Is Setting Up an LLC Worth it? How to Set Up an LLC for Real Estate Investing
Owners have a variety of options when it comes to their business structure. The type of business entity you choose will impact how your company is taxed and regulated by law. There are many reasons to choose an LLC for your business. Here are some of the main steps as well as basic information needed to set up an LLC.
7 Steps to Setting Up an LLC as a Real Estate Investor
- Pick a Business Name
- File Articles of Organization
- Appoint a Registered Agent
- Create an Operating Agreement
- Obtain an Employer Identification Number
- Pay Filing Fees
- Pay Taxes
There are several ways to structure a business and there are advantages and disadvantages to each type of entity. Limited Liability Companies, or LLCs, offer versatility along with many of the same protections afforded by other business structures.
Is Setting Up an LLC Worth It?
An LLC is regulated by state statutes and usually disregarded for federal tax purposes. Entrepreneurs and those interested in real estate investing can benefit from personal liability protection to protect their personal property and other investments. Businesses typically fall into one of the following structures: sole proprietorship, partnership, corporation, S-corporation, and limited liability company (LLC). If you are unsure which business structure would work best for your business, you may want to consult a legal professional for expert advice. The cost of setting up an LLC is typically lower than more complex business structures but differs from state to state. For more information on how to structure your business, be sure to read our guide to forming a business entity.
One of the most important features of an LLC, corporation, or S-corp is the liability protection offered. Without this protection, the owner’s personal assets could be seized to satisfy business debts and taxes. Sole proprietors and partners face unlimited liability, in most cases. With a partnership, all the partners could be held equally or even fully liable, in some cases. A general partner can be selected for liability issues with the other partners obtaining some liability protection, but the general partner is still left personally responsible for business debt and other issues. In the event of lawsuit or litigation against a business, these owners could face heavy losses.
The answer to this problem is to create a separate legal entity for your business. Corporations offer liability protection but could be costly to set up and are subject to many regulations, including double taxation. A limited liability company (LLC) combines the liability protection of a corporation or S-corporation with the ease of set-up and pass-through taxation of sole proprietorships and partnerships.
Liability protection for businesses is not absolute. There are many cases where courts have pierced a business’ corporate veil and held business owners or even managers personally responsible for business decisions. There are many reasons this can happen. Such situations develop when owners use their business for personal expenditures, such as using a business bank account to pay for personal property or expenses.
Depending on where your business is located, there may be other requirements to maintain liability protection. These usually serve to separate the business entity from the owners. Holding periodic meetings, keeping separate financial accounts and books, and not using business funds for personal use might help establish a clear separation. Hiring a manager or electing board members can also help. Investing in real estate can bring many challenges, especially if you also rent out or lease property. Situations may arise where liability protection can help keep your personal assets safe.
One of the major disadvantages of being a corporation is double taxation. A corporation is considered a separate legal entity for tax purposes and business income is taxed at the corporate tax rate. When the corporation distributes profits to shareholders, their dividends, salary, or other property is taxed again on their personal income tax returns. This double taxation is only applied to corporations or LLCs that elect to be taxed as corporations. Sole proprietors, partnerships, S-corps, and some types of limited liability companies are considered pass-through entities because the business income is not taxed until it is passed on to the owners, members, or partners. Businesses subject to pass-through taxation may benefit from recent changes to the tax code.
7 Steps to Setting Up an LLC as a Real Estate Investor
1. Pick a Business Name
The first step to set up an LLC is to name your business. Your state may have specific rules regulating your business name. For example, in Texas, your business name cannot be confused for a government agency or contain restricted words like bank or university. The name must also include the words Limited Liability Company (L.L.C. or LLC is also accepted). The Secretary of State or other regulating agency will usually provide a searchable database of business names online. Sole proprietors usually use their name as the business name, since the business and owner are considered one and the same. However, businesses can file or register a Doing Business As (DBA) name for their business operations. This can be especially helpful in certain marketing situations but does not offer any special liability protection.
If your business will operate in multiple states, you may also want to conduct business name searches in those states, as well, before making a final decision. You can also check online to see if there are URL names available that closely match your business name. Many states also allow a business to reserve an available name for a fee.
2. File Articles of Organization
Limited Liability Companies are set up according to state statutes. To find out the requirements for your specific state, you can start by going to the Secretary of State’s website or other regulatory agency for your state. Many states require filing documents that detail information about the company and its owners, as well as the purpose of the business. Texas and California both require “articles of organization” to be filed in order to operate as an LLC. In Texas, articles of organization may be called a “certificate of formation.” Other states may call this document a certificate of organization or even a “certificate of incorporation.” This document serves as a charter, with basic information such as the business name and address or primary location of the business. You may also have to include the purpose or nature of the business, the name and address of the registered agent, or the registered agent service, and the names of members, managers, or owners at the time of filing your paperwork.
Once you create and file your articles of organization with your state and meet the requirements, you may be approved and registered to do business in that state. Registering to do business in a state is usually required before banks will approve loans or investors will consider funding. LLCs and many businesses formed in other states must register with each additional state where they plan to do business, according to the local laws and regulations. Failing to register with a state before conducting business can lead to civil penalties, taxes, and late fees, as well as restrictions which prohibit the business from conducting transactions or utilizing the state courts.
3. Create an Operating Agreement
An operating agreement is a document that basically lays out ownership, the rules for operating the company, and the rights and responsibilities of owners and managers. The agreement also outlines how conflicts will be decided (voting, for example) and how profit and loss will be handled. Many states, such as Texas, do not require an LLC to file an operating agreement prior to doing business. California, on the other hand, requires an LLC to have an operating agreement even though it may not need to be filed.
Operating agreements are very useful, and it is highly advisable to create one — especially if you have a multiple-member LLC or MMLLC. Defining a specific method for solving conflicts between owners and establishing rules detailing how profits are split will go a long way toward preventing issues. Even if everything seems great between partners in an LLC, if a disagreement occurs and there is no operating agreement, it could tear the business apart. For more information or for assistance in setting up an operating agreement, seek professional legal advice to ensure you include the important caveats specific to your business and industry.
4. Appoint a Registered Agent
Most states require an LLC to establish a registered agent who serves as the business’ point of contact. Usually, this person must live or be located in the same state. The agent will receive service of process notices as well as communications from the Secretary of State and other government notices, such as taxes. This is the person that will be notified in case of a lawsuit. A registered agent may also be called a “resident agent” or “statutory agent,” in some cases. Considering that there may be a limited timeframe to respond to legal mail or appeal regulatory decisions, whomever you choose to be your registered agent is a very important decision. Almost any third-party can serve as the registered agent (even a spouse, depending on state regulations), and there are also many companies that offer registered agent services.
5. Obtain an Employer Identification Number
An Employer Identification Number (or EIN) is a nine-digit number issued by the Internal Revenue Service (IRS). The EIN is used to identify a business with employees on many important legal documents, including taxes. You can usually obtain an EIN from the IRS for free through a variety of methods, such as online, over the phone, or even in person. A disregarded entity, such as a sole proprietorship or single-member LLC (SMLLC), may be able to use the owner’s social security number as the EIN, in some cases. However, since this will appear on legal documents, it may be best to obtain a free EIN instead.
6. Pay Filing Fees
Setting up a business in any state comes with a wide range of fees. You can expect to pay fees to file or register your account as well as to form your business structure of choice. These fees vary depending on the structure. For example, you can expect to pay $300 in Texas with a certificate of formation just to register an LLC. Out-of-state businesses registering in Texas typically have to pay a $750 foreign LLC filing fee. California has a $70 fee but also levies hefty taxes on businesses. Depending on the state or states where you operate, you may be able to reserve a business name for a fee. California charges $10 for a reservation fee, while Texas charges $40. Payments are typically made online by credit or debit card, but you can also mail a check or submit payment in person.
Each state has requirements for operating a business with specific due dates for each requirement. Failure to file and pay appropriate fees can result in penalties, such as a $50 failure-to-file penalty if the annual report and franchise tax are not filed and paid, respectively.
7. Pay Taxes
How you elect to set up your business will determine how you are taxed. For example, corporations face double taxation, while S-corporations avoid double taxation by passing income to shareholders. Sole proprietors and partners with business income are taxed on their personal income tax returns. You may also be subject to self-employment taxes, depending on how the income is classified. In addition to federal income taxes, you may also be required to pay monthly employment taxes, quarterly estimated taxes, as well as state and local taxes such as real estate property tax. California levies almost 9% tax on business income as well as an annual California Franchise Tax of $800. Texas also calls its business tax a franchise tax, but many businesses may only have to pay 1% or less.
With the Tax Cuts and Jobs Act recently passed, there are many new ways for business owners to limit their tax liability. Real estate investors also benefit from this change. For example, a new 20% deduction for eligible pass-through business income is available for some real estate investors and real estate investment trusts (REITs). Real property investors can also benefit from 1031 like-kind exchanges that are no longer available for other property types. Business owners can claim bonus depreciation as well. One important thing to know about your real estate business is that you may be able to claim depreciation for business use, but when you sell the property, you may have to pay for that depreciation — especially the taxes due on the eligible depreciation amount. When you sell real estate, you may be subject to capital gains taxes, depending on how long you’ve held the investment. You might also be hit with a Net Investment Income Tax (NIIT) for investment income over certain thresholds.
Due to the complicated nature of taxation as well as the many deadlines for fees and taxes, it’s a great idea to consult with a tax attorney to ensure your business is properly set up and registered correctly in each state where you do business. There are many tax advantages for real estate investors looking to rent, especially if they live in the property or have lived in the property for certain time periods. For example, if you invest in multifamily housing, you can live in one unit, rent out the rest, and take advantage of some tax benefits.
Texas vs. California
There are many differences between Texas and California when it comes to setting up an LLC. While the basic steps are similar, the taxes and fees can be very different. California requires a Statement of Information to be filed within 90 days of filing the articles of organization, and every two years thereafter. The California form that needs to be filed with the Secretary of State is form LLC-1. Texas calls it a Certificate of Formation. Both states charge a business tax, known as a franchise tax. California also requires an LLC to have an operating agreement but doesn’t require it to be filed.
Frequently Asked Questions about Setting Up an LLC for Real Estate Investing
Why start an LLC instead of opening a joint brokerage account?
The main issue with a joint brokerage account is the lack of liability protection. If you use a joint bank or brokerage account to fund real estate investing, you may be personally liable for any problems that arise, such as previous outstanding property taxes, lawsuits from renters, and so on. When handled correctly, an LLC or limited liability company offers much better personal protection. You can even open a joint brokerage account in the name of an LLC to get liability protection for your investment account.
Can you be personally liable in an LLC?
Yes, there are plenty of situations where a court may hold owners or members of an LLC personally liable for business debt or liability. You limit your exposure to liability by properly managing the LLC and associated business accounts. For more information on ways to limit your liability correctly, consider consulting with a professional advisor for relevant legal advice.
What are the benefits of an LLC?
An LLC offers many advantages over other business types. First, they are usually more affordable and easier to set up than corporations or S-corps, which are subject to additional regulations. A limited liability company also offers liability protection above and beyond what sole proprietors or partners can usually get. An LLC is also a very flexible business structure. You can elect to have your LLC taxed as a sole proprietor if there is only one member, and as a partnership or even a corporation for more than one member. There are limits to how often you can change your business structure and each entity type has its own advantages and disadvantages.
Do you need a lawyer to set up an LLC?
No, you do not need a lawyer to create an LLC. However, you may want to hire or consult with a lawyer to ensure your company is set up properly. One component of limited liability protection requires managing a business in a certain way. If you are not sure what you need to do to obtain and keep liability protection for your business or real estate investment accounts, then you would benefit from seeking a lawyer’s help. Hiring a professional to assist with the real estate asset management for your rental property can save you a great deal of money in the long run.
What are the basic requirements for setting up an LLC?
You need to pick out a name and register your LLC with your state. Generally, this includes registering by filing articles of organization or a certificate of formation as well as paying associated fees. You will need to obtain a federal Employer Identification Number if you are hiring employees and you will need to set up certain financial accounts to manage employment taxes. Most states require that a registered agent be appointed to accept legal mail. Once you are registered, you will need to pay the appropriate taxes by their due dates. Typically, this includes sales and use tax, as well as employment and self-employment taxes, which include social security and Medicare taxes.
Create an LLC for Real Estate Investing
Starting your own business is fairly easy, but can become complicated. One major issue every business owner or real estate investor faces is liability. Limiting personal liability is possible by selecting a business structure that will protect your personal assets from being seized to satisfy overdue taxes or business debt. A limited liability company is an excellent way to limit your liability in an affordable way without going through additional steps needed to create a corporation or S-corp. There are necessary steps and procedures to follow in order to maintain limited liability. These include keeping business and personal finances separate and proving that the business is a separate legal entity — otherwise, a lawsuit could result in a court piercing the business’ corporate veil and seizing the owner’s personal assets.
Entrepreneurs or real estate investors who wish to take advantage of these liability protections can file for an LLC in their state according to state statutes. You may be required to create an operating agreement and file official articles of organization or certificates of formation. You may also need to obtain a federal Employer Identification Number (EIN) from the IRS. Once the appropriate fees and taxes are paid, your business is well on its way. To ensure that your business is registered correctly, or if you seek asset protection, you may want to consult with a lawyer. Reach out to Anderson Advisors today for a free consultation.
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