It is important to note that a properly formed and operated corporation or limited liability partnership can offer the same amount, if not more, protection from outside lawsuits than an LLC. However, a properly functioning Real Estate LLC does offer many other advantages that make it the most desirable form of entity, particularly with respect to real estate investment companies. The following highlights the benefits of an LLC to real estate investors and their individual businesses:
Real Estate LLCs Have Several Lesser-Known Benefits
LLCs came to prominence approximately 10 years ago, as real estate investors were made privy to the upside they offered. In particular, forming a real estate LLC provides investors with a liability guard that can protect them from malicious lawsuits. Moreover, the legal entity of an LLC comes with additional tax benefits. However, there is so much more to an LLC than meets the eye. Real estate LLC benefits are relative to other legal entities that, while not unique, apply to the use of LLCs when holding real estate assets. Those perks include, but are not limited to the following:
- The structure presented by an LLC makes delegating management responsibilities and positions a lot easier. Whereas a corporation is statutorily required to have officers and directors, LLCs are free to be managed by their owners, or even a third-party.
- There are a lot of states that impose additional fees on the authorized number of shares a company has. While LLCs are still subject to these fees, they may pay less than corporations. State registration and maintenance fees are therefore lower for businesses structured under an LLC.
- LLCs award real estate investors the ability to exercise incredible flexibility during profit distribution. Unlike that of an S Corporation, LLCs do not have to be pro rata (in proportion) in the distribution of cash flow. In other words, members of an LLC have the ability to financially reward the “sweat equity” put forth by a specifc individual.
- Unlike that of an S Corp, LLCs promote foreign ownership and investment in U.S. real estate.
- The structure of an LLC makes it easy for anyone to transfer ownership. Real estate holdings can actually be “gifted” to heirs each year, without actually going through the process of signing a deed. In fact, gifting property allows owners to avoid certain taxes.
Business owners are aware of the vast amount of legal entities they may structure their companies under. LLCs, while more recognizable than the average legal entity, are but one of several options. In fact, due to their recognizable nature, most business owners chose the structure of an LLC because they are unfamiliar with the many legal nuances associated with other options. Others simply assume LLCs are the best way to go. In reality, there is not one entity that encompasses, or covers the needs of every business. While most real estate investors favor LLCs, there are other options available. Corporations and partnerships, while different in their own right, share many similarities. The following is a breakdown of other legal entities:
A corporation stands alone as its own legal entity. It is created within the parameters of each states’ particular laws and owned by shareholders. As a result, corporations protect their owners from personal liability for corporate debts and obligations. By default, corporations are taxed on multiple levels (corporate tax and income tax). The advantages of a C Corporation are as follows:
- Owners are only personally liable up to the amount invested in the corporation.
- Owners have the option of either participating as a manager or solely as a passive investor.
- There is no limit on the amount of shareholders a corporation can have at a given time.
- The transfer of ownership is relatively easy. All an owner has to do is sell their shares.
- Corporations transcend the life of their owners. Despite the loss of an owner, the corporation will continue to exist.
An S Corporation is created under state law, much like the C Corporation. However, unlike a C Corporation, it elects to be treated as a pass-through entity for tax purposes. Moreover, S Corporations are not subjected to double taxation because of the nature of a pass-through entity. Income is distributed directly to the shareholders, who in turn file said income on their individual tax returns. As a result, accounting for an S Corporation is generally easier. The advantages of an S Corporation are as follows:
- S Corporations are privy to many of the same benefits exercised by C Corporations.
- Thanks to a special tax election, S Corporations avoid double taxation.
While not officially considered to be a separate legal entity, a sole proprietorship is the simplest form of business. In fact, by default, once you start a small business, you become a sole proprietorship. Having said that, there is no separation between the business and the individual—the two are synonymous. Even with low start-up costs and ease of operation, factors such as unlimited liability for all business debts and liabilities can make a sole proprietorship the most expensive type of structure in the long run. The advantages of a sole proprietorship are as follows:
- There is no paperwork to get started.
- Lowest initial costs of all legal entities.
- No extra tax filing requirement, as profits or losses can be reported on the owner’s tax return.
- The business is reliant upon one individual.
As a real estate investor, you should be aware that your particular industry is prone to risk. Without sounding too negative, there is simply no way to eliminate all risk associated with starting a real estate investment company. However, with the right education and legal entity, you can mitigate a great deal of risk. Accordingly, complying with the formalities set forth by an LLC will protect your business from a great deal of threats.
If you skipped the first part of our series: A Beginner’s Guide To Forming A Real Estate LLC Part 1, go back to understand the basics. Part one will teach you the difference between an LLC and liability insurance and which option is best for your business. You will also learn how LLCs limit personal liability and allow you to qualify for pass-through taxation.
If you’re ready to file for an LLC but don’t know how to move forward, you’ll enjoy part 3 of our series: A Beginner’s Guide To Forming A Real Estate LLC Part 3 | The Next Step. After forming an LLC, you’ll want to obtain an employee identification number, get your business licensed and permitted, open a separate bank account for your business, and much more. Learn everything you need to do in order to move forward in part 3.