Choosing the best entity to hold real estate investments is typically dependent on the particular circumstances involved, such as the size and nature of the company’s business, and number of owners or members and their respective rights and obligations.
Many people choose a LLC, Limited Liability Company, to hold their real estate in order to protect their other assets and property from claims that might result from their real estate investment. If the LLC for real estate is formed and managed correctly, investors can limit their potential liability if there is a claim or lawsuit relating to the real estate.
Although an LLC and a corporation can both help protect investors from liability, many people choose an LLC to hold real estate. In addition, an LLC can have tax advantages over a corporation. For example, an LLC with only one owner may not have to file a separate tax return and its profit or loss can be included on the owner’s tax filing. In contrast, a corporation must file a separate tax return.
The greatest legal benefit of an LLC is that these kinds of companies provide all the liability protection of a corporation, but with fewer restrictions. For example, an LLC does not require regular stockholders meetings, a board of directors, regular board meetings, or records of all these meetings and bodies. The legal liability protection of an LLC is extremely valuable in other ways, as well. It can protect from “worst case scenarios” such as accidents on an investor’s property. With an LLC as the property owner this worst case is liquidation of the LLC. The members of the LLC will lose their investment, but nothing more. Members’ personal assets are protected.
The first step is to form an LLC. The LLC is a state-regulated business entity that allows liability protection for the owners, but also preserves the pass-through tax features of a partnership or sole proprietorship.
In order to form an LLC for real estate, you will need to file articles of organization with the state in which you intend to do business. For a single-member LLC, an operating agreement is optional. It is required for a multi-member LLC and should spell out the manner in which profits and losses will be allocated to each partner.
The property to be held in the LLC can be purchased before or after the LLC is formed. Purchasing real property after the LLC is formed can have the unintended consequence of subjecting the purchaser to the more stringent commercial lending standards. Commercial lenders have less flexibility in underwriting loans when compared to residential lenders.
To transfer interest in real property, you must ensure the title company will allow you to add the LLC to the title. Even after the transfer, you are personally responsible for the mortgage. The transfer is not a taxable event. No gain or loss is recognized by the transfer.
Once the property is transferred, any income or losses generated will be attributable to the LLC. The net income — loss — will be reflected on Schedule C of the Form 1040 return for single-member LLCs. Mutli-member LLCs — other than husband and wife — will file a 1065 partnership return and each member will recognize the net income — loss — from the Form K-1 on their Schedule E of the Form 1040. An LLC may have tax advantages over a corporation. For example, an LLC with one owner may not to have file a separate tax return and its profit or loss can be included in the owner’s personal tax return. A corporation must file separate returns.
Another option to consider, if permitted under applicable law, is a series LLC, which is an umbrella entity consisting of one LLC with multiple “series” or “cells.” You can read all about this in the previous blog.