Forming An LLC For Real Estate Investments: Pros & Cons
Real Estate
You’ve probably heard of LLCs, but you may not be sure what they are or how they function. LLC stands for “Limited Liability Company.” It’s a business structure that can combine the best features of a Sole Proprietorship, Partnership, and Corporation.
This article will examine some pros and cons of forming an LLC for real estate investing. We’ll also provide tips on deciding if an LLC is right for your business.
What Is an LLC?
An LLC, or Limited Liability Company, is a business entity created by state statute. LLCs are popular among small business owners and entrepreneurs because they offer personal asset protection from creditors and lawsuits while providing flexibility in how the business is managed and taxed.
- LLCs are formed at the state level. Each state has its own rules and regulations for forming an LLC. In most states, you’ll need to file Articles of Organization with the Secretary of State’s office and pay a filing fee.
- Once your LLC is approved, you’ll need to obtain an Employer Identification Number (EIN) from the IRS. You’ll use this number to open a bank account and file taxes for your LLC.
- It’s also essential to create an Operating Agreement for your LLC. This document outlines the ownership structure and rules for running the business.
Let’s take a closer look at the pros and cons of forming an LLC for your real estate investments.
Pros of Forming an LLC for Real Estate Investments
Asset Protection
One of the main reasons to form an LLC for your real estate investments is asset protection. If you own property in your own name, any lawsuit or creditors’ claim against that property could potentially put your other assets at risk.
But if the property is owned by an LLC, it is considered a separate entity from you personally. This means that your personal assets are protected in the event that the LLC is sued or incurs debt.
Tax Benefits
Another advantage of forming an LLC for your real estate investment is the potential for tax benefits. LLCs are considered ” pass-through” entities for tax purposes, which means that the LLC itself is not taxed on its income. Instead, the LLC’s income is “passed through” to the LLC’s owners, who then report it on their personal tax returns.
This can provide a tax benefit if you are actively involved in managing your rental property, as you may be able to deduct a variety of business expenses related to the property. These expenses can include things like advertising, repairs and maintenance, accounting and legal fees, travel expenses, and more.
Flexibility
Another advantage of an LLC is the flexibility it offers in terms of how the business is structured and operated. Unlike a Corporation, an LLC does not have to follow rigid rules and regulations regarding things like ownership, management, and reporting.
However, both LLCs and Corporations need to have a Registered Agent. For example, if you form an LLC in Florida, then the company will need to list a registered agent there in case legal mail, called Service of Process, is sent.
This means that you can customize the LLC to fit your specific needs and goals. For example, you can choose to have a Single-Member LLC (which means that you are the only owner), or a Multi-Member LLC (which allows for multiple owners). You can also decide whether or not to have managers overseeing the day-to-day operations of the LLC.
Improved Credibility
Finally, forming an LLC for your real estate investment can improve your credibility with potential lenders and tenants. Many lenders and tenants view LLCs as being more professional and well-organized than Sole Proprietorships.
And again, because an LLC provides asset protection, they are very commonly used by real estate investors to hold title to real estate.
Cons of Forming an LLC for Real Estate Investments
Costs
One of the main drawbacks of forming an LLC for your real estate investments is the cost. There are both one-time costs associated with the formation and ongoing costs associated with maintaining the LLC.
So you need to make sure that the benefits of forming an LLC outweigh the costs. However, for most people, the added liability protection of an LLC is well worth the filing fee and annual fees.
Recordkeeping
While this isn’t really a con (it’s just a good habit), it’s important that your LLC keep proper recordkeeping. This is helpful for bookkeeping, taxes, and dealing with your accountant.
And depending on how your LLC is taxed, some of this information will end up on reports (of balance sheets) that will get sent to the IRS.
Requirement for Active Management
As we mentioned earlier, one of the benefits of forming an LLC for your real estate investments is the potential for tax benefits. But in order to take advantage of those tax benefits, you need to be actively involved in managing your business.
If you’re not actively involved in managing the property, you may not be eligible for all the potential tax savings. You should double-check with your accountant on this to explore the details.
How to Decide if an LLC Is Right for Your Business
When deciding whether or not to form an LLC, there are several factors to consider. First, think about your business goals and needs. If you’re looking for asset protection or tax benefits, an LLC may be a good choice.
But if you’re just starting out in real estate investing, and you’re not yet comfortable, it’s probably a good idea to learn more about business entities and how they’re used by real estate investors.
While you don’t have to form an LLC for holding real estate (you can just take title in your own name and get adequate insurance), they are often beneficial because of the extra asset protection you get.
However, if you need financing for your purchase, you’ll often pay a higher interest rate with an LLC (compared to a loan in your own name) and the LTV (loan to value) may not be as high.
Ultimately, the decision of whether or not to form an LLC should come down to what’s best for your business. If you’re not sure, it’s a good idea to consult with an attorney and an accountant who can help you decide which business structure is right for you.
Forming An LLC For Real Estate Investments: Pros & Cons
