In this economy, it seems like more people than ever before are becoming landlords, whether that was in their original plans or not. If you’re looking to move, but you can’t sell your home without losing money, renting it out is a great option. In an effort to save money, many people are opting to manage their own properties instead of hiring a management company. If you find yourself renting out property, whether a house, a condo, or an apartment, just make sure that you draft a strong lease agreement that will protect both your rights and the rights of your tenant. This agreement needs to be clear, well organized, and detailed. Here are five mistakes to avoid when drafting your own lease agreement.

1. Relying on Verbal Agreements

As much as you like your new tenants and hope that they will pay their bills on time and take good care of your property, you simply cannot afford to make the mistake of only making verbal agreements. Discussing your terms and shaking on it isn’t going to cut it. To protect yourself and your tenant, you must draft a legally binding written agreement, signed by both parties.

2. Writing a Vague Agreement

If ever there was a time for precision and detail, this is it. Don’t just throw together some sloppy agreement and have your tenant sign at the bottom. You need to list the property address, the length of the lease including the specific dates of that time frame, any specific regulations regarding pets on the premises, any damage already present in the home, and other details like eviction policies and late payment fees. The more specific you are, the easier it will be to sort through any problems that may come up in the future.

3. Forgoing a Background Check

As much as you might like to simply trust everyone that applies to rent your property, you must conduct a background check prior to accepting an application. Yes, it might cost a little bit to have this done. However, this information, including credit history and criminal background, is vital. You are entrusting someone with your property. It only makes sense that you need to do your homework in order to ensure that you find a trustworthy tenant.

4. Forgoing an Initial Inspection

Although it will take a bit of your time, make sure that you conduct an initial inspection of your property with your tenant. During this inspection, make a written list noting any damage to the property including stains in carpeting, nail holes in the walls, and other issues related to the structure and cosmetic appearance of the property. Once the list is complete, both parties should sign and date the document. This will come in handy down the road when your tenant is preparing to move. At this point, you can walk through the property again and it will be clear what damage occurred after the tenant took up residence in the unit. This will allow you to receive proper payment for any repairs you need to make.

5. Forgetting to Collect a Deposit

Finally, it is imperative that you collect a deposit. You can include this stipulation in your property listing and you should also detail the amount of the deposit and the parameters for refunding the deposit in your lease agreement. You may want to collect the equivalent of one month’s rent at the beginning of the lease and stipulate that a certain percentage of the deposit will be refunded when the lease is concluded. It is wise to make a portion of the deposit non-refundable to cover the cost of having the property cleaned in between tenants. You will also want to state in your lease that the cost of repairs for any damage caused by the tenant will come out of the deposit. A deposit adds an extra level of security for you as a landlord and gives your tenant added incentive to pay their rent on time and take care of your property.

Trying to choose the right business structure to achieve your goals may seem like an overwhelming process.  In making your selection, it’s important to weigh the legal and tax ramifications of each to find which best fits you.  Below is a breakdown of the most common business structures to help make your decision a little easier:

Limited Partnership

A Limited Partnership (“LP”) is comprised of one or more general partners and one or more limited partners.  LPs are creatures of statute – you must file a form with the state to bring one into being.  A LP exists apart from its creators as a distinct legal entity.  This means it can sue, be sued, and own property on its own.  General partners are in charge of daily operations and are still personally liable for the company’s obligations and debts.  The limited partners invest capital in the company and share in the profits, but take no part in the daily operations.  A LP protects limited partners from personal liability; liability is restricted to the amount of capital the limited partner has decided to invest.  LPs distribute funds among different shareholders as “dividends”.

Benefits of a Limited Partnership:

• Tax benefits are a big perk for this particular business structure. A LP pays no federal income taxes; instead, partners report their share of the profits and losses on their individual federal income tax returns.
• The LP files an information return with the IRS noting each partner’s share of the year’s profit or loss.  LPs also provide numerous tax deductions to employees.
• Even a one-person LP can take health insurance and entertainment deductions, and the general partner is allowed to deduct pension plan and 401(k) expenses.
• LPs also provide attractive liability protection for limited partners.  When a limited partner is sued, the assets inside of the LP are protected from seizure.
• It is also easier to attract outside financing, as investors are easier to come by when they can be shielded by becoming a limited partner.  Forming a LP also provides an initial legal framework while promoting credibility and anonymity.

Detriments of a Limited Partnership:

• In LPs, the general partner(s) take on the dirty details of business management and assume personal liability for the obligations and debts of the company.
• As a separate legal entity, there is some paperwork required for start-up.
• There are also corporate formalities that must be adhered to throughout the life of the LP. LPs must also plan for their duration — otherwise the partnership dissolves when a general partner leaves, dies, or succumbs to bankruptcy.

Examples:

TruGreen Salt Lake

2435 West Custer Road

Salt Lake City, UT

www.trugreen.com/saltlake

866-319-4936

Limited Liability Company

A Limited Liability Company (“LLC”) is a business structure that can vary from state to state.  In Utah, a LLC is created by completing and filing “Articles of Organization” with the Utah Secretary of State. A LLC allows for an unlimited number of owners, or “members,” and “managing members”, all of which are protected by limited liability. The managing member is usually the mouth piece or nominal head.  As an LLC member, you can contribute capital and assets to the LLC or loan the LLC money.  You can then obtain repayment for your loan (plus interest), a distribution of profit, or a guaranteed payment from the LLC. “Guaranteed payment” is considered members’ earned income, qualifying them for the benefits of tax-favored “fringe benefits.”  A Utah LLC is a “pass through” tax entity. This means that the company’s profits and losses are passed on to the owners who must report it on their personal tax filings (IRS form 1040); LLCs do not pay taxes on a company level.  The LLC files a form 1065, listing each member’s taxable profit on IRS form k-1.  Members of an LLC can elect to have their LLC taxed as either a C corporation, or, by timely filing the 2553 form, as an S Corporation.

Benefits of an LLC:

• An LLC allows for an unlimited number of members and provides for the special allocation of profits. This means members benefit from receiving profits (and writing off losses) in excess of their individual ownership percentage.
• As a member, you will also enjoy limited liability, so your personal assets cannot be used to satisfy the LLC’s debts.
• The managing members are also considered “active” managers of the business, so their share of net profit is earned income – qualifying them for tax-favored “fringe benefit” treatment.
• There can also be tremendous benefit because of the flexibility by which the LLC can be taxed.
• Finally, if any member of the LLC dies, the LLC can still survive — subject to a unanimous vote by all surviving members to continue the business.

Detriments of an LLC:

• Each LLC member’s pro-rata share of profits is taxable income, regardless of whether or not the profits are actually distributed to him/her.
• The managing member’s share of the bottom-line profit is considered earned income and subject to self-employment tax.
• A member is considered an “inactive owner”, so their share of bottom-line profit is not considered earned income and cannot be used to obtain tax-favored “fringe benefit” treatment.

Example:

REFS-The Real Estate and Foreclosure Specialists

635 W. 5300 S. Suite 303

Murray, UT

http://www.refs-utah.com/

801-747-CASH

Corporation

You create a corporation (a.k.a. C Corporation) by filing documents (“Articles of Incorporation”) with the state.  A corporation is a legal entity apart from its owners (shareholders).  Corporations can establish credit, acquire assets, and enter into contractual engagements. Potential liabilities are incurred by the corporation, not by the owners themselves.  This means that the personal assets of officers and shareholders are usually safe from the corporation’s creditors.  However, if shareholders fail to follow corporate formalities, a court may “pierce the corporate veil”, allowing creditors access to personal property. Owners of corporations don’t pay tax on the corporation’s earnings unless they actually receive the money as dividends or as compensation for services (e.g. salaries and bonuses).  The corporation itself pays taxes on all profits left in the business.

Benefits of a Corporation:

• First and foremost, there is limited liability for shareholders.  This perk attracts investors, as an investor’s liability and exposure is limited to the amount of his or her investment – less risk! This makes raising capital for your corporation less challenging.
• Forming a corporation also increases the credibility of your company, and provides an opportunity for prestige among business and corporate officers.
• Finally, corporations have several tax, compensation and wage benefits.

Detriments of a Corporation:

• You have to observe corporate formalities.  These are the basic operating rules that are necessary to ensure that the corporation maintains its status as a separate legal entity.  Some of the formalities include appointing officer positions, electing a board of directors, proper documentation of the corporation’s activity, annual meetings, etc.
• Reaching corporate status is not a monumental task, but one must be sure to ensure the process is done correctly.
• Another downfall is that a corporation goes through double taxation.  A traditional corporation must pay tax on all corporate income, followed by individual shareholders paying income tax again on whatever distributions they received. One way to avoid the double taxation dilemma is to establish the corporation as a “pass through” entity.  This way all corporate profits pass through to the individual shareholders, so they alone will be responsible for the tax burden.  When a corporation elects to be treated this way, it becomes known as an “S” Corporation, which is discussed below.

Examples:

Larry H. Miller Group of Companies

Several Locations throughout Utah

www.lhm.com

801-563-4100

Nonprofit Corporation

Nonprofit organizations are formed in the state where they intend to do business. Unlike a standard corporation, nonprofits do not conduct activities for the financial gain of shareholders.  Preventing the distribution of profits to members/shareholders is what distinguishes the nonprofit from a commercial enterprise; yet nonprofits still provide asset protection and limited liability.  A nonprofit corporation is not forbidden from making a profit — but if it does, that profit can only be used to further the overarching goal or mission of the organization.  Nonprofits can also trade at a profit and accept, hold and disburse money; but all profit and things of value are to be used to further the nonprofit’s quest.   Nonprofits are organized in many different ways: charities, service organizations, trusts, hospitals, universities, foundations, endowments and cooperatives can all operate as nonprofits.  Nonprofits can have “members”, although many do not.  They may have employees, and can compensate their directors reasonably, but only if compensation is documented ever-so-carefully.

Benefits of a Nonprofit:

• Nonprofit corporations generally have tax exempt status.
• Once the recognized nonprofit entity has been formed at the state level, the nonprofit corporation can seek tax exempt status by applying to the IRS.  The IRS, after reviewing the application to ensure the purpose of the organization meets certain conditions, will issue an authorization letter granting it tax exempt status for income tax purposes. The exemption does not apply to other federal taxes such as employment taxes. Charitable contributions made to nonprofit organizations by individuals and corporations are also deductible.

Detriments of a Nonprofit:

• The reliability by which a non-profit organization can hire and retain staff, sustain facilities, or create programs is an ongoing problem.  Because nonprofits generally rely on external funding, they do not have much say over their precious sources of revenue.  This leads to reliance on government funds such as grants, contracts, vouchers or tax credits to support their operations.

Example:

IHC (Intermountain Health Care)

36 S State Street

Salt Lake City, UT

http://intermountainhealthcare.org/

801-442-2000

Partnership

A partnership consists of more than one business owner; it comes into being whenever business takes place between parties, making them “partners”.  A “partner” does not need to be an individual.  Partners can be corporations, trusts, or other partnerships.  Partners take on profits, losses and liabilities together, and will generally create a written partnership agreement that clarifies their relationship.  It is important to keep in mind that a written agreement is not required by the law to find that a partnership exists — actions alone can suffice.   As for tax purposes, a partnership is considered a “pass-through” entity because taxes pass through to the owners on their personal tax returns. Each owner must report his or her percentage share of income on the individual form 1040 for federal income taxes.  Partners are not considered employees of the partnership; they are treated as self-employed, so each partner will be responsible for self-employment tax.  If a partnership has employees, the business must pay employment taxes.  This includes withholding and reporting federal and state income taxes, paying and reporting social security and Medicare taxes, worker’s compensation taxes, and unemployment taxes.  If the partnership owns real property, property taxes will also be required.  Finally, partnerships are required to pay state sales taxes and excise taxes.

Benefits of a Partnership:

• A partnership is easy to start and allows business profits and losses to be reported on the individual tax returns of each owner.
• Start-up paperwork and legal necessities are also at a minimum, as most states only encourage the drafting of a partnership agreement.  Despite this, it is important to look into the required licenses and certificates when forming a partnership.
• Finally, in a partnership you can capitalize on the managerial and financial strengths of each individual partner.

Detriments of a Partnership:

• Partners have unlimited personal liability for the debts and obligations of the company.
• Additionally, each partner can bind the company to outside obligations without the approval or permission of the other partners. Therefore, one partner’s decision can leave every other partner’s personal property vulnerable should a lawsuit result in an unfavorable outcome.  This divided authority can also cause internal disputes.
• Finally, without advanced planning, the partnership can fall apart very quickly; the death of a partner terminates the business arrangement.

Example:

Legal firms, e.g. “The Law Offices of Smith, Jones and Daniels”

S Corporation

Congress has clarified that all corporations are divided into two groups: S Corporations that fall under IRS revenue code subchapter S; and C Corporations, which encompass all other corporations. Your first step in creating an S Corporation (“S Corp”) is to form a traditional corporation.  Next, you must file a special form (form 2553) with the IRS, along with any other local state documentation.  S Corp status is effective for a tax year if form 2553 is filed: (a) any time during the previous tax year, or (b) by the 15^th day of the 3^rdmonth of the tax year to which the election is to apply.  An S Corp is similar to a traditional corporation with partnership-like traits.  Utah’s S Corps are for those who desire the limited liability and formal structure of a corporation, but can’t give up pass-through taxation.  Your business must meet S Corp qualifications and all shareholders must agree to S Corp status. An S Corp is generally treated like a partnership for federal income tax purposes. It files an “information” tax return to report its income and expenses, and is not separately taxed as a traditional corporation.  Income and expenses of an S Corp “flow through” to the shareholders in proportion to their share holdings, and profits are taxed to the shareholders at their individual tax rates.

Benefits of an S Corporation:

• One of the primary advantages of being treated as an S Corp is the pass-through taxation described above.  There is only one tax at the individual shareholder level.
• This is in contrast to a corporation where taxation occurs first on the company’s income level, then again at the individual owners’ distributions out of that income. Shareholders therefore enjoy “the best of both worlds” with an S Corp: they have the pass-through taxation benefits of a simple partnership, but the limited liability and asset protection of a corporation.

Detriments of an S Corporation:

• With an S Corp you cannot have an unlimited number of members – shareholders are restricted to a designated number.  In Utah the maximum is 35 shareholders.
• There is also a possibility that the IRS may look passed your subchapter S status for tax purposes if there is only one shareholder.  This is more likely to occur when formalities are not adhered to – so remember, always stick to corporate formalities, they are worth the trouble!
• Finally, you are restricted to just one class of stock with an S Corp.