As a real estate investor, I get this question a lot. Most people who ask generally fall into one of the following situations:
- Recently attended a guru training and were told they needed to create an LLC for asset protection
- See others who invest in real estate with an LLC
- Want an LLC so they can have a business name
- Want a business entity to inspire more confidence in business
- Get loans in the LLC name instead of your personal
Regardless of why they are asking, it is a good topic to think about. Below are my thoughts.
*Note: I am not a lawyer. The below thoughts are based upon my experience in real estate. I would advice seeking an attorney, one focused in real estate, for legal advice.
To me, the primary reason for getting an LLC is to separate your personal assets from those of the business. Depending on the type of real estate investing you are doing, it may or may not make sense to have an LLC. Typically I see LLCs making the most sense for long term investors who buy and hold property (ex. landlords). If you own a property in your name, a tenant could sue you and not only would your investment property be at risk, but also any other assets that you owned in your name. By forming an LLC and having the LLC own the property, you add a layer of protection in case of a lawsuit. The laws vary from state to state, which is why I recommend consulting a lawyer for your specific needs.
But to be clear, you often don’t need an LLC to accomplish some of the items listed above. An an example, you can go to your county clerks office and create a DBA (Doing Business As) for ~$25. This will allow you to operate under a business name as a sole proprietor, which is much cheaper and less costly if that is what you are looking for. If you want to inspire confidence, you can run your business in an organized manner. If you want to write off business expenses, you can do so as a sole proprietor. So LLCs do have their place, but understand your goals as an investor and determine if an LLC is something that you actually need.
Additional LLC Benefits
In addition to asset protection, here are some additional benefits I see from having an LLC to hold my investment real estate:
- Easier to Setup Compared to Other Entities – An LLC is typically less complicated to create than other business entities, such as a C Corporation.
- Build Business Credit – Where an individual has a social security number (SSN), an LLC has an EIN (Employer ID Number). This means that you can do business and get loans in the LLCs name, but until you have business credit and assets, you will still most likely be required to personally guarantee the loans.
- Tax Savings – As an LLC there are a few different options for how to to be seen from the IRS (sole proprietor, partnership, S-corporation or C-corporation), which can save money on your taxes. As an example, losses can flow through to your personal taxes and reduce your tax liability from other sources, such as a job where you receive a W2. An accountant (who should be part of your team) should be able to guide you on how an LLC may benefit your tax situation.
- The LLC Owns the Property – There are some advanced scenarios where you can change the member structure of an LLC without affecting the ownership of a property. An example if selling a business that owns a property. The business still owns the property, but someone else is now the members of the LLC.
Disadvantages of an LLC
There are some pitfalls and disadvantages of an LLC that I want to make you aware of as well. Some of these are not really disadvantages, but things to be aware of.
- Initial Cost – Creating an LLC can range from a few hundred dollars to over a thousand dollars, depending on the state and whether you do it yourself or hire an attorney.
- Ongoing Costs – Filing taxes for an LLC can be difficult, so you will most likely want an accountant to assist you, which will cost additional money each year. Although if you are a single owner, the IRS will see this as a “disregarded entity” and this can be added to your personal returns.
- Needs to be Separate – In order for the LLC to protect your assets, it need to be treated as separate from you. This means things like the LLC having its own bank account and not making personal purchases on that account.
- Single Owner – If you are the sole member of an LLC, it may be easier for an attorney to argue that the LLC is not separate from you. Each of my LLCs thus far has been a partnership, meaning more than 1 member.
- Does Not Cover Personal Neglect – An LLC will separate you from the company, but if you personally neglect something, then the LLC won’t help you. As an example, if you personally maintain your properties and your neglect or omission caused an injury, you could be help personally liable.
LLCs are just another potential tool in your toolbox as a real estate investor and are not needed or even the best option in all situations. Other tools include things such as contracts, insurance and your team of professionals. I would recommend understanding your goals and educating yourself on LLCs. There are many free resources online, but please make sure you are learning from credible sources. I used the following book and was really impressed with how detailed it was.
As always, check with your professionals (attorney & accountant) if you have specific questions regarding your situation and if an LLC would be beneficial. I have formed 2 LLCs for my real estate businesses, which primarily focus on buy and hold investments. Also, if you decide on an LLC, you can create one on your own without an attorney. I created 2 of my LLCs with LegalZoom.