Holding companies are more than a typical business. Holding companies provide owners with a method of managing multiple businesses or investments using the same name. The main purpose of a holding company is to own assets or hold investments.
These may earn or lose money each year, but the business will not offer goods or services of its own. Many of the top real estate companies in the United States are holding companies and some of them are considered operating companies despite being holding corporations under current tax laws.
What is a Real Estate Holding Company?
Most often, real estate holding companies are set up as limited liability corporations. Real estate holding corporations exist in order to own multiple properties and retain them for management. The corporation is always a distinct entity from the primary business, and the real estate LLC earns income from interest. The LLC can also earn rental income from the property it owns.
Despite this, real estate holdings are known as somewhat of a risky business. Because of this, investors typically prefer to separate their liabilities and assets by forming a holding company.
Advantages of a Real Estate Holding Company
There is always risk when real estate investors make business transactions. With that risk comes the possibility of losses. A few causes of these losses might be because a property underperforms, or with liability issues. There are many advantages when it comes to forming a holding company. This is sometimes compared to that of a sole proprietorship or a limited liability company.
Here are 6 key advantages of real estate holding companies.
- Tax Incentives: Ability to avoid capital gains tax, and write off business expenses.
- Easy to Subsidize: It is possible to obtain government financing when it comes to having a real estate holding company depending on your tenants.
- Liability Protection: Forming a real estate holding company is similar to forming an LLC when it comes to liability protection because you are forming a new separate entity.
- Simple to Expand: There is no limit to expanding a real estate holding company.
- Voting Control: It will be set up in the articles of incorporation, how members are able to vote.
- Leverage Financing: Use debt as equity.
Disadvantages of a Real Estate Company
It is good to note that there are a variety of advantages to a holding company, but there can be disadvantages as well. The biggest disadvantage to owning a holding company is the risk of higher taxation. In order to avoid paying tax on capital gains, the holding company must legally own 80 percent of its subsidiary company stock.
Otherwise, capital gains tax must be paid on all revenue earned. This includes the sale of stocks, bonds, real estate, and other holdings. Other disadvantages include the costs of a Real Estate holding company, such as annual costs, and formation or start-up costs.
8 Steps to Start a Real Estate Holding Company
Follow these 8 simple steps to create a real estate holding company.
- Set Up the LLC for Your Real Estate Holdings: The first step of starting a real estate holding company is to set up an LLC. This is important because it creates a separate business entity and provides limited liability protection.
- Apply for an EIN number online
- File Articles of Incorporation at the Secretary of State office
Draft an operating agreement including:
- Ownership and operations rules
- Percentage interests of members
- Rights and responsibilities of members
- Management duties
- How profits and losses are handled
- Open separate checking accounts for business and personal reasons. This will keep your business assets separate from your personal assets, and provide you the ability to properly write off expenses when it comes to doing taxes.
- Find a property that fits your investment goals and budget: In order to actually operate as a real estate holding company, you must purchase real estate. Finding a property that fits your needs and your budget is essential.
- Secure financing for the property: This might include private financing, lender financing, or bank financing.
- Close the property under the name of the holding company: The final step in operating as a real estate holding company is to close on the property and begin practicing business. Whether this is to renovate and flip (resell) the property or to collect rental payments.
Cost of Creating a Real Estate Holding Company
Costs vary by state when it comes to forming a real estate holding company because it is essentially the cost to set up an LLC. The average state filing fee to set up an LLC is $127. This is if you’re doing it yourself, but if you choose to use an attorney, the average cost of setup is $1,000 or more.
Typical costs to set up an LLC include:
- State filing fees: Range from $10-$800 as a one-time fee
- EIN number: Free to obtain
- Annual LLC fees: $0 – $800, depending on the state your LLC is formed in
- Operating Agreement: $20 or more for a template
Should You Start a Real Estate Holding Company
If you plan to invest in multiple real estate properties, doing so as a holding company is the most secure option. This can help you to avoid personal liability, especially if you are working with other people on the investment. For the owners of small businesses, forming a holding company offers protection of assets and the reduction of taxes.
You may not need to open up a real estate investment company if you only plan to purchase one piece of real estate and want to rent it out. Despite this, it will offer you liability protection to at least form an LLC to purchase the property.