Let’s talk about what an LLC is and what it isn’t. An LLC is not equal to a get-out-of-jail-free card. You can be sued with an LLC, and you can still lose everything. An LLC is not designed to prevent you from ever being sued. An LLC is intended to help you manage and contain the fallout from such a lawsuit. According to the United States Small Business Administration (SBA), a limited liability company is “a hybrid type of legal structure that provides the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership.”
Given this definition, an LLC’s benefits are threefold.
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3 Benefits of Holding Your Properties in an LLC
1. Limited Liability
If you were to get sued, your liability (the damage to your wallet) could be contained to the assets within the LLC, not everything else you own. In other words, if the LLC is set up correctly, and you get sued and lose, the creditors probably would not be able to take your personal house or car, or garnish your W-2 job wages. Or course, there are ways a judge might “pierce” the protection of an LLC and go after these things if every I is not dotted and every T not crossed.
2. Tax Efficiency
The LLC is fairly easy to handle during tax time, especially if it is a “single-member LLC,” which means an LLC owned by just you or by you and your spouse. LLCs are known as “pass-through entities,” which means the income and expenses flow magically through the LLC and are reported (and paid) by each individual member on their personal income statement.
There is no “corporate tax” like a corporation might pay. This can definitely make taxes easier and less expensive than for, let’s say, a corporation. That said, although a single-member LLC does not require its own business tax return, a multimember LLC does. Don’t make this mistake.
3. Operational Flexibility
Finally, an LLC is fairly flexible in terms of running it. You don’t need thousands of documents or to issue stock. An LLC can be set up fairly easily and inexpensively and requires just a few documents.
It’s easy to see why an LLC might be advantageous to a real estate investor. Let’s say a tenant slipped on the stairs and broke their hip. The tenant decides to sue the landlord for “neglect,” and the court sides with the tenant. For whatever reason—let’s say your insurance doesn’t cover all the legal penalties—you, as the owner, are required to pay $500,000 out-of-pocket to the tenant. Ouch. If you own the property without an LLC, the tenant could have your wages garnished, force you to sell all your properties, and drive you to bankruptcy. You could end up eating cold beans out of a can under a bridge while pigeons sit on your shoulder—not a fun place to be.
On the other hand, if the owner of that property was “Main Street Investments LLC” rather than you personally, then the LLC would be the entity getting sued. The courts could make you sell that property, or other properties owned by that LLC, but they likely wouldn’t be able to make you sell other properties owned by other LLCs, if you have them. They won’t take your primary residence. You won’t be eating cold beans. Sorry, pigeons.
Of course, this example is a bit overdramatized and unlikely to happen. And I don’t actually mind eating cold beans. But it illustrates the fear that drives most investors to pursue an LLC. Even though it may sound like I’m encouraging you to establish an LLC, remember that there are still cons to doing so; it all depends on your personal situation.
Do you use an LLC for your real estate business? Why or why not?
Let me know with a comment!