A limited liability company (LLC) is a corporate structure that can give you liability protection and shelter you from financial risk in case your business incurs debt or a lawsuit is filed against it.
There are numerous types of LLCs, as many businesses can be structured in this way. The one we’ll be discussing in more detail in this article is a real estate LLC – what it is, how you can set up one, and what the key benefits and disadvantages of this business structure are.
What Does LLC Mean in Real Estate?
Forming a Real Estate LLC
An LLC can be established for a particular real estate asset or own multiple real estate properties. What’s important is that your LLC, being a separate legal entity, can purchase, own, or manage real estate. That’s thanks to the fact it has its own bank account, it files taxes on its own, and it acts as an independent real estate company.
Several factors should be taken into consideration if you are thinking of setting up an LLC for your real estate business. We’ll now go over each so you can decide if this is the right option for you.
Advantages of an LLC for Rental Property
Here are some of the main reasons in favor of forming an LLC if you run a real estate business.
Asset and Liability Protection
First and foremost, you should make sure that your personal and business assets are separated. This is why most investors choose to form separate LLCs for each of their properties. By separating your properties, you are protecting them in case of bankruptcy or a lawsuit. Should one of your LLCs fall into debt, the creditors can only come after its assets, while your other real estate LLCs or your personal assets will remain out of reach.
One of the major advantages of an LLC structure certainly is the tax benefits. The Internal Revenue Service doesn’t tax LLCs directly, and there is a certain amount of flexibility in the process. And since single-member LLCs are eligible for pass-through income taxation, LLC members can tax any business income under their own personal tax rate. However, when it comes to employment tax, single-member LLCs are still counted as separate entities.
If you are starting an LLC for real estate, you should know that the IRS can treat your LLC in three different ways, depending on the option you choose when filing Form 8832:
- Corporation – The IRS considers your business as an individual taxpayer. If classified this way, your LLC would need to report all of its income and deductions and pay the appropriate taxes.
- Partnership – All LLCs with at least two members are automatically classified as partnerships unless you specifically choose to be treated as a corporation. This setup of your real estate LLC would make you responsible for putting together the annual partnership tax returns.
- Disregarded entity – All single-member LLCs are eligible to be classified as disregarded entities, unless you specifically choose to be treated as a corporation. In this case, all the taxes owed by your LLC would be paid as part of your income tax return.
Prior to deciding on the option you want to go with, note that you won’t be able to alter that decision for five years.
Reliability and Ease of Transferring Interests
Creating an LLC for real estate will give more professional appeal to your business, especially if you are trying to lease a particular property. A business or an individual will probably be far more confident renting real estate from an LLC than from an individual.
And if you are considering selling your LLC, you’ll be happy to know that transferring membership interests is a relatively straightforward process. The LLC will remain the owner of its real estate assets; the only thing that will change is the ownership, which makes it easier to complete the transfer and preserve the business’s continuity.
How To Set Up a Real Estate LLC
A few steps need to be completed to set up an LLC for your real estate property. You can do it on your own by following our list of steps provided below or get help from an LLC service agency.
- Step 1: Research your state’s regulations
Most investors decide to form their LLC in the same state they are doing business or where the property is physically located. This is generally the best course of action since you’ll have to pay a tax return in that state; however, some states do have more flexible tax policies. Either way, we advise you to get thoroughly acquainted with the laws of the state where you plan to form your LLC for real estate. If you are not sure where to begin, you can get help from a professional legal service.
- Step 2: Choose a business name
When picking out a name for your LLC, you primarily need to make sure it doesn’t already exist. Of course, you should also focus on coming up with a name that has the potential to attract new clients. So, make a list of a few catchy names and check their availability. Along with this, you’ll need to find a registered agent to sign a consent to accept any legal paperwork on behalf of your LLC.
- Step 3: File the Articles of Organization
If you wish to create an LLC for rental property, you are obliged to file the Articles of Organization. It’s a document that states the company name, start date, address, business owners, and it contains a description of the business itself. This is the single most important step, so make sure to double-check you’ve included all the required info before you submit the document. There is also a filing fee you’ll need to pay. Its cost varies from state to state and can be as low as $50 or as high as $500.
- Step 4: Compose an operating agreement
This agreement should be a part of your business plan, even if it’s not obligatory in your state. Real estate LLC operating agreement is a handy tool which will help you specify how decisions will be made inside the company and how you’ll distribute tasks among members. The agreement’s main purpose is to protect the business owners and predict scenarios that can potentially damage the business and its structure.
- Step 5: Step Publish your intent to file
This step is only required in three states: Arizona, Nebraska, and New York, and it practically means that, if you are starting an LLC in one of them, you need to publish an ad in the local newspapers saying that you wish to create an LLC.
- Step 5: Get the necessary licenses and permits
When registering a real estate LLC, you usually need to gather various permits and licenses. The list varies by state, but it usually consists of a general business license, professional license, and a sales tax permit. Along with that, you should apply for a tax identification number with the IRS. You can find all of this information on your area’s Secretary of State website.
Downsides of Starting an LLC in Real Estate
While there are many benefits to structuring your real estate business as an LLC, there are some disadvantages of an LLC for rental property. So, before deciding whether to take a step in that direction, we advise you to consider the following cons:
Certain states charge a franchise tax on LLCs treated as corporations by the IRS. These taxes vary depending on the state; therefore, it’s advisable to check this with your local authorities.
No Board of Directors
The fact that an LLC doesn’t have a board of directors as a standard corporation does might impact your business. If your rental company wants to form a joint partnership with another corporation, they might see it as an issue.
Also called a self-employment tax, this is something you should take into consideration if you wish to set up a real estate LLC. All members of an LLC are obliged to pay the self-employment tax. The rate is usually about 15% of the taxpayer’s overall income.
Nowadays, most real estate investors structure their businesses as LLCs. The most significant advantage of this business structure is that it offers protection from liability claims in cases such as construction accidents or issues with tenants. Tax benefits and the fact that LLCs can be filed with the IRS as disregarded entities are also reasons in favor of starting a real estate investment LLC, but before you go ahead, check your local LLC regulations.