What is the best business structure for a real estate investment company? We’ll be exploring that question in a series of future posts. Today, we’ll investigate one kind of structure . . . a sole proprietorship.
Sole proprietorships are the most basic, and least complicated, business structure. When you are a sole proprietor, you are simply doing business as yourself. Many kinds of professionals – from carpenters to CPAs to shoemakers – choose to function in this way.
There are good reasons for that. When you are a sole proprietor you are in the driver’s seat of your own business. You make the decisions, decide how much salary to pay yourself, and don’t have to report to a board or to stockholders. However, you also incur personal risk if your business loses money or fails.
Some of the advantages include:
- You make all the decisions yourself. You pick the properties that you will buy and develop. You decide how much money to spend, and when. No one can rent an apartment to a tenant you wouldn’t approve, or sell your property for a price that you know is too low. You have all the control.
- Your business is easy to run. You can probably manage your business with the help of only an attorney and a tax accountant. That’s because you are enjoying one of the basic freedoms we have in the United States – the right to conduct business as an individual.
- You can treat your holdings the same way you treat all your personal property. If you want to give some of your buildings to your children or set them aside in a trust for them to inherit, you can. Your sole proprietorship is basically an extension of yourself.
Yet sole proprietorships pose some disadvantages too:
- You are personally liable for losses. If your building sits vacant for a year and no one buys or rents it, you will be the only person who suffers the damage of negative cash flow. You need to make doubly sure that your insurance is adequate, since it is protecting your personal finances, not those of a corporation or LLC. And if someone slips on the stairs of your building and gets hurt, you are the person who gets sued.
- You don’t enjoy certain tax advantages. All your business income and expenses are reported on the Schedule C of your personal tax return. If you die, your spouse and heirs may have to pay a lot of inheritance tax instead of inheriting all of the money you worked so hard to earn.
- The rising value of your properties can become a liability. If you divorce, for example, the “on paper” value of your holdings can become a real asset to which your former spouse can lay claim. If you decide to sell properties for a great deal more than you paid for them, you will probably pay capital gains taxes – or implement other strategies, such as rolling your profits over by buying other properties. Be sure to consult with your attorney or tax advisor.
- Accounting for business profits and expenses can get complicated. Let’s say that you have been taking a tax deduction for a home office. If you sell your house for more money than you paid for it and move, you may have to pay capital gains tax on the increased value of your home office, based on the percentage of space it occupies in your home. So seek the advice of an accountant before you decide whether a sole proprietorship is the best choice for you.