<blockquote style="border-left-color: rgba(255,0,0,0.5); background-color: #faf2cc;"><div class="lesson-quote--tag orange">NOTE</div>
<p>This article does not constitute investment or legal advice. This article was created for informational and educational purposes only. We recommend that you seek the advice of a professional attorney that specializes in real estate before you create your business entity. </p></blockquote>
Creating a business entity for your house flipping business is an important step to ensure that you are compliant with state and federal business regulations and limit your personal liability.
Do I Need To Create An Entity For My House Flipping Business?
Whether you are flipping houses as a side hobby or deciding to transform your hobby into a business, creating a business entity is not necessarily required by the State or Federal Government. You can flip houses as an individual without creating a business entity, but creating a Business Entity should be considered to limit your liability and provide potential tax savings.
What Type Of Entity Should I Create?
Generally speaking there are two different types of business entities that you could use to setup your house flipping business:
- LLC (Limited Liability Company)
For most house flippers creating an LLC will be the best option to help them easily form and manage their business, limit their personal liability, and provide potential tax benefits.
LLC (Limited Liability Company)
A Limited Liability Company is an unincorporated business entity, that provides benefits such as limited personal liability, less paperwork, and tax flexibility for you as a business owner.
Advantages Of Creating An LLC
Limit Personal Liability
The main reason for creating a business entity is to limit your liability and protect your personal assets from loss if anything goes wrong on your flip. You may personally own a residence, a car, and have personal savings, while your Business Entity may only own the flip property itself, a business computer, office equipment, etc. If you have a properly structured and maintained business entity, your Business Assets would be considered separate from your personal assets. In the event that your Business was sued, your personal assets would be protected, and your Business Assets would only be at risk.
LLCs are easier to form and require less annual paperwork and documentation than Corporations. You will only need an LLC Operating Agreement that establishes the rules to govern and manage your business.
Tax Flexibility & Savings
- Tax Elections Members of the LLC have the flexibility to elect how they want to be taxed, so they can be taxed as a Sole Proprietor, a Partnership or a a Corporation.
- No Corporate Taxes - The Profits from the business aren't taxed at the Corporate level, but will pass through to the individual members tax filings. This is a double-edged sword, because although you will be avoiding Corporate taxes, you will have to pay Self-Employment Taxes.
- Potential to Limit SE Taxes - LLC's that elect to be taxed as an S-Corp can potentially limit their tax liability on Self Employment taxes.
Disadvantages Of An LLC
Self-Employment Taxes - Unless you elect to be taxed as a Corporation, you as a Sole Proprietor or Partner will have to pay Self-Employment Taxes which is currently 15.3%. Again, if you elect to be taxed as an S-Corp there is potential to save on SE Taxes. Talk to your attorney or accountant to discuss the best entity and strategy to minimize your tax burden.
How To Create An LLC
File Organizational Documents with Your State.
To create an LLC, a business owner must file organizational documents with their Secretary of State and pay a small application fee of generally around $50. Logon to your Secretary of States website, and fill out an online application for your business.
Create Articles of Organization or Operating Agreement.
Some states will require that you create and file a document called the Articles of Organization or Operating Agreement. Your Articles of Organization or Operating Agreement is a document that details how the business will be run, and how the profits will be distributed to the owners of the company. Even if your state does not require these organizational documents it is a good practice to create an Operating Agreement to set the terms of business operation, and profit distribution in case of a conflict.
Get Federal Employer Identification Number (EIN)
Sole Proprietorships and LLC are not required to get EIN for their business if they do not have any employees However, if your business will have employees working for you, you will need to file an application for a EIN. The EIN is used by the IRS to track your businesses tax obligations. Apply Online for a Federal EIN.
Open a Business Bank Account with Your Business Name.
Open up a Business Bank Account and adequately capitalize the LLC with funds to support the on-going business operations.
Create a Business Credit Card Account with Your Business Name.
Once you open a Business Bank Account, you should also create a Business Credit Card account for paying for business expenses.
Conduct Your Business Affairs Separately From Your Personal Affairs
Once you formally create your Business Entity with the State and get your Bank Accounts & Credit Card Accounts setup, you can start conducting business. The way that you conduct your business is one of the most important aspects of legally owning an LLC.
If you as the business owner don't treat the LLC as a separate business, a court might decide that the LLC doesn't really exist and find that you are really doing business as an individual and hold you personally liable. For this reason, it's important to keep your Business Affairs separate from your Personal Affairs.
Keep Separate & Accurate Books.
One of the main reasons you should create a Business Bank Account & Credit Card Account is to help you keep your business financials separate from your personal financials. For one, having separate accounts makes the accounting process much easier to track. Secondly, having separate books will provide a paper trail for the courts to prove that you are a legitimate business.
Sign Contracts and Leases on Behalf of the LLC.
When you sign a contract with a contractor or a lease with a tenant, sign the contract on 'behalf of the LLC', just as if you were signing contracts for another person.
Track Owner Contributions, Distributions & Loans.
As a sole business owner it is tempting to take money out of the company and put money back-in whenever you see fit, but this kind of casual accounting blurs the lines of your personal financials and your business financials. Pay yourself a salary on a regular schedule to prove that you are an 'employee' of the business entity.
Other Items To Consider
Get Liability Insurance
An LLC provides protection for your personal assets, however, your business needs protection as well. If your LLC was sued, your personal assets should be protected, but the lawsuit could financially cripple your business. For this reason, it's important to consider getting business liability which will protect your business from liability issues on your property such as a contractor or pedestrian getting hurt. In the event of event of a lawsuit, the business liability insurance would cover the court costs, legal fees and damages paid to the claimant.
Talk To A Professional!
Setting up your business properly upfront is an important first step to protect your personal assets, business assets and limit your tax burden. All flippers' personal situations, legal statuses and financials are different, so it's important to work with at legal or tax professional so they can create a business entity that is tailored for your specific needs.