When faced with setting up their business for the first time, some people will say "can't I just run my business as a Sole Proprietor?" Well sure, but there are significant disadvantages to this. For example, it has been shown that sole proprietors are about 10 times more likely to be audited by the IRS. Also, if you have serious business setbacks as a sole proprietor, your personal assets could be up for grabs too. So it makes sense to use the correct type of business entity, but this alone isn't protection. You must run it correctly. Here are some missteps that real estate heavyweights should avoid when running their chosen business structure.
Using The Business For Fraudulent Activities or For "Unfair" Transactions
Lets say that Mr. John Doe starts an LLC and accepts monies from investors for the purpose of developing a section of land. But John never actually uses the money for this. In the lawsuit that follows John thinks his personal holdings will be left untouched as he was using an LLC. Well, guess what John? No court in this fine country of ours is going to think that way because fraud was involved. John's personal assets could get taken as well!
I don't think any of your would do something this stupid and unethical, but consider that some deals struck with "motivated sellers" could cause a lawsuit under your state's Deceptive Trade Practices Act (DTPA) or some similar statute. A rule under a DTPA action may be the equivalent of a fraudulent action. So make sure that your agreements are fair.
Failure to Keep The Business Separate From Its Owner
Don't mix money from business accounts with your personal accounts. Don't do things like buy personal assets, gifts, groceries, etc. with company money. If you do, maybe even just once, then your business structure isn't likely to hold up in court. The use of company and personal assets in the business can get sticky REAL fast.
Forgetting to File State Reports
States require you to keep up with reports and state taxes (sometimes referred to as franchise taxes) Yes, it's a tedious process, but if you don't keep up with these reports and/or taxes owed your business privileges will probably be revoked. Know what gets taken away first? That's right, they'll take away your corporate or LLC charter. In that happens, kiss your liability protection goodbye!
None of these points are meant to scare you away or rush you into creating a business entity. They're meant to impress upon hopeful real estate heavyweights the importance of getting a good asset protection plan together. It's not glamorous or sexy and some gurus shy away from the topic. But it's VERY important, and any investor worth his salt should spend time mapping out his business structure. NEVER neglect to plan how you're going to cover your assets.
This article is based a chapter of book Be a Real Estate Heavyweight, entitled Your Liability Protection and Real Estate Wealth Creation Secrets by Darius Barazandeh. For more information on the book, be sure to check out www.RealEstateHeavyweight.com
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