However, starting REITs can be challenging, especially if you’re a first-timer. Luckily for you, we’re here to help. In this blog, we’ll explore how real estate investment trusts work and discuss the different benefits that they offer to LLCs.
How Do Real Estate Investment Trusts Work?
Real Estate Investment Trusts (REITs) are companies that buy and manage real estate investments. It’s modeled after a mutual fund where real estate investors or shareholders pool capital to create an investment portfolio and purchase profitable properties.
The income their portfolio generates will then be distributed to shareholders as dividends.
Types
There are three common types of REITs:
- Equity REITs: These companies purchase and manage rental properties. They profit from the rent they collect from their tenants.
- Mortgage REITs: These REITs lend money to real estate owners or operate through mortgages or loans. They earn income from the interest on the loans they offer.
- Hybrid REITs: Hybrid REITs combine both equity and mortgage REIT models.
REITs can also be classified depending on how they purchase and sell their shares:
- Publicly Traded REITs: The shares of these REITs are listed on the national securities exchange. They’re regulated by the U.S. Securities & Exchange Commission (SEC).
- Public Non-Traded REITs: Just like publicly-traded REITs, the shares of public non-traded REITs are regulated by the U.S. SEC. The only difference is that they’re not listed on the national securities exchange.
- Private REITs: These companies are not registered with the U.S. SEC, which means their shares can only be sold to institutional investors.
Qualification
Now, for your company to qualify as a REIT, it needs to follow the requirements of the Internal Revenue Service (IRS):
- Maintain a portfolio with at least 75% of total assets allocated to real estate, cash, or U.S. treasuries.
- Generate a minimum of 75% of gross income from rents and mortgage interest from real property or real estate sales.
- Commit to distributing at least 90% of taxable income to shareholders through annual dividends.
- Operate as an entity subject to taxation as a corporation.
- Must be managed by a board of directors.
- Have at least 100 shareholders after its first year of existence.
- Ensure that no more than five individuals collectively hold no more than 50% of its shares.
How to Start A Real Estate Investment Trust
Here’s what you need to do to start a real estate investment trust:
Pick A Type
First, you must decide what type of REIT you want to form. Do you want to purchase properties, or are you more interested in helping other real estate owners?
The REIT type you choose will determine your company’s investments, taxes, and overall operations. Before you make a decision, we suggest you look into the advantages and disadvantages of each type.
Form A Corporation
Under U.S. laws, businesses must be structured as corporations to qualify as a REIT. Once you finalize what type of REIT you want to create, you must form a corporation.
The formation process for corporations varies from one state to another. However, they typically require applicants to submit their Articles of Incorporation and corporate bylaws to their respective Secretary of State.
Draft A Private Placement Memorandum (PPM)
A Private Placement Memorandum (PPM) is the legal document you give to possible investors when selling your company’s stocks. It’s typically used in private transactions, where the U.S. SEC does not regulate the deals.
A well-written report should address how your REIT plans to distribute its profits and discuss any potential risks investors must know.
Look For Investors
According to IRS requirements, your company must have at least 100 shareholders by its second tax year to qualify as a REIT. This means you can start your operations with two or more shareholders if you reach the requirement a year later.
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If you fail to have 100 shareholders, you’ll lose your REIT status, which could be bad for your investor relations.
Turn Your Corporation Into A REIT
After you fulfill the IRS requirements, you can turn your corporation into a REIT by filing a Form 1120-REIT with the IRS.
REITs & Limited Liability Companies (LLCs)
There’s denying that there are a lot of risks in owning and managing multiple properties. One asset could endanger all of your other holdings. So, how do REITs protect themselves from such threats? By creating a Limited Liability Company (LLC) within its structure.
LLCs are a type of business structure that offers strong liability protection to its owner. It protects entrepreneurs like you from any debt or lawsuits your company might incur.
Some REITs would establish LLCs for specific properties they deem risky. This way, they can protect their other assets from liabilities it may get. In other instances, REITs would create series LLCs, which is a type of LLC that provides each property with its own separate legal entity.
Series LLCs are fairly new, so only a handful of states recognize them, including:
- Delaware
- Illinois
- Iowa
- Nevada
- Oklahoma
- Tennessee
- Texas
- Utah
Establishing LLCs within your REIT is a great way to manage risks effectively. By segregating your properties, you can reduce the potential impact of financial or legal challenges on the rest of your portfolio.
However, it’s worth noting that creating an LLC in REITs is not easy. There are a lot of tax and legal implications you must consider before you proceed with the formation.
If stronger asset protection is vital for you and your shareholders, we recommend you consult NCH’s legal and tax experts.
Start Investing Today
NCH specializes in simplifying the creation of REITs for savvy investors like you. Our expert team guides you through every step, from structuring your REIT to optimizing tax benefits.
Start building your real estate investment trust today, and let NCH help you make smart investments. To learn more about our services, you can visit our website here or call us at 1-800-508-1729.
DISCLAIMER: The above material has been prepared for informational purposes only, containing opinions of the provider, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Please consider consulting tax, legal, and accounting advisors before engaging in any transaction.
