LLCs are a tried-and-true way to protect your personal liability and get your business finances in order. But, it may not be for everyone.
Luke Babich //April 19, 2023//
LLCs are a tried-and-true way to protect your personal liability and get your business finances in order. But, it may not be for everyone.
Luke Babich //April 19, 2023//
Whether you are new to real estate investing or a seasoned professional, chances are good you have considered forming an LLC at one time or another. This type of business structure has many different pros and cons when it comes to making money on your investment. Weighing these can help you make a more informed decision on whether this approach is right for your investment strategy.
A limited liability company (LLC) is a type of business organization that protects its sole proprietors or partners from any personal liability. A single person can form an LLC (sole proprietor), or multiple people can form a group of members.
Anyone can form an LLC, but many states have different requirements or restrictions. It’s also important to note that not all LLCs are recognized in all states. So if you form an LLC in Maryland and are looking to buy property in California, make sure you’ll have all the same protections for yourself and your investment on the other side of the country.
Definitely not. Some people mistakenly believe that investors need to form an LLC to invest in certain kinds of real estate (e.g., wholesaling real estate or purchasing an apartment), but that’s not true. As with most kinds of investments, all you need is money to spend.
There are many reasons why investing through an LLC makes good sense.
LLCs provide a legal separation between personal and business assets. This shields members from personal liability in case of:
Investing is inherently risky, but LLCs help minimize personal financial damage.
An LLC allows for pass-through taxation, meaning that profits and losses flow through to the individual members and are reported on their personal tax returns. This avoids double taxation, as corporate taxes don’t apply to an LLC.
If you’re investing on a budget and trying to save money on fees and costs, an LLC can keep more money in your pocket at tax time.
LLCs offer flexibility in management structures, which can be beneficial for real estate investors. Members can choose to manage the company themselves or appoint a manager to handle the daily operations.
Transferring ownership of real estate held in an LLC can be simpler than transferring personal property. Instead of executing a complicated property deed transfer in a personal real estate transaction, an LLC simply adjusts membership interests.
An LLC is another real estate tool that makes it easier to organize, transfer and manage your investments.
Depending on the state in which the LLC is formed, public records may not display the names of individual members. For some investors, this privacy is one of the main reasons an LLC makes sense.
Not everything is sunny when it comes to LLCs and real estate investing. There are a few drawbacks to consider.
Setting up and maintaining an LLC requires time, effort and money. Depending on your state, you may need to pay filing fees, annual fees and potentially consult with legal or tax professionals to ensure compliance with regulations.
That money you saved on lower realtor commissions or other cost-saving measures may be spent on annual fees and more complicated tax preparation.
While an LLC provides some protection against personal liability, it may not be absolute. In certain situations, such as fraud or personal guarantees on loans, members can still be held personally liable.
Obtaining financing for an LLC-held property may be more difficult than for an individually-held property. Some lenders perceive the investment as higher risk. Interest rates may be higher and larger down payments may be required.
For investors looking at different strategies to purchase real estate (e.g., rent-to-own or alternative types of financing) forming an LLC may not provide any advantages.
While pass-through taxation can be advantageous, it can also complicate personal tax returns for individual members. Each member must report the LLC’s income, deductions and credits on their personal tax returns.
LLC regulations vary by state. The process of setting up and maintaining an LLC can be more complicated if you’re investing in properties across multiple states.
Investing in real estate through an LLC offers both benefits and drawbacks. Before making a decision, it’s essential to consider your individual financial situation, investment goals and risk tolerance. Consult with legal and tax professionals to see if it’s right for you.
Luke Babich is the Co-Founder of Clever Real Estate, a real estate education platform committed to helping home buyers, sellers and investors make smarter financial decisions. Luke is a licensed real estate agent in the State of Missouri and his research and insights have been featured on BiggerPockets, Inman, the LA Times, and more.