1. LLCs and Real Estate
2. The Costs and Alternatives
3. Why LLCs?

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.

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.

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.

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