Key Takeaways:

  • Buying property through an LLC provides liability protection, tax benefits, and organizational flexibility for real estate investors.
  • LLCs shield personal assets from lawsuits related to property holdings, ensuring risks are confined to the LLC's assets.
  • Setting up an LLC may involve higher costs, including filing fees, attorney services, and annual maintenance.
  • Financing through an LLC may be challenging; many lenders impose higher interest rates or require personal guarantees.
  • Alternatives like liability insurance or other business structures might be suitable depending on business needs and risk tolerance.

Buying property under an LLC is one of the most popular ways to put together real estate holdings for both businesses and private individuals. An LLC, or limited liability company, provides legal protection against onerous legal judgements in the unfortunate case of bad circumstances, while also keeping a powerful tax position. If you are putting together real estate holdings, it is crucial that you understand the benefits and requirements of LLCs as you make your organizational choices.

LLCs and Real Estate

An LLC is a company status that combines the liability insulation of a corporation with the advantageous tax status of a sole proprietorship or partnership. Like a corporation, an LLC is only legally liable for the sum of its assets in any legal action; a company wholly owned by its partners gives access to the assets of the owners when considering garnishments and other methods of seeking damages. But like a sole proprietorship, an LLC allows profit to “pass through” and count as an income stream for its owners. This avoids double taxation, which is the normal situation for corporations, paying both when they make the money and when they distribute the proceeds to their owners.

It is important to understand that LLCs are locally organized. Their tax status is not recognized by the IRS, and they are treated as normal companies of their type when filing federal taxes. The S corporation election is a way for small corporations that agree to stringent rules to file in a similar way to an LLC, but not all LLCs are qualified to be S corporations. For instance, all S corporations are required to file as corporations, which is complicated and may not be something you are interested in.

LLCs first became a popular way to handle real estate in the United States in 1977, when Wyoming enacted LLC laws to help oil companies. Other states followed close on their heels, and nowadays, every state has their own form of the laws. Of course, the exact content of those laws varies from state to state, which is a particular burden on businesses operating in multiple jurisdictions. But many real estate companies only need to worry about their ability to function in one or two states, due to the nature of their business.

Financing Properties with an LLC

Securing financing for a property purchased under an LLC can be more complex than for personal real estate transactions. Many traditional mortgage lenders view LLCs as higher-risk borrowers. As a result, LLCs may face higher interest rates, require personal guarantees from members, or need to present a well-structured business plan demonstrating the entity's financial viability.

Some LLCs opt for commercial real estate loans, which are designed specifically for business entities. While these loans may offer more flexibility, they also typically come with shorter terms and stricter repayment requirements. Alternative funding options include hard money lenders or private equity investors, though these options often carry higher costs.

The Costs and Alternatives

LLCs are not the magical solution to every real estate dilemma, however. Filing an LLC and maintaining its status usually requires annual fees and taxes, and the paperwork to set one up can be complex. This in turn usually requires hiring an attorney to prepare the filings. If owners think their real estate business is unlikely to generate any lawsuits, they may turn to liability insurance instead and stay with more intuitive business formations. Like any insurance, however, liability insurance comes with loopholes and limits designed to keep costs to the insurer under control. While it may seem like a simple solution, one bad incident can turn the cheap alternative into an unexpected and crushing expense.

State-Specific Requirements for LLCs

The laws governing LLCs vary by state, influencing both the process and cost of creating and maintaining the LLC. For instance, states like Delaware and Wyoming are known for their business-friendly regulations and lower fees, making them attractive for LLC formation. On the other hand, states with higher annual filing fees or more stringent reporting requirements, such as California, may increase operational costs.

Real estate investors should evaluate their home state's LLC laws against their operational needs. For properties across multiple states, LLCs may need to register as foreign entities in each state, leading to additional compliance obligations. Consulting with an attorney familiar with state-specific LLC laws can help navigate these complexities.

Why LLCs?

The advantages of LLCs in holding real estate are several.

  • LLCs reduce liability to the assets of the company, not the assets of its owners. This is useful in the event of an accident on the property. If someone injures themselves on company property, owners of a non-LLC company might find a judgement filed against their personal property. An LLC, by contrast, would only be liable to the amount of the assets held by the company.
  • The “pass through” income of an LLC reduces the taxation on rental incomes and other monies generated by properties held by the LLC. When a corporation makes money, it must pay taxes on its own income. The remaining profits go out to its ownership, who then must pay taxes again on the same money. With the “pass through” in effect, the owners simply count rents and the like as other income on their personal tax forms.
  • Finally, LLCs offer various benefits in terms of organizational flexibility and paperwork requirements. While these can vary by state, generally an LLC has an easier time filing taxes and otherwise interacting with state government, and can reorganize quicker than its competitors.

Tax Considerations for Real Estate LLCs

LLCs offer significant tax advantages compared to traditional corporations, primarily through their "pass-through" taxation. However, the tax implications of owning property under an LLC extend beyond basic income reporting. For example, expenses related to the property—such as maintenance, property taxes, and mortgage interest—can be deducted from the LLC's income.

Additionally, LLCs may qualify for certain federal tax benefits like depreciation deductions, which can significantly lower taxable income. State-level taxes, however, can vary widely, with some states imposing franchise or excise taxes on LLCs. Proper tax planning, ideally with a certified accountant, ensures compliance while maximizing benefits.

FAQ Section:

  1. What are the benefits of buying property through an LLC?
    Buying property through an LLC provides liability protection, tax advantages, and organizational flexibility, making it ideal for real estate investors.
  2. Are there disadvantages to purchasing property under an LLC?
    Yes, disadvantages include higher costs for setup and maintenance, limited financing options, and varying state-specific requirements.
  3. Can an LLC get a mortgage?
    Yes, but lenders often impose stricter conditions, such as higher interest rates, personal guarantees, or shorter repayment terms.
  4. Is it better to buy property under an LLC or as an individual?
    This depends on your risk tolerance, tax planning needs, and whether you want personal liability protection. An LLC suits those prioritizing asset shielding.
  5. What are the tax advantages of owning property through an LLC?
    LLCs allow for deductible property expenses and can benefit from "pass-through" taxation, avoiding double taxation faced by traditional corporations.

If you need help with preparing an LLC to own real estate holdings, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.