Real estate investment has several lucrative advantages compared to other forms of investment. However, it can also expose real estate investors to risks they never knew existed. That is why real estate investors must form a real estate LLC to protect them from outside interference. LLC is an abbreviation for Limited Liability Company.
What Is an LLC?
An LLC is a business structure. An LLC can be created individually, with a partner, or as a group. If you own a limited liability company, you become an LLC member.
The regulation of LLCs is done at the state level, which means the process of LLC creation will vary depending on the state. It is advisable to do state-specific research to understand more about the process of creating an LLC in your jurisdiction and what fees and associated costs you will incur.
Benefits of Creating an LLC for Your Rental Property
There are a few reasons why you need to create an LLC for your rental property.
Limit Your Liability
If you are the sole rental property owner and a lawsuit is filed against you, your items will be at risk since you have personal liability. However, if you had created an LLC, the only assets that will be at stake are those owned by the LLC.
The LLC ensures that the owner’s assets are protected from business liabilities, just like it would have been done in a C corporation.
Keep Your Rental Properties Separate
Apart from separating your rental property from your assets, you also need to separate your rental properties from each other if they are more than one. You can protect your different properties from liability claims by creating separate LLCs for each rental property.
If all your rental properties are under separate LLCs, you ensure that each property is protected from any lawsuit that might be filed against a different property that does not affect it. Different LLCs make sure that your properties are individually protected from liability.
Pass-Through Taxation
Pass-through taxation is an advantage enjoyed by individual-owned businesses. Usually, a company is taxed on its profits, and the owners are taxed separately on the income they get from the company.
If you have an LLC, the company’s income will “pass-through” to you as the business owner. All income generated by your LLC goes into your individual income tax return. This means you reduce what is deducted from your income for tax purposes.
Helps Separate Business and Personal Expenses
A newly created LLC should be accompanied by a new and separate bank account. That means you will be able to separate your personal and business expenses. A different bank account makes claiming rental property operating expenses easier when doing your taxes. Independent bank statements help in differentiating between business and personal expenses.
Ability to File in a Different State
It is not mandatory to file your LLC in your resident state. You can file an LLC in another state that may offer better benefits or even more relaxed laws concerning LLCs. While filing an LLC in a different state can be complicated and time-consuming due to the various paperwork to be filed and the fees charged, the benefits might add up and be worth the trouble.
Loan Terms
Registered companies are offered better loan terms and interest rates by mortgage lenders. Even if you are a real estate LLC with one member, you may still get a better offer from the lender than someone applying as an individual.
Comparison Between Real Estate LLC and Liability Insurance
Some investors view the process of forming an LLC as too much, and it is not worth the protection they will get from a lawsuit. Such investors may decide to take liability insurance.
Liability insurance is less expensive, but it might be risky because they include exceptions and its protection has limits. LLCs are becoming more popular because of their benefits to real estate investors.
Setting Up a Real Estate LLC
The formation of real estate investment LLCs has increased in the last ten years due to their unique advantages that can’t be ignored. Creating a real estate LLC is not hard; rather, it only requires that you do research and be organized. The following are steps you can follow.
However, these steps may vary depending on the state:
Research Regulations
The procedure for creating an LLC will slightly differ from state to state, especially concerning the fees charged and the various state regulations. Most investors prefer to incorporate within the state they do business. A few of them opt for places where the business laws are a bit “relaxed,” such as Delaware and Nevada.
You need to remember that if your business is across state lines, you are required to register a foreign LLC in each one of these states. Selecting a state will depend on you but do research and know how the process goes before you start. You can access all the information you need on your area’s Secretary of State website.
Select a Business Name
It is very critical to get the right business name. The name must be able to attract potential clients and should be unique enough to register as an LLC. You can write all your suggestions down before checking their availability online.
One tip you must remember when choosing a name is to avoid categorizing yourself. Creating an LLC is just the beginning of your real estate business, so you must choose a name with potential. Once you have narrowed down the candidates, you must ensure that those names are not taken. One common reason for LLC application rejection is an issue with the business name.
File for the “Article of Organization”
The layout of the business is what is referred to as the Article of Organization. It should declare the company’s name, primary address, date it was started, owners of the business, also known as members, and a brief illustration of the business. As mentioned earlier, the specificities may differ depending on the state.
You need to ensure that all the necessary parts are included in the Article of Organization before submitting it to the Secretary of State’s office. At this stage, the business owners will pay any fees associated with the formation of an LLC. It takes a few weeks to get feedback from their office, but issues rarely occur with approval if everything is submitted correctly.
Create an LLC Operating Agreement
An operating agreement is not required by all states, but it is a good idea to have one as part of your business plan. The following states insist on an LLC operating agreement; California, Delaware, Maine, Missouri, and New York.
An operating agreement can be useful no matter the state you live in. It discloses how the business is divided among owners and how decisions are made. It also describes how to deal with the departure of a member from the company. An operating agreement protects business members by predicting possible situations that might harm the business.
Publish an Intent to File
Only Arizona, Nebraska, and New York demand an intent to file. If you are starting an LLC in the above-mentioned states, you have to publish an ad in the local daily declaring your intention to form an LLC in that state.
Investors usually publish ads for over 3-6 weeks in the newspaper. The newspaper sends back an Affidavit of Publication, which has to be submitted to the Secretary of State’s office.
Get Licenses and Permits
You will need more than a real estate investment LLC to start your business. Every state requires licenses and permits before any business can be conducted in its jurisdiction. These licenses and permits may include a general business license, professional license, sales tax permit, and so much more. You can get a list of all requirements by doing an online search. It is a good idea to start with the U.S Small Business Administration’s website.
Disadvantages of Using an LLC For Rental Real Estate
The cost of setting up and managing an LLC might be high depending on the state you live in. Before setting up an LLC, you need to be sure that the cost of operating an LLC is less than the tax benefits and additional protection you get from an LLC.
The structure of your LLC may result in additional tax consequences registered to your business. Therefore, you need to know your tax obligations and whether the additional deductions and your LLC structure benefit your situation.
Forming a new company and all associated with it may involve a lot of paperwork and additional organization to your rental property. You might be forced to recruit a property management company or a property manager.
Whether your company is a sole proprietorship, limited partnership, or limited liability company, having an LLC is still a good idea since its liability protection is not limited. However, if you are unfamiliar with creating an LLC, you should consider professional help from the experts.
