Do you need a register an LLC to obtain a hard money loan for your real estate investment? Let’s explore the LLC and hard money loans so you can decide.
What is a Limited Liability Company?
A Limited Liability Company (LLC) is a formal business structure that is the simplest to form and maintain. Creating an LLC offers some of the same benefits as a corporation, without the costs and compliance complexity. Business owners who are looking for personal liability protection, tax flexibility, and management options may find that registering an LLC will be an ideal choice for their company.
When it comes to investing in real estate, most investors choose to create a separate legal entity to purchase a property. The reason? To protect personal assets from liabilities associated with real estate transactions. Moreover, the Limited Liability Company (LLC) business structure has become a preferred entity of real estate investors for some very good reasons.
The LLC business structure offers many benefits:
- Limits personal liability
- Provides tax treatment flexibility
- Is relatively simple to establish and maintain
- Costs less to set up and maintain
- Offers more flexibility in how you distribute profits
- Makes it easier to give real estate investments
- Can be owned by a non-U.S. individual or company
- Is preferred by hard money lenders
Keep Learning: Is A Real Estate LLC Really Necessary?
What is a Hard Money Loan?
What is a hard money loan? A hard money loan is a type of loan primarily used for real estate. The lender is not a traditional bank, but rather an individual or another business. Because hard money loans usually use property as collateral, are used to raise money quickly, and have an inherently higher risk, they usually cost the borrower more money.
Hard money lenders are set up as business investors and terms for the loan depend on the value of the property being used as collateral. Therefore, borrowers are not as much evaluated on creditworthiness, as they would be if they had gone to a bank. For example, borrowers looking to flip a property (buy, renovate, and resell) would seek a hard money loan because even though the loan is costly, the borrower plans to repay the loan quickly (from one to three years).
Hard money loans may also be sought when borrowers need a quick infusion of cash. The approval process is usually much quicker than applying for a traditional loan and lenders are not as concerned about repayment because they can always sell the property used for collateral if the borrower defaults on the loan.
Finally, hard money lenders do not make consumer loans, so to make sure the lender knows the loan is a business investment, you should set up the real estate under an LLC.
Benefits of Real Estate LLCs
In addition to making the process easier for hard money lenders to approve, setting up your property purchases under a real estate LLC offers you many benefits, also.
An LLC limits personal liability
As a property owner, any casualties occurring on your property are your responsibility and could put you at risk for lawsuits. If the property is owned by a company, such as an LLC, it is a separate entity and the responsibility belongs to the entity. Therefore, your personal assets would be protected, and only the LLC’s assets would be exposed in the lawsuit.
An LLC offers tax advantages
LLCs offer the option of pass-through taxation of profits and losses, whether they have a single owner or multiple owners. When it comes to tax filing for an LLC, the IRS considers a real estate holding company with one owner a sole proprietor for tax purposes. Income and profit or loss of the LLC pass through directly to the owner’s personal tax return and must be reported on a Schedule C.
With no income tax for the LLC to pay, the owner avoids double taxation (i.e., she only pays tax at her personal tax rate for the rental income and appreciation in property value). Another benefit is that the owner of a single-member LLC can use mortgage interest as a tax deduction.
Multi-member LLCs are typically taxed like a partnership. A multi-member LLC needs to file an informational tax return but will not pay taxes as a company. The LLC’s members (owners) will report and pay income tax on their individual tax returns via a Schedule C or K (with Form 1065).
An LLC requires fewer compliance obligations
An LLC is not required to have officers and directors to oversee the business as you would in a C Corp. LLC owners can manage the business, or you can assign third-party managers to do the job.
An LLC allows you to pass the real estate to your heirs
With an LLC, you can gift your real estate holdings to your heirs each year. Therefore, over time you can pass your owned properties through an LLC without being required to execute, record new deeds and pay the state’s transfer and recording taxes and fees.
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