Consider Turning Your Real Estate Investment Into a Business With An LLC
When it comes to real property investing, issues of management, risk, and liability are real. Whether or not to form a limited liability company, otherwise known as an LLC, for your real property investments entails careful consideration of the pros and cons.
A limited liability company is a legal entity that merges the pass-through tax benefits of a partnership or sole proprietorship with the liability mitigation of a corporation. In other words, a limited liability company can shield its members from liability just like a corporation shields its shareholders, while escaping the double taxation effect that corporations are subject to.
Holding title to a real property investment in an LLC is common practice is the real estate investment industry. The following three reasons support forming an LLC for your real property investments instead of utilizing a corporation or nothing at all:
Liability Protection – A limited liability company can shield a property owner from liability, much like a corporation can, thereby protecting the personal assets of the members, or owners, in the event of a lawsuit or other loss. The reasoning is simple: if the LLC holds title to the property, then it is the LLC that is the owner and therefore responsible for the harm or monetary losses of the property (assuming debt collateral is not held in another name). If the only asset the LLC owns is that same property, the bleeding stops there. It is important to note, however, that liability can be imputed to an LLC member if the LLC is not truly run as a business and is merely a “shell.” This is called “piercing the corporate veil” and can be avoided by talking to your lawyer or CPA. Nonetheless, protection from liability can make or break the decision whether to invest in a certain investment.
Easy and Inexpensive – A limited liability company is usually easy and inexpensive to form, especially in comparison with corporation entities. LLCs are governed by state law. To create an LLC, one must create then file Articles of Organization with the applicable government agency. To create Articles of Organization, many states offer streamlined forms that you can complete yourself. Or, there are various legal self-help websites that offer cost-effective solutions for each state. Once created, you must file the Articles of Organization with your state, and while each state is different, state filings are relatively inexpensive, especially if you do it yourself.
Tax Benefits – A Limited Liability Company’s tax structure is similar to an S-Corporation or Partnership in that the taxes on the income of the LLC pass through to the members, or owners, of the LLC. Conversely, a C-Corporation, which is a standard corporation, is taxed at the corporate level and then again at the shareholder level when profits are distributed or shares are sold. Depending on the return of the real property investment, tax savings can be tremendous, even making or breaking a deal.
While there are good reasons to have your real property investment titled in an LLC, there are the following considerations that are less supportive:
You Own Multiple Properties – As noted above, title to the real property investment cannot just be held in the LLC’s name, but also the LLC must run like any business. This generally means that banking, bookkeeping, and other activities should be separately performed for each LLC. If you have one rental property, this will probably not be a big issue; on the other hand, if you have ten rental properties, each in its own LLC, you will be tasked with managing ten businesses, including management and accounting operations, which can become cumbersome.
Debt Service – If you intend on leveraging your real property investment by procuring a mortgage or deed of trust secured by the property, then unless the LLC has additional substantial assets to secure the loan, the loan will probably have to be in the name of the individual investor. Depending on your loan’s terms, you may or may not be allowed to transfer title to an LLC after that, especially if the LLC has a membership makeup that does not identically reflect the individuals on the loan.
If you follow the practice of seasoned real estate investors, you would find that the benefits of forming and using an LLC to hold title to real estate investments far outweigh the costs, and most investors engage in this practice consistently. However, each property and situation is unique, so just make sure to critically think through all the pros and cons before resting on a final decision. Happy investing!
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