A Real Estate LLC (Limited Liability Company) business structure has become a preferred entity of real estate investors for holding title to investment properties. That’s not too surprising considering the advantages of forming an LLC:
- It limits personal liability.
- It provides tax treatment flexibility.
- It’s relatively simple to establish and maintain.
- It’s less costly to set up and maintain.
- It offers more flexibility in how you distribute profits.
- It makes it easier to pass real estate investments to your loved ones.
- An individual or a company beyond the United States can own it.
Let’s dive deeper into each of these benefits in relation to forming LLCs for your real estate investments.
Benefits of Forming a Real Estate LLC
Limits Personal Liability
In an ideal world, no accidents or mishaps would happen anywhere. But unfortunately, they do. And they can happen anytime, even on the most well-maintained and well-managed property. An icy sidewalk or a tenant’s wild party can bring unanticipated injuries to a visitor on your rental property. Even though the circumstances weren’t your fault, you, as the owner, would likely be the target of the lawsuit if the guest decided to sue.
Your personal assets would be at risk in the lawsuit if you personally owned the rental property. But if you instead form a Limited Liability Company to own the property, you establish your real estate holding as a separate entity from your personal self. Therefore, your personal assets would be protected, and only the LLC’s assets would be exposed in the lawsuit.
With much of what happens at an investment property beyond your control, that’s peace of mind that can help you sleep at night!
Offers Tax Advantages
Whether they have a single owner or multiple owners, LLCs offer the option of pass-through taxation of profits and losses.
By default, just as it does for all LLCs, the IRS considers a real estate holding company with one owner a sole proprietor (disregarded entity) 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 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.
Real estate holding companies with more than one owner are known as multi-member LLCs. The IRS will typically tax a multi-member LLC similar to a partnership. An LLC set up that way will need 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).
Has Less Setup and Compliance Complexity
Registering an LLC and ongoing compliance obligations are less complicated than with corporations. With an LLC, you’re not required to have officers and directors to oversee your business as you would with an S corporation or C corporation. Your LLC’s owners can manage your business, or you can assign third-party managers to do the job.
Cost Less to Set Up and Maintain
With many states charging higher fees to companies with a larger number of authorized shares, you will likely find it will cost less to register and maintain LLCs for your real estate investments than it would if you were to incorporate. The fees vary from state to state. Do your homework, so you know what to expect.
Provides Flexibility for Profit Distributions
In an LLC’s Operating Agreement, you can state how profit distributions should be handled. Rather than having them on a pro-rata basis to owners as with an S corporation, you can instead reward select members for the hard work they put into the LLC regardless of their ownership percentages.
Simpler to Pass Real Estate to Your Heirs
With an LLC, you can proactively gift your real estate holdings to your heirs each year. By doing so, over time, you can pass your real estate owned through an LLC to your loved ones—without being required to execute and record new deeds. This saves money because you avoid the state’s transfer and recording taxes and fees.
Allows for Foreign Ownership
With an S Corporation, only U.S. entities and investors can be owners. LLCs (and their real estate holdings) can be owned by individuals or by organizations outside of the United States.
How to Form an LLC
1. Choose a name
Although you may not plan to get too creative with the name, you’ll still want to check your state’s Secretary of State database or do a corporate name search to see if the name you want to use is available. Also, use a trademark search tool to see if any other business has already filed for a trademark on the name.
2. Obtain an EIN
An Employee Identification Number (EIN) is the equivalent of a social security number for your business. It’s the unique identification number your LLC will use to open a bank account and use it on certain documents. EINs are issued by the IRS and are free of charge.
3. File Articles of Organization
You must file Articles of Organization with the state in which you want to form your LLC. The information required varies depending on the state, but generally expect to share:
- Your LLC’s name and address
- The nature of your business
- The name and address of your registered agent
- The name of the members (owners) and managers of your LLC
You can file your Articles of Organization online through the Secretary of State website or print, complete, and submit it. To avoid the hassle and to make sure it’s done properly, consider having CorpNet take care of filing your Articles of Organization for you.
4. Create an LLC Operating Agreement
Even though most states don’t require LLCs to have an Operating Agreement, I suggest you consider creating one. This is especially true if it’s set up as a multi-member LLC. An LLC Operating Agreement defines the roles and responsibilities of owners and can help you avoid misunderstandings and arguments about the management of your company.
5. Obtain the Business Licenses and Permits
Depending on where you’re operating your LLC, you may need certain business licenses and permits. Contact your Secretary of State office, county, and municipality to find out what requirements apply to you. CorpNet can also help you identify which licenses and permits you’ll need and keep track of your renewal dates.
6. Open a Business Bank Account
Commingling personal and business funds is never a good idea—and for LLCs, it’s prohibited. If you’re caught mixing personal and business finances, you pierce the “corporate veil” that separates your personal assets from your business. That’s bad news because if someone sues your real estate LLC or it runs into financial difficulties, you could find your home, savings accounts, vehicles, and other personal belongings at risk of being included as damages.
7. Know What You Need to Do to Stay Compliant
Although less complicated than maintaining a corporation, your LLC will need to take care of some ongoing compliance tasks to stay in good standing with the state. Make a list and track the due dates, so you don’t slip up and risk losing your status as an LLC. If you need assistance in keeping tabs on all that, consider using our free cloud-based business compliance and monitoring tool, CorpNet’s Compliance Portal.
What’s Right For You?
While a real estate LLC presents many potential benefits to investors, they aren’t a suitable option for everyone in every situation. As with any matter that has legal and tax implications, I encourage you to talk with your attorney and accountant before you decide to form an LLC or other business entity.
And when you’re ready to take the next step, CorpNet is here to help you handle all of your business registration and compliance filings. Contact us today to get started.