All real estate agents must decide what type of business structure is best for their agency, whether it is an existing independent contractor sales office or a new startup the owner wants ready when the doors open. While many real estate agents will choose a sole proprietorship, this may not be the best decision in the long run when taxes and cash flow inconsistencies occur within the scope of business operations.
Protecting personal assets becomes a priority quickly and is often of primary concern from the very beginning of starting a real estate business. The best method of protecting personal wealth is by setting up the agency as a company before even generating sales income. Even a first commission for a real estate agent can result in significant earnings that could be taxed at the highest income rate if the business is not structured properly.
The question, then, becomes what is the proper business entity type for real estate professionals?
Agents who are independent contractors with a major real estate company and who are not focused on growing their individual business will usually operate as a sole proprietorship. The owner is the manager and only party liable for any legal issues the agency may face from dissatisfied clients. Income tax rates are higher as well, but the only taxpayer is the owner. This is the simplest form of business entity, and it can work well for small agencies.
Forming a real estate agency as a limited liability company can be an excellent choice where multiple sales personnel will be finalizing transactions. Limited liability companies (LLCs) have a general owner who serves as management while the other agents are limited in liability regarding legal issues arising from conducting business. This establishes the company as a pass-through entity, allowing the real estate agents to maintain their own personal income tax accounts.
It also allows the owner to designate commission rates. The LLC entity is not required to pay income taxes, and sales commissions processed through the company can be held as company property when necessary.
Limited liability partnerships work well for agents who are doing business together in a central or multiple locations. The terms of the partnership can determine the extent of liability for each partner based on the amount of investment or cash flow generated. Many independent agents will decide along the line that networking with other service industry professionals in the realty industry can increase local real estate market share and reduce competition.
Some real estate agents will actually opt to incorporate their business at some point, even if the business began as a sole proprietorship or LLC. However, there can be advantages and disadvantages of incorporation.
One primary advantage is that all personal wealth is protected from claims against the business entity. This can be very important when a real estate agent is being sued for errors or omissions made when conducting business. Incorporating a business insulates even the largest stockholders, as well as allows for the issuance of additional stock to those wanting to invest. Other advantages include establishment of benefits and retirement programs for employees and management officials alike.
The primary disadvantage of incorporating is that reporting rules and tax liabilities are more stringent, meaning it may not be right for the smaller real estate agent who is not focused on building a major agency.
There are two basic types of corporations, with those being S and C designations by the IRS, and deciding on the right one for an agency requires evaluation of possibilities that could arise during business operations.
If you’re wanting to learn more about how to form an LLC or LLP or incorporate your real estate business, MaxFilings helps you do it with confidence with our Real Estate Incorporation Guide.