Holding Companies Explained
What Is a Holding Company?
In an effort to mitigate risk by isolating specific properties from any other assets, many investors create and utilize holding companies. Most commonly found in the form of a limited liability company (LLC), a holding company protects an investor’s assets by placing everything of importance regarding the ownership of a commercial real estate asset under its name instead of the investor’s. This typically includes all of the asset’s relevant ownership and financing documents such as the deed, contract, and any active mortgages.
What Is the Purpose of a Holding Company?
Holding companies are often deployed as a hedge against liability. Usually, if any legal actions are pursued relating to a property, those charges would typically fall on the owner of said property. As an illustration of this, consider: Should someone slip and fall while on the grounds of an apartment complex, they may choose to file a lawsuit against the owner of the property — and more often than not, the owner of the asset would need to compensate the victim, possibly putting personal assets at risk. With a holding company as the owner of commercial property, payment would be the responsibility of the holding company — not risking the personal wealth of the investor.
Liability aside, holding companies can also present investors with some interesting tax benefits. For starters, holding a commercial real estate asset under a separate legal entity makes separating business finances from personal finances substantially easier when it comes to filing taxes. Additionally, there are a few significant business income tax deductions investors may be able to reap by operating via an LLC in some states — adding to the plethora of deductions commercial real estate property typically owners enjoy such as asset depreciation, property taxes, and insurance.
Related Questions
What is a holding company and how does it relate to apartment loans?
A holding company is a limited liability company (LLC) that is used to protect an investor's assets by placing ownership and financing documents of a commercial real estate asset under its name instead of the investor's. This helps to mitigate risk by isolating specific properties from any other assets. Holding companies also help reduce a commercial real estate investor’s risk profile and the potential liabilities they could incur as a result of owning an investment property. In addition, the separation that a holding company provides often makes things easier from a financial reporting and taxation standpoint.
Life Companies offer an interesting alternative to Fannie Mae and Freddie Mac apartment financing, in that they have longer loan term options and exceptionally competitive interest rates. As a matter of fact, many investors would agree that life companies are also the most competitive option for larger balance ($10MM and up) commercial real estate loans for properties including office buildings, retail centers, single-tenant retail (Walgreens, Target, Walmart, CVS, etc), and other commercial properties. Still, they do have a few shortcomings. For example, they are known to be less competitive when it comes to leverage, especially when it comes to cash-out refinancing. Additionally, life companies tend to focus on the highest class/quality assets and therefore are very selective when it comes to financing.
What are the benefits of using a holding company for apartment loans?
Holding companies help reduce a commercial real estate investor’s risk profile and the potential liabilities they could incur as a result of owning an investment property. In order to minimize risk, a holding company isolates one or more properties from an investor’s other assets, making it harder for a creditor or a plaintiff to repossess (or be awarded) their property. In addition, the separation that a holding company provides often makes things easier from a financial reporting and taxation standpoint. From a liability perspective, it’s almost always a good idea for an investor to start a holding company, rather than to personally own a piece of real estate or to hold it in a company with a variety of other assets.
The benefits of using a holding company for apartment loans include reducing risk, isolating properties from other assets, and making financial reporting and taxation easier. Additionally, it can help protect an investor from potential liabilities.
What are the risks associated with using a holding company for apartment loans?
Using a holding company for apartment loans can help reduce risk and potential liabilities for commercial real estate investors. However, there are still some risks associated with using a holding company. For example, if the holding company is not properly structured, it may not provide the desired level of protection from creditors or plaintiffs. Additionally, if the holding company is not properly managed, it may not provide the desired level of financial reporting or taxation benefits. It is important to consult with a qualified attorney or accountant to ensure that the holding company is properly structured and managed.
What are the legal requirements for setting up a holding company for apartment loans?
The legal requirements for setting up a holding company for apartment loans vary depending on the jurisdiction in which the company is being established. Generally, the process involves filing the necessary paperwork with the relevant government agency, such as the Secretary of State or the Department of Corporations. Depending on the jurisdiction, the paperwork may include articles of incorporation, a certificate of formation, or a certificate of authority. Additionally, the company may need to register with the state's taxation department and obtain a federal tax identification number.
In addition to the legal requirements, the company may need to obtain a business license, register with the state's labor department, and obtain any necessary permits or licenses. Depending on the type of business, the company may also need to obtain insurance and/or bonding.
For more information on setting up a holding company for apartment loans, please consult a qualified attorney or accountant.
What are the tax implications of using a holding company for apartment loans?
Using a holding company for apartment loans can provide investors with some interesting tax benefits. For starters, holding a commercial real estate asset under a separate legal entity makes separating business finances from personal finances substantially easier when it comes to filing taxes. Additionally, there are a few significant business income tax deductions investors may be able to reap by operating via an LLC in some states — adding to the plethora of deductions commercial real estate property typically owners enjoy such as asset depreciation, property taxes, and insurance.
If you’ve realized a profit as a result of the sale of your property, you’ll be required to pay capital gains taxes, rather than regular income taxes. However, if you’ve taken depreciation deductions against your income taxes, you’ll often only be expected to pay your regular (typically higher) income tax rate on those gains. This is a process referred to as depreciation recapture. Investors wanting to avoid paying capital gains taxes when selling a property, sometimes choose to engage in a 1031 exchange. This allows investors/owners to ‘exchange’ one commercial or multifamily property for another of equal or greater value, deferring the payment of their capital gains taxes until the sale of the new property.
In general, all apartment investors should hire a professional real estate accounting firm through the duration of their holding period. This will help ensure that the sale and tax payment process goes off without a hitch. Investors interested in 1031 exchanges will need to hire a 1031 exchange company, and, for certain types of exchanges, an exchange accommodation titleholder.