When entering the world of real estate investing, deciding on a business structure is one of the most important decisions you can make. While you can choose to buy and sell properties as an individual, setting up an official business entity can help you scale your investments and protect your personal assets.
With some basic knowledge of entity formation and management, you can use the limited liability company (LLC) structure to manage your investments and take informed risks in the real estate market. Let’s explore the basics of operating a real estate LLC, plus common considerations to look out for.
- A real estate LLC is a business structure that legally operates as a separate entity from its owners.
- Forming an LLC is a relatively simple process that’s accessible for many business owners.
- As an LLC owner, you can enjoy tax benefits, including pass-through taxation.
- All LLCs provide personal asset protection in the event of a financial or legal challenge.
- You can use your LLC to simplify the administration and management of your real estate company.
What Is a Real Estate LLC?
An LLC is a type of business structure that separates a business entity from its owners while still retaining some characteristics of a sole proprietorship. Real estate LLCs allow you to invest in real estate while limiting your personal liability and risk.
Real estate LLCs exist specifically to facilitate investments in real estate properties. The LLC can oversee activities such as purchasing properties and managing their care and operation. If you want to invest in multiple properties, forming a real estate LLC can help you organize your real estate investments under a single entity.
Tax & Asset Protection Workshop
Learn about Real Estate & Asset Protection at our next
FREE LIVE STREAM
Advantages of Forming an LLC
Creating an LLC for your investment activities has several financial, administrative, and legal benefits. Here are some of the main advantages you can enjoy:
Enjoy Simple Setup
Setting up an LLC is relatively straightforward and provides a low barrier of entry for aspiring real estate investors. Each state has its own rules regarding LLC formation, but here are the basic steps to expect:
- Pick a company name. To operate as an LLC, you need to establish a company name under which you’ll do business. Check the business name registry in your state to ensure the name is available.
- File your formation documents. Submit LLC formation paperwork with your local secretary of state. These documents are commonly known as the articles of organization or a certificate of organization, depending on your state.
- Draft an operating agreement. An operating agreement summarizes the overall regulations and expectations for your LLC, including the entitlements of LLC members.
- Get your EIN. Register your business with the IRS to acquire your employee identification number (EIN). You use your EIN to open a bank account and do taxes.
You can complete these steps on your own or work with a filing service to handle the technical details of your entity formation. Research the regulations in your state to ensure you understand any additional expectations, such as choosing a registered agent.
Save on Taxes
One of the main features of an LLC is pass-through taxation, which allows you to only use your personal income tax return to pay for earnings. This can provide significant savings on your capital gains through real estate sales while still providing you with personal asset protection. You have the option to be taxed as an individual, a partnership, or a corporation depending on your financial goals.
Setting up an LLC can make you eligible for extra deductions, such as a 20% income tax deduction. In addition, you can deduct expenses related to your real estate business, such as renovations, insurance, mortgage interest, and any other business costs you incur while buying, selling, and managing properties.
Reduce Your Personal Liability
Investing in real estate and managing properties often comes with significant risk, and LLCs provide personal liability protection to owners and investors. Having insurance on your property can provide some protection as an individual investor, but forming an LLC ensures that the company itself is fully responsible for legal and financial matters. Even if a claim extends beyond your coverage from homeowners’ insurance, you won’t be personally liable for those expenses.
Here are a few situations where operating as an LLC may come in handy:
- If someone gets injured on your property and files a lawsuit to pay for medical expenses, they would sue the LLC, not you personally.
- Legal disputes with any tenants would occur through the LLC, and any payouts would come from the LLC’s assets instead of your personal savings.
- If the LLC is unable to pay off debts, creditors can only pursue the LLC’s assets, not the personal belongings of LLC members.
Incorporate Other Investors
When you purchase investment properties as an individual, bringing in co-investors can involve complex paperwork. You may need to change the deed on your property and rely on approval from your lender. With an LLC, you can simply make an adjustment to the operating agreement to incorporate a business partner. This involves detailing the percentage of the property each person owns and how the LLC members plan to divide any profits. Seeking counsel from a financial or legal advisor can help you draft a fair and functional agreement.
Develop Credit as a Business Owner
Once you establish an LLC, that entity can start building credit as a business. Even if you have excellent credit as a private individual, having business credit can increase your credibility with business partners and lenders. After developing good credit for your business, your LLC may be able to qualify for non-recourse loans, which you don’t have to personally guarantee. This can allow you to take out much larger lines of credit than you could as an individual, increasing your ability to scale your investments and purchase more valuable properties.
Because the LLC also assumes business risk, any potential hits to your business credit won’t influence your credit as an individual. You can take reasonable business risks with your LLC while enjoying peace of mind regarding your individual credit and finances.
Manage Rentals Easily
Operating as an LLC can provide you with a convenient framework for overseeing any rental properties. Many of the administrative details of property management are simplified when you use an official legal entity, such as an LLC. Here are some of the main benefits:
- Simple management options: You can use the LLC structure to appoint a third-party manager, allowing you to outsource administrative duties to a professional.
- Increased professionalism: Rentals that operate under an established entity can appear more professional to potential tenants or contractors.
- Easy property transfers: If you ever decide to sell a rental property, you can consider selling the whole LLC to a new party, allowing current rental agreements to stay intact.
Key Considerations for Real Estate LLCs
Before you form your first real estate LLC, it’s important to be aware of common drawbacks and how to manage them:
If you plan on transferring property that you own as an individual to your LLC, you may be subject to the mortgage’s due-on-sale clause. This provision states that the property owner must pay the remaining balance of the mortgage when they sell the property. Transferring your property to an LLC can count as a sale, requiring you to pay back any outstanding debts to your mortgage lender.
Some lenders may be willing to waive this clause if you contact them ahead of time, so being proactive about the terms of your agreement can help you facilitate an easy transfer. Reading your mortgage agreement thoroughly can also prevent any other surprises as you move your property to the LLC.
Forming an LLC isn’t free, and it also comes with ongoing business operation fees. A few hundred dollars per year may not seem like a lot in the grand scheme of real estate investing, but it’s still important to factor these expenses into your business budget. Filing your initial LLC paperwork by yourself can save you some money, but many business owners feel that the convenience and expertise of a professional are worth the cost.
Getting Started With Your Real Estate LLC
Due to their overall flexibility, forming an LLC is a popular option for new business owners in the real estate sector. Both new and experienced investors can increase the professional legitimacy of their operations and start establishing a positive business reputation with an LLC.
Forming an LLC is a big decision, and working with a professional can help you understand all the ways an LLC can impact your finances and investments. Whether you’re curious about how an LLC can protect your personal assets or simply want guidance on managing an existing LLC, Anderson Advisors is here to help.
Free Strategy Session with an Anderson Advisor
Receive a detailed risk assessment to assist in lowering problem areas that could wipe out all of your assets with one wrong move. Speak with an Anderson Professional Advisor to get your FREE Strategy Session. Limited-Time Offer: FREE (a $750 value.)