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Starting any kind of business can feel overwhelming. Working under a sole proprietorship may work in the short term, but expanding the business often requires reconsidering the business structure and how it may be impeding growth. Many business owners form a limited liability company (LLC) because it’s a fairly straightforward and cost-effective process that provides tax flexibility, personal liability protection, and may boost the credibility of the business. While an LLC can provide many broad benefits to any type of company, there are several unique advantages for real estate investors.
Using LLCs to purchase, sell, and own real estate investments have become more popular because it comes with several additional benefits like:
While there are additional complexities and potential cons introduced with LLC ownership, let’s review these pros first.
One of the most common reasons to use an LLC is the personal liability protection it provides. Investing in real estate, like any asset, comes with risks. When holding property long-term, a few of those risks include value depreciation of the property, lawsuits from accidents that occur on the premises, and legal disputes with tenants. Additionally, it limits what assets creditors can target when satisfying business debts.
Creating an LLC for a real estate business is one of the ways investors reduce the risk of personal liability should they face a lawsuit or accumulate debt on behalf of the business. The LLC acts as a shield separating personal assets like bank accounts from business assets. Sole proprietorship and general partnerships do not offer this kind of liability protection.
Because tenants, contractors, and subcontractors may be at risk of slip-and-falls and other accidents, creating an LLC for rental properties and flipping makes good business sense.
Unlike other types of business entities, like C-corporations, the default tax structure for LLCs is a “pass-through tax.” Instead of taxing the LLC directly, the owner or members of the LLC report the income on individual tax returns. They may also qualify for certain deductions, like the Qualified Business Income Deduction, which “allows non-corporate taxpayers to deduct up to 20% of their qualified business income (QBI), plus up to 20% of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income.”
When transferring the title of a property into an LLC or selling a property as an LLC, another potential benefit is avoiding taxes on the appreciated value. In certain cases, individuals without an LLC or other types of corporations will have to pay capital gains tax after selling a home or transferring the title.
Because the federal tax code is nuanced and state taxes may have additional impacts on LLCs, consider reaching out to a tax professional for guidance.
Working under a business name instead of an individual can help build trust among clients and other real estate professionals. Contractors may be more likely to do business with flippers who do business under a registered entity. Homeowners may be more likely to sell to wholesalers who build an online brand presence under an official name. Financing a loan may become easier when all the proper business documentation is available to lenders.
Ultimately, doing business under “Jones Properties, LLC” rather than “Sam Jones” can create an impactful first impression and demonstrate professionalism.
As long as an LLC is supported by an Operating Agreement that clearly outlines the rights and responsibilities of each member, LLCs are a good way to structure real estate business partnerships. The Operating Agreement provides details on how ownership is divided among the LLC members. While this benefit provides flexibility in how title rights and profits are divided, it can come with additional complexities. To avoid confusion and division among members, it’s advisable to gather all members and seek legal counsel when creating the business documents that will support the function of the LLC.
Operating a real estate investment business under an LLC may provide additional financing opportunities. The screening process for an LLC is similar to the application process for a personal loan. In certain cases, the lender may require business applicants to sign a personal guarantee or sign the loan documents using their name as an individual, making them personally liable for the repayment. There is debate as to whether investors with LLCs will receive more favorable terms than individuals. That may be the case if the LLC has already established good business credit. However, the biggest benefit is the access to a new ecosystem of lenders who work specifically with professional investors.
In addition to conventional mortgage lenders like banks and credit unions, private lenders, hard money lenders, and other portfolio lenders can provide more creative and flexible financing options for LLCs. However, these lenders may require signing a personal guaranty or sign using a personal name, which removes the limited liability provided by the LLC. Like with any contract, investors should be sure to understand the legal ramifications of the loan terms before signing.
Related Reading: Five Ways to Finance Real Estate Investments
Maintaining the personal liability protection afforded by the LLC requires all members to act according to particular formalities. One of the ways to lose that protection or “pierce the corporate veil” is by engaging in misconduct like co-mingling business and personal finances, missing an annual filing, failing to file a separate tax return, or not complying with other state requirements to maintain the LLC. Creditors or litigious individuals may attempt to pierce the corporate veil and go after personal assets if they believe any member of an LLC has failed to abide by the required standards.
Forming an LLC is considered a privilege, so it’s up to business owners to familiarize themselves with the rules and regulations to maintain one properly.
At Blueprint, we work with various real estate professionals including investors leveraging all types of business structures. We provide a title and closing experience to support the complex transactions associated with real estate investing. With a multi-state footprint, expanding your real estate business across state lines is easier with one key title partner. On top of that, our platform allows investors and their counterparties to gain insight into transaction milestones and upload and electronically sign documents. For those with proprietary software, you can connect with our API to submit and track transaction information in one place.
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