When I was a freshly-minted real estate attorney (my firm now employs over 400 people in four states), I was all about the asset protection and the tax savings. I would give my clients great strategies on how to reduce their taxes to nearly zero and make their assets disappear on paper. I developed some great techniques, some of which I still use today, for helping real estate investors accomplish specific goals.
But it wasn’t until I became a real estate investor myself that I learned an important lesson: all the choices you make in your business must come together in an organic, mutually supportive way. What law school couldn’t teach me, and what I had to learn by doing, is that a successful real estate investing business is a three-legged stool.
A stool can’t stand on two legs. Nor can it stand if one of the legs is longer or shorter than the others. All three legs must come into balance with one another. The three legs of the successful real estate investor’s stool are asset protection, tax planning, and business planning.
1. Asset protection is about making sure you’re not putting your entire business or your personal wealth at risk if something goes wrong in your life or business.
A major aspect of asset protection is privacy. Lawyers can’t take what they don’t know you own. I talked about this in an earlier post—you want to disguise your assets so that, in a lawsuit, the opposing attorney is likely to accept your insurance policy limits and walk away. In the perfect privacy scenario, you want to appear as if you don’t own a blessed thing.
The problem, though, is that if you do such a great job disguising your assets that even a banker can’t figure out what you actually own, you won’t be able to borrow money to build your business. After all, where’s your supposed equity? Where’s your track record of success?
2. Tax planning has similar issues. When it comes to taxes, everyone wants to pay as little as possible. Early in my career, I supported this one-legged goal, but now when an investor comes to me for tax strategies, I’ll ask them, “What are your plans for the future? Are you planning to buy more real estate? Will you seek financing to do that?” If so, you don’t want to appear, on paper, as if you don’t earn any income. No lender will come near you.
3. Business planning is the third leg of the stool, and really the most important one. The one that keeps the other two in balance. I didn’t think about it enough when I was only an attorney, not an investor. Business planning is about serving your business as a whole and making the right decisions to foster its growth. Every decision you make regarding the other two legs must support the long-term best interests of the business.
Business planning might involve, for example, creating the right structures for your business so you can take needed steps forward. For example, your tax accountant might have told you to set up an S-corporation to run your business. The problem is, if you do that, all that income shows up in your 1040. And that invites scrutiny. Lenders will ask for copies of your tax returns and will go through them with a fine-tooth comb, looking for anything that might affect your ability to repay the loan.
It may be better to set up a C-corporation and pay yourself a wage as a W-2 employee. I’ve found that lenders are more comfortable lending to W-2 earners.
All three legs of the stool need to work in harmony to support what you’re trying to accomplish for the big picture of your business. If you balance the three properly, then when opportunities and challenges come along, you’ll be able to take smart, decisive action, because you haven’t cut off one of your own legs.