. A partnership LLC with two or more investors typically requires that each member is taxed as a partner. Finally, LLCs can be created as corporations, which would lead to members being taxed as a corporation.
How to Set Up an LLC as a Holding Company
Creating your holding company involves a few key steps. These actions are heavily reliant on the state in which you’re registering your entity, so take special care to review any unique requirements that your state may have before you begin. However, broadly speaking, every LLC requires the following actions.
1. Pick a name.
You generally can’t pick a name already in use in your state, and certain words — like bank or insurance — may be restricted. It’s best to consult with the Secretary of State’s office of your state to determine eligibility. Most have a searchable online database to see if a name is available.
2. Designate an agent
Every LLC in every state requires a registered agent to receive formal official or legal documents on behalf of the entity. You can name yourself as a registered agent, or virtually anyone — the only requirements are that the person must be at least 18 years old and reside in the state where the entity is registered. Many investors elect to have a company act as a registered agent, though this comes with additional costs.
3. Prepare and File Articles of Organization
The next step is preparing all the paperwork for your LLC. You will need to utilize your state’s organization form, which typically requires basic information including the business name, your address, and the purpose of the entity, but other information like the entity’s management structure, registered agent details, and the length of time your holding company will exist are also required. Every state’s requirements differ slightly, and so it is best to check for the documentation you need as early as possible.
4. Create an Operating Agreement
While this step isn’t required by every state, it is extremely useful to draft an outline of your company’s rules, how profits and losses will be shared among members, and what percentage of ownership each member has, along with each member’s rights and responsibilities.
Other Considerations
Depending on the type of financing you require for your commercial real estate investments, a lender may require you to set up your LLC as a special purpose entity, or SPE. This type of entity may only own a single asset, and it is generally advantageous as a further limit on liability for CMBS and many other loan types.
Maintenance considerations for your LLC must also be considered. While some states charge little or no regular fee to keep a legal entity active, many do require an annual fee as well as regular business filings to update the state on your LLC’s activity.
Related Questions
What is a holding company in industrial real estate?
A holding company is a legal entity that is used to isolate one or more properties from an investor’s other assets, making it harder for a creditor or a plaintiff to repossess (or be awarded) their property. In addition, the separation that a holding company provides often makes things easier from a financial reporting and taxation standpoint. From a liability perspective, it’s almost always a good idea for an investor to start a holding company, rather than to personally own a piece of real estate or to hold it in a company with a variety of other assets. Most commonly found in the form of a limited liability company (LLC), a holding company protects an investor’s assets by placing everything of importance regarding the ownership of a commercial real estate asset under its name instead of the investor’s. This typically includes all of the asset’s relevant ownership and financing documents such as the deed, contract, and any active mortgages.
What are the benefits of investing in a holding company in industrial real estate?
Holding companies help reduce a commercial real estate investor’s risk profile and the potential liabilities they could incur as a result of owning an investment property. In order to minimize risk, a holding company isolates one or more properties from an investor’s other assets, making it harder for a creditor or a plaintiff to repossess (or be awarded) their property. In addition, the separation that a holding company provides often makes things easier from a financial reporting and taxation standpoint. From a liability perspective, it’s almost always a good idea for an investor to start a holding company, rather than to personally own a piece of real estate or to hold it in a company with a variety of other assets.
Holding companies are often deployed as a hedge against liability. Usually, if any legal actions are pursued relating to a property, those charges would typically fall on the owner of said property. As an illustration of this, consider: Should someone slip and fall while on the grounds of an industrial complex, they may choose to file a lawsuit against the owner of the property — and more often than not, the owner of the asset would need to compensate the victim, possibly putting personal assets at risk. With a holding company as the owner of industrial property, payment would be the responsibility of the holding company — not risking the personal wealth of the investor.
Liability aside, holding companies can also present investors with some interesting tax benefits. For starters, holding an industrial real estate asset under a separate legal entity makes separating business finances from personal finances substantially easier when it comes to filing taxes. Additionally, there are a few significant business income tax deductions investors may be able to reap by operating via an LLC in some states — adding to the plethora of deductions industrial real estate property typically owners enjoy such as asset depreciation, property taxes, and insurance.
What are the risks associated with investing in a holding company in industrial real estate?
Investing in a holding company in industrial real estate can help reduce risk by isolating specific properties from any other assets. However, there are still risks associated with this type of investment. These risks include potential liabilities, financial reporting and taxation issues, and the potential for creditors or plaintiffs to repossess the property. Additionally, investors should be aware of the potential for fraud or mismanagement of funds, as well as the potential for the holding company to become insolvent.
Sources:
What are the tax implications of investing in a holding company in industrial real estate?
Investing in a holding company in industrial real estate can help reduce risk and potential liabilities for commercial real estate investors. According to Commercialrealestate.loans, the separation that a holding company provides often makes things easier from a financial reporting and taxation standpoint. Wages paid to employees and independent contractors, as well as professional fees, are tax deductible on Schedule E of the tax return. If you pay an independent contractor more than $600 in a single calendar year, you will have to send and file 1099s for them.
What are the legal requirements for setting up a holding company in industrial real estate?
In order to set up a holding company in industrial real estate, you will need to choose a legal entity such as an LLC, C corporation, or S corporation. It is essential to have an ironclad operating agreement before signing the papers on your new real estate holding company. The operating agreement should include percentage ownership interests for each member, members rights and responsibilities, delegation of management responsibilities, and voting rights. For more information, please see Commercialrealestate.loans's article on Holding Companies in Commercial Real Estate.
What are the best practices for managing a holding company in industrial real estate?
The best practices for managing a holding company in industrial real estate are to have an ironclad operating agreement before signing the papers on your new real estate holding company. This agreement should include percentage ownership interests for each member, members rights and responsibilities, delegation of management responsibilities, and voting. It's also important to isolate one or more properties from an investor’s other assets, making it harder for a creditor or a plaintiff to repossess (or be awarded) their property. Additionally, the separation that a holding company provides often makes things easier from a financial reporting and taxation standpoint. For more information, see Commercialrealestate.loans.