A pass-through entity is a business structure, such as an LLC, series LLC, or S corporation. We use the term “pass through” because you can claim the income of these types of businesses on your personal income tax returns. Ordinarily, you would have to file a separate return for your business (or businesses).
The chief benefit of using a pass-through entity is that you won’t be taxed twice. Nor will you end up paying a CPA thousands of dollars to file a business tax return. Typically, other types of business structures will be obligated to file such a business return. We’ll talk more about the best entity for real estate investors below.
Some of you may be starting to think this doesn’t apply to you because you file a return jointly with your spouse. Well, you can relax. This poses no problems, and all the benefits described above would still apply. But there are some instances where you will have to file a separate return, despite using a pass through entity. The main case for this is if you’re using a partnership return.
The Partnership Return and Taxes
Some states require at least two members to form an LLC. So let’s say you file your LLC in one of these states and have another partner in it besides yourself.
In this scenario, you’re going to have to file a document called a partnership return. A partnership return is a separate return for your business itself. By separate, we mean separate from your personal taxes. Due to the complexity of a partnership return and its filing process, you would be wise to recruit somebody to help you prepare it. I suggest you hire a CPA, ideally one who is also a real estate investor, to assist you in preparing your return.
And now, onto the bigger concern for real estate investors.
Which Pass-Through Entity is Best for a Real Estate Investor?
I so love when the answers to complex questions like these are simple. This one can be answered in three words: the series LLC. Hands down. I’ve given some of the basics below, but if you want to learn more, check out my recent BiggerPockets article that compares the series LLC to the traditional LLC.
Related: Maybe You Shouldn’t Start an Entity. Consider 4 Alternative Asset Protection Strategies Instead.
The series LLC offers unbeatable asset protection, easy tax filing, and is the foundation of a solid asset protection plan. To illustrate how this works, play along with the following example.
Say you own six properties. Instead of holding all six properties in one LLC, with a series LLC you can create a “series” within your LLC. Each series will hold a single property. So you’ll have seven companies total: the parent company, and then six individual series for your assets. But you don’t have to separately account for all seven come tax time, thanks to the fact that you’re using a pass-through entity. Of course, this is only true if your series LLC was formed properly. You also will have to do your part to ensure your entity is compliant. You can look forward to a future article on what “doing your part” entails, but the basics are:
- Follow the advice of your professionals. This applies to attorneys and CPAs who help with your entity.
- Keep assets separate from operations. Let the series entities hold your assets, and run all of your business with the public through a separate company or person.
How The Series LLC Prevents Lawsuits & Saves Money
The benefit of the series LLC structure from a lawsuit prevention standpoint is clear. If someone sues one of your series and wins, only that one property in that individual series will be vulnerable to costly judgments. That means the remainder—and likely the vast majority—of your wealth and assets would be protected. The series LLC’s structure protects those other assets and isolates them from the one in the line of legal fire.
Related: 6 Mistakes to Avoid When Setting Up Your Real Estate Entity
Another great benefit is that no matter how many “series” you have within your LLC, they can all be filed on the same income tax return. This is a huge money-saver that you won’t receive with a traditional LLC, let alone multiple traditional LLCs. When you couple these savings with the lawsuit protection capabilities of the series LLC, it’s easy to see that using entities like that saves you time and money in multiple ways. If you want to learn more, read my previous post about the role of LLCs in protecting real estate investments.
Congratulations! You’re now better informed on pass-through entities and the benefits of the series LLC for real estate investors.
Feel free to keep the conversation going by adding any questions or comments below. If you have experience with pass-through entities, feel free to share that as well.
Thanks for reading, and good luck out there in the real estate industry.