Guest Post: Jean Wilson Murray
Limited liability companies are becoming an ever more popular vehicle for investing in real estate. In buying property through an LLC, the purchase then belongs to the purchasing company, not to a specific individual. There are some key advantages to investing in real estate in this manner – as well as disadvantages. Here, we’ll take a look at what they are, but firstly, we’ll look at how a limited liability company works and how buying property under a business name is done.
So, What Is a Limited Liability Company?
A limited liability company is an evergreen business structure, with new formations appearing all the time. Easier to form than most business structures, LLCs come with several unique benefits. These benefits coupled with the more economical start-up costs have made them hard to resist. This is particularly applicable to first-time entrepreneurs taking their first cautious steps into the world of company ownership.
So, what are the benefits of owning an LLC?
- Not being personally liable: the chief benefit of LLC ownership is that if the company runs into trouble, ie, lawsuits, debt collections, bankruptcy, and so on, you, the owner, along with your personal assets are protected. The liability protection offered by this particular business entity is a legal barrier separating the business owner and the business itself. So only business assets risk being seized in lieu of any money owed resulting in action via the courts.
- Pass-through tax entity: the IRS considers LLCs to be a pass-through entity when it comes to filing taxes. When your enterprise makes a profit, that money is passed directly through to you, the owner (or owners, if it is a multi-member LLC). In turn, that means that that revenue is now part of your personal finances – so will be taxed accordingly at your own personal tax. An LLC owner (or its owners) will record any profits or losses of the business and then file it with their own personal return. The Tax Cuts and Jobs Act means that, being a pass-through entity, you can qualify for a tax deduction.
- Flexibility: unlike most business entities, LLCs are not set in stone. They offer a large amount of flexibility as to how they are operated by owners. An LLC could have one lone member (owner) or it could have two dozen – even more. There’s no limit on an LLC membership. Members can choose to manage the business themselves, equally, or they can vote and select an individual member to take on the overseeing of the companies daily activities. Alternatively, a third party could be hired in as manager and put on the payroll, if no member wants the responsibility of managing the company themselves.
- Better business credentials: making a business, an LLC enhances business credibility. Not just in the eyes of the public, but in the eyes of a courtroom if ever there is cause to deal with one. Seeing that an enterprise is a registered LLC is more reassuring and better looking professionally than an enterprise that is not. Being aware that a business is registered and on file with the state adds trust with potential customers and professionalism within a courthouse.
These benefits need to be remembered and taken into consideration when it comes to starting an LLC with the purpose of investing in real estate – as do the following disadvantages of owning a limited liability company.
- Creation and maintenance fees: LLCs are one of the cheaper business entities to start up and maintain the operation of. However, that said, they can prove to be a lot more costly than establishing a sole-proprietorship or even a partnership. The costs don’t just stop once all the necessary filing fees have been submitted to the Secretary of State. Once formed, an LLC will be required to meet with state compliances regularly, including – but not limited to – tax filings and annual reports. For a small business, these costs can add up and need to be factored in when defining a budget.
- Investment: Corporations roll via sales of stock to shareholders. The buying of company stock invests dollars into the business. This is not the case for LLCs. Limited liability companies are owned by their members. These are the people who put up the money and formed the business in the first place. To bring in outside investment necessitates the investor becoming a member of the organization – and things can get complicated. The whole organizational structure will then require a reboot, as well as there being a change to the profit percentage being passed through to original members. In short, investing in LLCs can be complicated – and potentially not even possible.
Now that you know more about limited liability companies and how they work, let’s take a look at both sides of the coin when it comes to real estate investment under the umbrella of an LLC.
Buying Real Estate with an LLC
Now that you have your company, you can buy property under its business name to use for the company’s various operational activities. Office, production, or storage space, for example.
The business name’s ability to be used like this means that it is increasingly popular for LLCs to be formed so as to enable its members, or members, to hold rental property. This possibility offers large scope for rental property investment. More often than not, it opens more doors and provides increased opportunities for LLC members than they would otherwise have if they tried it without a business identity.
As with the formation of an LLC for any business, limited liability companies have their perks and their pitfalls whatever industry the company will be fielded in. Forming an LLC for the purpose of real estate investment is no different, and the pros and cons of getting into such an enterprise need to be looked at.
The Advantages and Disadvantages of Real Estate Investment via an LLC
Advantages
As with any LLC operation, the owner/s personal assets are protected in the event of legal action being taken out against the company. So, in the instance of buying a property and renting it out, should the tenant file legal action against you, you will be protected. However, the property itself could be in the firing line as it is an asset of the business. Should you happen to lose the property as a result of action against your company, you could lose your business if it was dependent on that property.
There is a way to negate this potential disaster. It’s more than possible to have multiple LLCs. To play it safe and avoid the catastrophe mentioned above, it’s not unusual for an LLC to be formed with the purpose of acquiring just one property. With a separate LLC for each property, each one is then kept isolated from the other, therefore any trouble that happens to come the way of one, won’t reach them all. It may seem a lot of hassle (and more money) to form a new LLC every time you wish to acquire another property, but it can be a very safe way in the bigger picture of building and protecting your real estate activities.
Renting out a property as an LLC is likely to be far more successful over time than not. Someone may not feel confident about an advertisement in a local newspaper for a rental apartment if the contact detail is simply a “John Smith”. Should they instead see the apartment listed as being available through “John Smith Rental Properties, LLC” they are far more likely to feel reassured and trust that the rental is legitimate and professional. This isn’t just limited to potential tenants – this added credibility will go a long way too with vendors and any other businesses you have to deal with while in the rental property business.
LLCs are straightforward to form and one of the cheapest ways to get a business registered and legitimate with the state. That being the case, the cost of forming a new LLC for every new property is small change comparatively. It can be done for a sub-2K figure. As a rental property business, it shouldn’t take too long to get the ROI that will make it worth the effort.
Disadvantages
An LLC may shield your private assets in the event of a lawsuit taken out against it, but it doesn’t mean that LLCs are bulletproof. They are not. If a court declares the owner of an LLC to be guilty of serious negligence, the winner of the case may then be able to hold the owner liable themselves.
The big disadvantage that has the potential to get things messy is the ‘due on sale’ clause. Generally speaking, a mortgage needs to be paid off in full in order for ownership to be transferred. Any member that assisted with the financing of the mortgage will have their name on the mortgage paperwork, documenting them as legally being the owner of the property. The ‘due on sale’ clause is an industry norm. What it means is that the owner (the named member on the mortgage document) is required to pay the remainder of the money owed if the property is sold. The transference can be a difficult business, and it is strongly advisable to get professional advice relating to the matter before proceeding.
In Conclusion
Real estate investment through the use of limited liability company formation can be a very profitable business that is easy to get up and running. The ability to have a separate LLC for each owned property offers a unique safety barrier, one which is absent for other entities and private landlords. There can be substantial gains with this type of investment through an LLC – but be aware that there can also be some substantial complications.
About the Author
Jean Wilson Murray is a legal expert who is a co-founder of Best LLC Services and has been helping aspiring entrepreneurs start their own companies for seven years already. During this time, he has investigated all the pitfalls in choosing the financial and management structure of a business, the establishment of companies, as well as the legal structures of enterprises and has become a highly skilled professional in this field.
