Why Do I Need a Business Entity (LLC) in Real Estate?

by | BiggerPockets.com

If you are a real estate investor or thinking of becoming one, it is imperative that you understand the legal issues involved in order to protect your assets.

One of the most important decisions you have to make regards the legal structuring of your real estate business — or what is more commonly known as an LLC.

LLC is short for limited liability company, a newer form of business entity that offers benefits that partnerships and corporations do not guarantee. At its heart, it is meant to protect real estate investors from themselves and the malicious intentions of others.

LLC can seem like an intimidating topic when you’re entering the real estate scene. This is probably because it is the foundation upon which your entire real estate company will be built.

In truth, there isn’t much to it, really.

Related: Yes, You Absolutely SHOULD Use an LLC to Invest in Real Estate: A Counterargument

Understanding LLC

A limited liability company is an entity that you can either own solely or partially.

The main objective of forming a real estate LLC is to draw a line between your personal and business assets. This way, in the event that you run into any legal or financial trouble, no one can seize your personal assets to pay off the debts you owe.

Likewise, it is not easy to use the assets listed under the LLC for your own personal use or gain.

A good LLC setup is one that proves your business is not simply used as a vehicle to hold your personal assets, but rather, to conduct business.

To prove you are using your LLC for business purposes, there are certain things that need to occur to establish this such as, for instance, filing tax returns.

Why you need LLC as a Real Estate Investor

There are several compelling reasons why every real estate investor should consider setting up a limited liability company:

  • Limit your Personal Liability

Real estate investment can be a rather lucrative endeavor. Typically, there is a whole lot of money involved in each deal, often more than the average individual can cover on his or her own accord.

With this in mind, it is extremely important, as an investor, to make sure your personal finances (finances not tied to your business) are protected, otherwise a lawsuit could wipe your accounts and personal assets clean.

The good thing about LLC, and what has got to be its most interesting aspect, is that it limits personal vulnerability to potential lawsuits related to any respective property.

When your real estate business is under LLC, should you get sued, your personal finances, personal residence, and other personal assets will not be at risk.

  • Enjoy the Perks of Pass-through Taxation

When it comes to tax, many corporation owners usually pay a double tax. They are required to file both their business-income and personal-income tax statements.

This is not the case with a real estate LLC, which excludes you from paying taxes at the business level. This is thanks to pass-through taxation, which traces back to a 1988 revenue ruling which allowed real estate investors to avoid double taxation by holding property through LLC.

This pass-through taxation allows any real estate LLC member to report business profits or losses at a lower rate through individual tax returns. Not only that, as an owner of a single-member LLC, you enjoy more deductions because you can use, say, your mortgage interest as a deduction come tax time.

Relate: 5 Reasons I Do NOT Invest in Real Estate Using An LLC

  • Ease of Establishment

Establishing an LLC is easy. The process itself is simple and straightforward. Just about anyone can do it.

According to SBA.gov, all you need to do is choose a business name, file the articles of organization to validate your LLC, create an LLC operating agreement (if your company will have multiple members), and lastly, obtain licenses and permits.

  • More Freedom

When it comes to management responsibilities, a real estate business structured as a limited liability company doesn’t have too many restrictions binding it as is common with partnerships and corporations.

It is not mandatory for a real estate LLC to hold regular meetings or even maintain in-depth business records. As regards the distribution of cash flow, this is a prerogative of the LLC member(s).

  • Builds Credit for your Business

The ability to build credit for your business is an often underrated benefit of establishing a real estate LLC.

When you make up your mind that this is the right corporate structure for your real estate business, you can obtain what is called an employer identification number (EIN). What this does is allow your business to build credit without affecting or using your personal credit.

This can be a powerful tool for you as a real estate investor since it gives you the opportunity to establish an exceptional credit rating for your business.

Assuming your personal credit profile is in good standing as well, this essentially means you have double the borrowing power.

What’s your experience with setting up an LLC?

Share your tips and advice below!

About Author

Nasar Elarabi

Nasar is a corporate failure who was saved by Real Estate. Nasar is now a Wholesaler, Rehabber and Landlord in the Charlotte area. Nasar may have just barely graduated college but can flip a house like an acrobat. Nasar’s work can also be found at RealEstateDoru.com.

14 Comments

    • Alpesh Parmar

      Haha. So true. I don’t agree with most of what’s mentioned under tax. Except C-corps, every other entity is pass-through entity. IRS doesn’t recognize LLC as an entity so a single-member LLC is disregarded and multi-member LLC is considered as partnership.

      This pass-through taxation allows any real estate LLC member to report business profits or losses at a lower rate through individual tax returns. Not only that, as an owner of a single-member LLC, you enjoy more deductions because you can use, say, your mortgage interest as a deduction come tax time. – you have mentioned this already that a single member LLC is disregarded so mortgage interest is deducted no matter if it’s owned personally or through LLC.

      LLC is for asset protection purposes and should be only looked at it from that perspective.

    • Susan Morath

      Nasar, I don’t know if you are a lawyer or not. But as one myself, I am very, very concerned about the amount of blogging and selling of legal documents and instruments by non-lawyers that profess to provide information on very complex legal matters. The amount of misinformation out there is simply unbelievable. Having spoken at a variety of real estate investor meetings, I have come to learn that the issue of LLC use is an absolute mess. Never, ever be penny-wise and pound foolish when it comes to this stuff. Fork over five hundred bucks for a couple of hours of quality attorney time to find out not only whether an LLC is right for the kind of investing you want to do, but also how it needs to be handled to work best for your situation. You will also be establishing a relationship with a lawyer on whom you can call now and then when problems come up – which they always will.

  1. Steve Vaughan

    If you’re going to hype LLCs for every property type whether people are using debt or not, we should see you in the forums answering questions about why they are subject to crappy commercial financing only, leaving themselves at risk of having no title or hazard insurance when they transfer it out and due on sale clauses.
    I have LLCs for my commercial assets and little houses with no debt, but do not recommend folks put little houses with debt into LLCs. Stick with wholesaling is my opinion for you.

    • Cody L.

      No. There is this odd misconception that if you spend 5 minutes and $100 getting an LLC, you can now get “business credit”.

      I have had my LLC for 10 years and when I filled out my credit app to get company cards for all my employees, with the bank I’ve been with for 6 years and have $25m in loans with, I still put my own social on the app.

      An LLC doesn’t do as much as people think in their minds. It doesn’t change your tax structure vs. having in your own name ONE BIT either.

    • Curt Smith

      Frank, so true. I bet almost no one’s LLC will protect them, they are doing something wrong and any trial attorney will pierce the LLC veil.

      Read: https://www.corporatedirect.com/running-a-business/piercing-the-corporate-veil-how-to-avoid-it/

      I always advise new folks to start doing deals first, own something, focus in finding deals, not LLCs, websites, all sorts of time eaters vs buying deals! After a few years then move all those bank financed rentals into the LLC etc. The LLC advocates conveniently fail to mention you can’t use bank lending to buy rentals titled into an LLC, so for some period of time the rental will be in the borrowrs name. I hear that few banks complain if you spend the $100 with a RE attorney/title offiice to move the deed into the pass through LLC after the closing.

      • David Gebert

        Hi All- This timely for me as I have signed warranty deeds to transfer my properties (all with Bank loans) to an LLC. I am hesitating because of the potential of a Due of Sale calling. I have been advised by my real estate agent that I would have 90 days to rectify if I did get called in which case I would just transfer back to my name. My attorney didn’t seem overly concerned either. Does anyone have REAL experience transferring title to LLC’s on properties with bank loans? I have heard it’s sort of a don’t ask and just keep making payments but that’s not very comforting. I’d appreciate some feedback.

        • Jonathan Jordan

          We have worked with one bank for our rentals and let them know up front that we planned on gifting the properties into our LLC after closing and they did not have a problem with it. With the amount of money involved, if the bank has a problem, I feel it is better to be up front about your intentions.

  2. David Petersen

    This is a very over-simplification of a complicated topic. For example – If the only income you have is the REI income, then the pass-through taxation might be beneficial. If you have additional income and that pass-through will put you in a tax bracket that is higher than the corporate tax rate, you may choose another entity. Also, when you get your EIN, you need to specify whether you want to be taxed as an individual or as a partnership or a corporation. Each of those elections has benefits and liabilities. As you can see, just understanding which way to answer can be very complicated – which is why I recommend to talk to a tax professional to make sure that you are selecting the correct option for your particular situation.

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