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Should I Remain a Sole Proprietor or Form a Separate Entity?

Dec 1, 2017

Posted by

Jeff Bergerson

Jeff Bergerson founded Bergerson Tax Services Inc. (BTS) in 2002years ago and pilots a rapidly growing practice in St Paul, MN. Jeff holds multiple business degrees from The University of St Thomas, i Read more

Should I Remain a Sole Proprietor or Form a Separate Entity?

There are a couple of main reasons why you should consider forming a separate entity for your real estate business.  The first reason, and probably the most important, is for liability purposes.  When you form these entities you are creating separation between your business and your personal assets such as your home, vehicles, or personal savings.  In the event that you become subject of a lawsuit through your business dealings and you have properly created a separate entity for your business, your personal assets generally would not be in jeopardy. 

Real estate professionals expose themselves to potential lawsuits on a daily basis by performing such ordinary duties as meeting with clients at their home or office or using their personal vehicle to drive clients to and from properties. If you are a sole proprietor there is no separation that distinguishes your business from your personal assets and owners would be personally liable for all lawsuits or business debts.

According to Tony Novak, a civil litigation attorney at the law firm of Larson King, LLP in St. Paul, MN, “Business owners should also be aware that properly establishing a corporate entity is only the first half of the process.  During litigation, aggressive plaintiffs’ attorneys may attempt to “pierce the corporate veil” in order to access the business owner’s personal assets.  This means that owners need to run their business as its own separate entity, not merely an extension of its owner’s personal affairs.  Tony also adds that, “typically, when deciding whether to ‘pierce the corporate veil,’ Courts will look beyond whether the corporate entity was properly established, into the substance of the business’ operations.

Some of the factors considered by the Courts include:  whether the business was sufficiently capitalized, whether corporate formalities were observed (including corporate records) and whether the existence of the corporation is merely a facade for the individual shareholder’s dealings.”  Although there are websites available to help you incorporate your business for a low fee, be careful that you are satisfying all of those factors that the courts would look at.  The benefits of hiring a good tax attorney to set up your corporation far exceed the cost in my opinion.  They can help determine if an LLC, C-corporation or S-corporation is suitable for you, which entity would be most appropriate for your particular business, and make sure all of your corporate records are handled properly.

Another reason to form a corporation or LLC is to take advantage of tax savings options that are not available to sole proprietorships or partnerships.  For example, corporations can establish pension, profit-sharing and stock ownership plans, which can lower the corporation’s taxable income.  Medical, life and disability insurance premiums may also be deductible for some entities.  In addition, other fringe benefits and distributions in the form of dividends might also be available for certain entities.  Be sure to meet with your tax professional to make sure you are taking advantage of all the possible deductions available to your business.

1) Frequent Question:  “I work out of my home for my real estate business, can I use it as a deduction on my taxes?”

If you use a portion of your home for business purposes, you may be able to take a home office deduction.  Generally, in order to claim a business deduction for your home, you must use part of your home exclusively and regularly:

As your principal place of business, or

As a place to meet or deal with clients or customers in the normal course of your business, or

In any connection with your trade or business where the business portion of your home is a separate structure not attached to your home.

For certain storage use, you are required to use the property regularly but not exclusively.  The amount you can deduct depends on the percentage of your home used for business.  For example, you have a room in your home that has an area of 200 square feet and you use it exclusively for your business.  The entire area of your home is 1,000 square feet, you can deduct 20 percent (200 divided by 1,000) of such expenses as your electric, water, gas, garbage, repairs and maintenance, and so forth.  If you perform maintenance or repairs exclusively to your office you can deduct 100 percent of them.  This could be a valuable deduction for some businesses with many factors involved such as area of your office as a percentage of your home and expenses incurred. Your deduction for certain expenses will be limited if your gross income from your business is less than your total business expenses.

2) Frequent Question: “My day consists of driving, what is the best way to maximize my deduction for vehicle expenses?”

First of all, the definition of deductible transportation expenses include the ordinary and necessary costs of all the following:

Getting from one workplace to another in the course of your business or profession when you are traveling within the general area that is your tax home.  Your tax home is your regular place of business or post of duty, regardless of where you maintain your family home.  It includes the entire city or general area in which your business or work is located.

Visiting clients or customers.

Going to a business meeting away from your regular workplace.

Getting from your home to a temporary workplace when you have one or more regular places of work.  These temporary workplaces can be either within the area of your tax home or outside that area.

If you are an employee or self-employed and do not have a home office, transportation between your home and your main or regular place of work are personal commuting expenses and therefore not deductible.  The following examples show when you can and cannot deduct transportation expenses based on the location of your work and your home:

a.) Your principal place of business is in your home.  You can deduct the cost of round-trip transportation between your qualifying home office and your client’s place of business.

b.) You have no regular office and you do not have an office in your home.  In this case, the location of your first business contact is considered your office.  Transportation expenses between your home and this first contact are non-deductible commuting expenses.  Transportation expenses between your last business contact and your home are also non-deductible commuting expenses.  Although you cannot deduct the costs of these trips, you can deduct the costs of going from one client or customer to another.

c.) You regularly work in an office in a city where you live.  Your employer sends you to a one-week training session at a different office in the same city.  You travel directly from your home to the training location and return each day.  You can deduct the cost of your daily round-trip transaction between your home and the training location.

Automobile Expenses

When deducting automobile expenses you can use one of two methods: Actual expense method or the standard mileage allowance.

The actual expense method allows you to deduct all of your out-of-pocket costs including:  gas, insurance, oil, lease fees, maintenance, repairs and a separate deduction for depreciation.  If you are an employee who uses a car for business, you cannot deduct interest on a car loan, but if you are self-employed, the interest may be treated as business interest. 

The standard mileage allowance is a set rate that changes every year (51 cents per mile in 2011 and it incorporates all of the above expenses.  This method simplifies record keeping and you do not have to do the tedious depreciation calculation.  If you choose to use the standard mileage allowance for a car you own, you must choose to use it in the first year the car is available for business use.  A choice of the actual expense method for the first year will forever bar the use of the standard mileage allowance in subsequent years.  If you use the standard mileage allowance, you can still use the actual expense method in later years. If you qualify for both methods, before choosing a method, you may want to figure your deduction both ways to see which method gives you a larger deduction.