Real estate wholesaling is an investment strategy that offers beginners an opportunity to enter the real estate realm with minimal investment capital requirements. The art of wholesaling resembles its sister strategy known as flipping houses. Each investment strategy requires similar due diligence, with wholesaling offering a faster and easier path to closing.
A real estate wholesaler targets properties that are typically priced below market value, usually because highly motivated sellers need to move distressed properties quickly. If done correctly, real estate investors can wholesale real estate without a real estate license, real estate broker, or real estate agent.
Wholesale deals can be done with an owner-occupied or rental property, a multi-family property, or distressed properties, like a foreclosure.
Wholesalers enter a real estate contract with a seller, receiving 'equitable interest' through the Principle of Equitable Conversion. But before closing on the initial purchase contract, the wholesaler assigns their' right to purchase' to another end buyer. As a result, the only required capital would be funding for the earnest money deposit.
The wholesaler uses an assignment of sale –the legal instrument that allows 'contracted buyers' to transfer their equitable interest to another buyer. The real estate wholesaler's gross profit is the pricing differential (between the initial and second purchase agreement).
Wholesaling real estate is like any other for-profit business with an objective to turn a profit. Like any business or organization, wholesalers can select from a number of business entities. These available business entity options are discussed below, including the use of a Limited Liability Company (a.k.a., LLC), a type of entity that a real estate wholesaler can establish under state statute.
In its simplest terms, business entities are organization types created by one or more individuals for the specified purpose of engaging in a trade, conducting business, or similar activities.
A business entity decision has important legal and financial implications, and the benefits and concerns for each are discussed below. These are the essential considerations when deciding how to structure your wholesale real estate business.
A sole proprietor is the simplest to establish and manage. It is defined by an individual or a married couple – acting as an owner & business operator. According to legal statutes, a business's sole owner is, by default, a sole proprietorship. Sole proprietors are not mandated to register with the state; however, they may need to meet licensing or permit requirements.
The most salient points regarding this entity are–
A partnership defines the legal relationship between two or more people who work together in trade or business. A general partnership is the default entity for multiple business owners and needs state registration.
Each partner contributes money, labor, or skill to a partnership, and each shares in the profits and/or losses.
A partnership is not allowed to be any of the following–
The partnership is required to file an annual tax return to report income, deductions, gains, losses generated from its operations. A partnership passes its profits and losses to its partners and members, who report it on their personal returns.
A corporation is an independent legal entity. It operates independently from its owners – a.k.a., shareholders. The corporation eliminates the owner's personal liability from the business debts and decisions. The corporation's officers and directors manage the company, although it is noted that only one person may perform each of these functions. So, one individual can create and control the entire incorporated business.
Corporations are ideal for larger businesses due to their expenses and laws that are to be followed. Each state sets forth its rules, forms, and fees for corporations. Corporations are great investment vehicles for venture capitalists or potential investors because it offers wider ownership.
The S Corp is part of the tax code added by Congress in the late 1950s to encourage family and other small businesses. This is because subchapter S avoids double taxation experienced by C corporations.
The S Corp offers limited liability protection (like the C Corp) but acts as a pass-through entity because S Corps have no corporate tax obligations.
An LLC is among the more popular legal entities. LLCs are formed at the state level, meaning the rules governing an LLC differ among states. An LLC is a great fit for startups and smaller companies.
LLC's offer an easy setup and a simple business structure. Creating and operating an LLC is generally less expensive than other C corporations with regard to compliance requirements.
LLCs offer protection from personal liability. For the most part, the debts and assets are owned by the LLC, not the owners. The LLC has no federal income tax obligation. The profit and loss simply pass through to the members and owners, who report it as personal income. LLCs have these tax filing options-
The selected business entity will directly impact the company's tax obligations and the ability of the company to borrow or raise capital. However, the main aspect to consider is how to protect yourself from potential lawsuits created by the business.
No, an LLC is not a requirement to successfully wholesale real estate.
But it may be a smart business decision to form an LLC as it offers protective financial and legal benefits to its owners.
As noted above, a Limited Liability Company (LLC) is a business entity that protects its owner's assets by offering a limited liability but with the simplicity provided by a sole proprietorship or partnership (i.e., the lack of legal, recordkeeping, & tax formalities & maintenance requirements).
Forming an LLC also opens the owner's ability to open a commercial bank account, obtain necessary permits or licenses and enter a legally enforceable contract of sale – without risk of personal liability.
One of the essential benefits of an LLC is the liability protection it offers its owners regarding their personal property. If the LLC, as a business, faces a lawsuit or creditors refuse to pay, business assets may be lost; however, the owners' property (i.e., car, home, savings & other assets) are protected.
In addition, a Limited Liability Company's tax structure allows a real estate wholesaler to avoid the double taxation typically found in corporate entities.
Instead of paying corporate taxes, the profits generated from the wholesale business, as an LLC, pass through to its owner(s). This saves on the expense of professional accountancy services required to file separate, more complex tax returns.
LLCs also help create a real estate wholesaler's professional image for future clients.
These are the steps to form a Limited Liability Corporation for a real estate wholesale business.
First, select a name for LLC in accordance with state rules. Each state's LLC regulations may differ, but most require –
Certain states may offer, for a fee, the option to reserve your chosen LLC for a short time, prior to the time the LLC files the Articles of Organization.
The formal creation of an LLC includes the filing of Articles of Organization. This is filed with the domicile state's corporate filing office, the Secretary of State more often than not.
A few states, like Washington, Delaware, New Jersey, Mississippi, and New Hampshire, refer to this document as a 'Certification of Formations.’ The Commonwealths of Pennsylvania and Massachusetts refer to this legal document as a 'Certificate of Organization.'
Often, articles of organization can be submitted online at the Secretary of State's website in your domicile state. To complete this filing, you will need the following –
Limited Liability Companies (LLCs) must have a Registered Agent (RA). The responsible party or RA can be an individual or company that agrees to accept the legal paper service on behalf of the LLC. The Registered Agent is required to have a physical street address in the domicile state in which the LLC is registered. An owner or member of the LLC may act as a registered agent. Most states maintain an ongoing list of private companies, aka commercial registered agents, that will act as a Registered Agent for a fee.
As one would expect, most small LLCs are managed by an LLC member; however, the company can appoint one (or more) non-members to manage the Limited Liability Company. These non-members would be like a Board of Directors who are responsible for corporate oversight.
Managers are the point people who are tasked with managing the business's financing, strategic planning, or the purchase of real estate, among others.
Most states do not require the creation of an operating agreement; however, it is a good idea.
An operating agreement acts as an internal memo that establishes how the LLC runs. If the LLC has no operating agreement, state law dictates the LLC's operations.
Additional regulatory & tax requirements may apply to your LLC. It is best to consult with a tax specialist or accountant.
Each state dictates the rules for whether an annual report must be filed – with a fee of as much as $750 each year. This LLC Tax and Annual Filings Requirements: 50 State Guide offers quick access to state requirements.
There is usually a nominal filing fee required when submitting the LLC's articles of organization. These fees vary by state, and on average, one can expect the fee to be around $100.
The specific requirements for forming an LLC in your state can be accessed by this link.
As noted above, after coming to agreed-upon terms with the seller, a real estate wholesaler enters a purchase & sale agreement with a seller. This fully executed contract (and the provision of an earnest money deposit) is the legal document that triggers a change in ownership dictated by the Principle of Equitable Conversion.
At this time, the buyer receives equitable interest, while the seller converts their interest to personal property until closing.
The purchase contract sets forth the terms of the deal and offers the buyer the opportunity –
But note, that while contracts generally allow for assignments (by default), homeowners or their representatives may modify the terms. Some contracts prohibit assignments or require that the seller or property owner approve the assignment. These are important terms for wholesalers, which can be changed through a mutual agreement by both sides of the transaction.
Forming an LLC is a strategic way to avoid situations where assignments are not allowed or conditioned-heavily contractually. Savvy wholesalers can enter a contract with a seller as the LLC-buyer and provide a deposit to be held in escrow.
When another buyer is selected, instead of assigning their equitable rights, the real estate wholesaler can simply transfer the ownership of the LLC to the buyer for a fee. In this regard, the original contract never needs modifying because the buyer didn't change. The only change was the LLC's ownership.
To be transparent, the seller should understand your intentions; however, the real estate transaction will likely proceed to close uninterrupted after this disclosure.
The double closing offers another technique to close for a real estate wholesaler operating as an LLC. As its name suggests, the double close is two closings – typically back-to-back, in which the wholesaler is the buyer in the first deal and the seller in the second transaction. One drawback of the double close is dual closing costs, including the filing and title company fees.
When a double close is done with an LLC, the wholesaler may complete the home buying purchase with the original seller and then sell the LLC to the final buyer after closing.
A wholesaler's brand offers the first impression that you want to relay to potential buyers and motivated sellers. Be sure not to pigeonhole your company and efforts by selecting too narrow a name.
Wholesale real estate LLC names may reflect your location, like Beacon Wholesaling, LLC.
Consider these important suggestions when considering a name for your Real Estate Wholesale business –
Which rolls off the tongue easier?
Although debatable, many professional marketers suggest a simple, short name – think Google or Apple. The general rule is to keep it to a maximum of three words (and ten syllables) to avoid branding issues.
Use alliterations or terms found in nature.
The entity that will best support a real estate wholesale business is contingent on the business goals and size.
Initially, an LLC may be the best choice before the wholesale business begins to turn a significant profit – somewhere around $50,000/year.
Once the LLC hits a certain income/profit level, it may make financial and legal sense to convert to an S Corporation.
However, each real estate wholesaler must determine which entity would serve them best by consulting with a real estate attorney or accountant professional.
In conclusion, wholesalers are certainly able to wholesale real estate without using a Limited Liability Company (LLC). With the many options available, from extremely simple to advanced corporate structure, the best option for you should be considered with your professional tax and legal advisors.
Successful wholesalers often choose an LLC, as it provides valuable flexibility. It protects the wholesaler's interests in the deal and provides more opportunities to wholesale multiple wholesale properties simultaneously.
Forming an LLC will help increase your real estate investing and wholesaling opportunities plus – likely improve your return on investment.
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