Being a real estate professional and business owner is not easy. There are many complicated laws and regulations associated with owning a business.
One of the ways you can simplify different areas of your real estate investing business is by forming an LLC.
There are many potential benefits in forming an LLC. An LLC also has some drawbacks. An LLC is a safe way to conduct business and protect yourself against unexpected liabilities that can happen.
Here is a general overview of what an LLC is and how an LLC works in real estate investing. This article will not provide legal or tax advice. You should talk to a real estate attorney and accountant before forming an LLC for your real estate investing business.
What is an LLC?
A Limited Liability Company is a business structure that combines the best elements of a corporation, a sole proprietorship, and a partnership.
LLCs are popular because they are easy to form, allow for a flexible management structure, and have tax advantages.
You can create an LLC for any kind of business, including a real estate investment business. An LLC can have one owner or many owners. It can also have no employees or many employees.
How does an LLC work for rental properties?
A real estate LLC allows you to purchase, own, and rent out your property to tenants while protecting you from personal liability. You can buy, sell, and conduct real estate related business in the name of your LLC.
If an individual or another business files a lawsuit, they will sue the LLC and not you.
As a rental property investor, you will need to form an LLC for each of your properties. It does not matter if you have one rental property or 100 rental properties.
You also need to file the appropriate paperwork with a local government agency.
It is possible to file an LLC in any state regardless of where your business is based. Each state has slightly different requirements to form an LLC.
It is better to form an LLC in the state where you base your business in most cases instead of creating an LLC out of your home state.
You will want to consult a real estate attorney or tax advisor if this is your first time forming an LLC for your real estate investing business. They can show you how to create an LLC, and help you understand the process.
Forming an LLC is a simple process, and many experienced real estate investors can form an LLC on their own.
The Benefits of a Real Estate LLC
An LLC has benefits and drawbacks. It is necessary to understand what these are to make the best decision when setting up your business. There are many benefits to having a real estate LLC when you establish it the right way.
Benefit #1: Protection from Personal Liability
The biggest benefit of having a real estate LLC is it protects you from personally being held liable if an unfortunate event happens with your rental property. An LLC shields your assets, such as your home, vehicles, bank accounts, and investments from any lawsuits.
Plaintiffs can only collect from the LLC’s assets if you lose a lawsuit.
An LLC also protects you from personal liability if your rental property business goes bankrupt. Creditors cannot go after your assets. They can only go after the LLC’s assets.
Benefit #2: Simplicity
Forming an LLC is inexpensive, simple to establish, and easy to operate. Establishing a corporation requires having a board of directors, board meetings, shareholder meetings, and other administrative burdens.
You do not need to have any of these things with an LLC.
All you need is an Operating Agreement when working with one or more members of your LLC, or when working with investing partners who are not members of your LLC.
An Operating Agreement is not required to form an LLC in most states, but it is a good idea to have one as a part of your business plan.
Benefit #3: Taxes
There is a tax benefit when you put your rental property in a real estate LLC. The tax benefit is called pass-through taxation. Pass-through taxation is a tax deduction that allows profits or losses to pass through your business to your income tax return and is taxed at the personal rate.
You can deduct up to 20% of your LLC’s net income from your income taxes. This deduction can amount to financial savings on your taxes.
Talk to your accountant or tax advisor for more details about the pass-through taxation that can financially benefit you by forming a real estate LLC.
Benefit #4: Flexible Ownership, Management, and Taxation
When you form an LLC, there are ownership limits. You can be the sole owner of the LLC, or you can have several dozen owners of the LLC.
It is also possible for you to be the sole manager of the LLC, or you can designate any number of the owners as managers.
They will all share management responsibilities and run the day-to-day operations of the LLC. Also, you can choose how your LLC is taxed. An LLC is usually taxed as a sole proprietorship or partnership.
You can choose to have it taxed as a C-corporation or an S-corporation.
Benefit #5: Credibility
Forming an LLC gives your business the credibility it needs to attract real estate investors who would like to become partners with you for future real estate investments.
These partnerships can result in working with more experienced investors who can provide you with an infusion of cash for larger investments.
The Drawbacks of a Real Estate LLC
Everything about forming a real estate LLC sounds good so far. Yet, there are some drawbacks that you need to be aware of before you create an LLC. These drawbacks are not a problem once you get used to operating your LLC.
Here are some of the drawbacks:
Drawback #1: Cost and Fees
Forming an LLC can cost up to $500, and the annual administrative and regulatory fees to maintain the LLC can cost up to $800. The cost and annual fees to form and maintain an LLC are different in each state.
You need to do some research to find a state that has a start-up cost and annual fees that are within your budget.
Drawback #2: Separating your Accounts
Separating your business accounts from your personal accounts is necessary for you to take advantage of the benefits of having a real estate LLC. You need to separate your business banking from your personal banking and separate your business expenses from your personal expenses.
Doing these things will help to protect you if you are sued. Separating your business from your personal life demonstrates your business is a separate entity and strengthens the protection from personal liability.
Drawback #3: Financing a Property as an LLC
Financing a rental property through an LLC with a bank or some other financial institution for the first time can be difficult and costly. Financial institutions like to have a track record with any business looking to finance real estate.
Expect to obtain less than favorable terms on your first loan through your real estate LLC.
My Final Thoughts on the Pros And Cons Of An LLC For Rental Property
Owning a real estate LLC gives you a business-like appearance. This appearance can provide some legitimacy to prospective tenants and partners. The law does not require you to establish an LLC, but it can shield you from potential liabilities and give you a better chance at success.
Let me know what you think. I would love to read your experiences of forming and using an LLC for your real estate investing business. Please leave a comment in the comments section below.
Thank you very much and have an awesome day.