LLC for Real Estate Investment: Everything You Need to Know
Having an LLC for real estate investment is a good move to make. LLC have become one of the most preferred choices among real estate investors.3 min read
2. Pass-through Taxes
3. Avoiding Double Taxation
4. Multi-Member LLCs
5. Added LLC Benefits
Having an LLC for real estate investment is a good move to make. Over the past decade, LLCs have become one of the most preferred choices among real estate investors. LLCs are a relatively recent phenomenon designed to give small business owners and investors certain liability protections. Before LLCs, real estate investors could only use a corporate entities to acquire property titles.
The liability protections given to investors, combined with the tax benefits, make owning property through an LLC an attractive option in many cases. With that, retaining property through an LLC is not always the best option, and you should conduct your own research to see if an LLC option would be suitable for your investment endeavors.
Many investors do not see LLCs as worth their time, especially when they can choose liability insurance as an alternative. However, investors who only rely on liability insurance expose themselves to potential risk because such policies come with limitations and exceptions. The chances of losses surpassing the policy may seem rare, but it does happen, and the consequences could be dire.
This is why holding real estate through LLCs has become a more attractive idea to investors.
First, LLCs give you safeguards from legal action against you. In other words, creditors cannot seize your personal assets if a court levies a judgment against you.
- For instance, you are an investment property owner who leases to tenants that throw a large party, and a guest falls from a balcony. The injured party could file a claim against you based on unsafe conditions of the apartment, and you, the owner, would be named in the lawsuit. If your name is attached to the property without an LLC, you would have to defend your personal assets in court. On the other hand, an LLC would protect your assets, and you would only owe assets under the LLC.
Another plus is that investors can employ pass-through taxation.
- Note: Pass-through taxation occurs when losses and profits pass from the LLC to members to file on their personal tax returns.
Corporate owners could achieve pass-through taxation through an S-corp tax election from the IRS, but corporate entities must adhere to cumbersome restrictions that limit real estate investing.
Under default guidelines, the IRS designates a real estate holding company with a sole owner in the same manner as a sole proprietorship. In other words, the business would be considered a disregarded entity. Therefore, capital gains and income from the LLC pass to you, the owner, and you would only pay individual taxes and still enjoy limited liability protections.
Avoiding Double Taxation
Because you do not have to contend with LLC taxation, owners can avoid double taxation, which is a common drawback of C corporations. You would not only avoid double taxation on rental income, but the value appreciation of the property when disposition occurs. Additionally, sole LLC owners must subtract mortgage interest, which is similar to a sole proprietor under IRS guidelines.
Real estate holding LLCs with several members are also called multi-member LLCs, and they are usually taxed in the same manner as general partnerships. In other words, your LLC would only have to file an information-based return.
- Note: Informational tax returns do not compel you to pay business income taxes. Rather, the IRS uses information tax returns to ensure that LLC members record profits and losses accurately on their individual tax returns.
Further, multi-member LLCs employ pass-through taxation on all profits and losses. They may note such profits and losses on their individual tax returns in the following ways:
- Schedule C
- Schedule K
- Form 1065
Added LLC Benefits
LLCs provide greater flexibility overall. LLCs do not require formalities, such as appointing directors and officers, and conducting official meetings. Also, LLCs generally pay lower fees than a corporate entity and have greater freedom to distribute profits as they see fit, as outlined in the company’s operating agreement. For instance, LLC members do not have to distribute shares equally based on a member’s contribution to the LLC. This is not the case with an S-corp classification.
To learn more about an LLC for real estate investment, submit your legal inquiry to our UpCounsel marketplace. UpCounsel’s lawyers will help you in matters pertaining to real estate and the best approach in safeguarding your assets if you own real estate. In addition, they will be at your side if you find yourself in the middle of a lawsuit, and they will defend your interests vigorously.