“One is the loneliest number.”
A sole proprietorship is the simplest ownership form under which can operate a business and consists of a single person. It is not a legal entity but rather a business form in which there is no separation between business and owner. Many sole proprietorships operate under the owner’s name, i.e. Ryan Rauner; however, they can also operate under a fictious or trade name, i.e. Ryan’s Nail Salon, which does not create a separate legal entity.
Here are the pros and cons of operating as a sole proprietorship:
Pros
- Ease of creation – Sole proprietorships are created the moment an individual does business for oneself. There is no formal filing or event, only buying and selling goods or services is required.
*** Sole proprietors must still register their name and secure any licenses required for their particular business activity, i.e. real estate license. - No cost – there are no formal costs to set up a sole proprietorship.
- Little to no formalities – Sole proprietors do not need to file articles of incorporation with the state, hold formal meetings, etc. Owners typically sign contracts and receive payments under their own name even if the business uses a trade name. They can also comingle business and personal funds/assets.
- No unemployment tax (on owner) – Owners are not required to pay unemployment taxes on themselves (but must for any employees).
- Tax advantage (losses) – Because income, expenses, gains, and losses are reported on the owner’s individual tax return any losses from operations can be used to offset income earned from other sources.
- Simplicity of taxation – Owners must only fill out and file a Schedule C along with the standard Form 1040 to report income, losses, and expenses. Sole proprietors must also file a Schedule SE to calculate the amount of self-employment tax owed.
Cons
- Unlimited personal liability – Perhaps the largest disadvantage to a sole proprietorship is that the owner is subject to unlimited personal liability for the business’ debts. If an owner borrows money to operate the business and is unable to repay the loan or is sued by another party for negligence the owner’s personal assets, such as their house, retirement accounts, etc. are at risk.
- Difficulty raising capital – Because they consist of a single person and thus cannot sell interests in the business, sole proprietorships may have difficulty raising capital.
- Mortality – Sole proprietorships end with the death of the owner and thus do not retain any value.
- Self-employment tax – Owners of sole proprietorships must pay self-employment taxes up to legally mandated limits, which amounts to double taxation as the owner must pay both the employer and employee portion of the tax for a total of 15.3%.
Taken as a whole the advantages of sole proprietorships are outweighed by their disadvantages and, as a result, are not the ideal form of ownership for real estate investments. The unlimited personal liability, alone, puts the owner at risk of losing more than just their equity in a particular investment as courts can proceed against the individual’s personal assets to satisfy judgments.
As always, it’s recommended to speak with an attorney before deciding on which business entity works for your personal situation.