Beginner’s Guide To Starting A Real Estate LLC
Starting a real estate investment LLC is now a time-honored tradition that many prolific entrepreneurs follow today. An LLC also called a limited liability company is a legal business entity that has the eligibility to get a tax identification number and run as a business separate from the owner or partners. In short, those who form the LLC would not personally be responsible for any debts or other types of liabilities incited by the company. This is the reason why it is called the “limited liability company.”
Now since we are talking about starting a real estate investment LLC, let us get back to it. Even though the enforcement of LLCs started back in the 1970s, the real estate investors have recently begun to take an interest in starting a real estate investment LLC due to the benefits over the past decade. The main benefit that allured them towards starting a real estate investment LLC was to reduce the personal exposure to financial and legal risk.
With the help of an LLC, if you own an investment property, there are many important benefits that you can enjoy. Along with that, you would also have the ease of administration which is not beheld by other legal entities. Even though an LLC is not the only option that is available and good, many of the real estate investors perceive that the privileges offered by an LLC are the most obliging.
Basically, in case you wish to find out all about how to own your own business, it would not hurt you to have an LLC for your protection. This means that you can easily benefit by starting a real estate investment LLC instead of choosing any other business structure for your real estate business.
As a matter of fact, the LLCs are usually very intimidating to the first-time business owners. And the reason behind this is a good one; they are the legal foundation on which you would be building your complete business. But it is worth noting that if you move towards starting a real estate investment LLC, it is not as daunting as many say it to be.
Yes, there are many challenges that you would have to face, but that doesn’t mean you would not get the best out of them. Alternatively, consider due diligence and welcome the benefits that the forming LLCs can offer you and your company.
Advantages Of Setting up a Real Estate LLC
Starting a real estate investment LLC has become very popular amongst many entrepreneurs since the last decade. The reason is that by incorporating their businesses, the real estate investors would not only be able to get the access to the various benefits but would also have the eligibility to enhance the long-term health of their company.
The real estate LLC benefits comprise of, but are not limited to, the building of credit for your business, pass-through taxation, and the protection of investors from personal liability. Moreover, anyone who wants to know the exact way of starting a real estate investment LLC would be happy to know that it would be much easier to do so. The sections below would give you all the information you need for starting a real estate investment LLC.
Limiting Personal Vulnerability
If you are planning to take up investing in real estate as a career, it is a great choice due to its high profitability. There is a lot of money that exists in every deal made for a real estate, which is more than what amount an average person can earn on their own.
With all this said, it is highly important for the investors to protect their personal assets in this business. And by starting a real estate investment LLC, the LLC would limit the vulnerability of the investors’ personal assets to any potential lawsuits, which is also the most intriguing aspect of starting a real estate investment LLC.
In short, any lawsuit that comes against the company would be against the LLC company and not at the individual who is the owner or responsible for it. In case the property in question belongs to the company, the risk of exposure of the owner would be protected by the company. And this means that the property owned by the company would be exposed to the lawsuit and not the one owned by the owner. So, with this, the personal assets would not be in danger.
Considering liability coverage is one of the most critical parts of starting a real estate investment LLC, then it’s the taxes that comes after it. As a matter of fact, a few of the investors in the real estate world think that building their company structure as an LLC is based entirely on the tax benefits. And the liability protection is added as a bonus to it.
In 1988, the court had ruled and approved the request where real estate investors can easily avoid the double taxation trouble while they acquire property by starting a real estate investment LLC. As per the default tax classification rules, the IRS lists a real estate operating company with one owner exactly in the same way they would a sole proprietorship. Otherwise, the company is regarded as the “disregarded entity.”
In this way, any gains from the company would transcend to the owner, and the owner would then pay the taxes on it as an individual. Nevertheless, the particular owner would still enjoy the protection against liability. In short, it is actually the best of both worlds.
Moreover, since there is no separate tax for starting a real estate investment LLC, the owners can easily avoid double taxation. Basically, neither appreciation in value upon disposition, nor the rental income generated by a property incurs the tax penalties. And that is not all; the single-member LLC owners can utilize mortgage interest as a deduction while they file for the tax return at the end of the financial year. By starting a real estate investment LLC, you aren’t just enjoying fewer taxes, you are also offered many deductions as benefits.
In the eyes of the IRS, the real estate companies that are owned by more than one person is not taken the same as the company owned by just one person. This is also called the “multimember” LLCs, and are taxed exactly like how a partnership is taxed.
But you need not worry about the double taxation in this case too. This is since it is still an LLC and also enjoys the benefit of the pass-through taxation where the profit or losses are passed through to the members. Each owner of the company has to then report their share on either the Form 1065, a Schedule C, or K with their individual income tax returns. So, you get both the tax through benefit and the liability protection.
Many Lesser-Known Benefits
It was only about 10 years ago when the LLCs became famous, while the real estate investors were made aware of all the benefits that they can get by starting a real estate investment LLC. Other than the points mentioned above, there are a few more things that makes starting a real estate investment LLC the best option. These include, but are not limited to:
- You would be able to assign the management positions and responsibilities easily due to the LLC structure. LLC are free to be managed by a third-party or the owners of the company, unlike the corporations where the management is only for the officers and directors.
- Many states impose fee on the authorized number of shares that the business has. Even though the same fees is applied to the LLCs, they pay much lesser fee as compared to the corporations. The maintenance and registration fees are hence lower for the LLC.
- It is easy for anyone to transfer ownership in an LLC. The real estate holdings can easily be gifted to the heirs every year, while there is no need for the owner to go through the process of signing a deed. Moreover, gifting the property helps the owners to avoid more taxes.
- LLCs promote the investment and foreign ownership in US real estate, unlike the s-corporations that don’t.
- By starting a real estate investment LLC, the investors have the ability to use incredible flexibility during profit distribution. The LLCs do not have to be in proportion (pro rata) while distributing the cash flow, unlike the s-corporations. This means that the LLC members can financially reward the “sweat equity” that has been placed forward by a particular individual.
Steps for Starting a Real Estate Investment LLC
After you have understood all about the benefits of starting a real estate investment LLC, it is now time to know how to open one. Here are the steps to it:
- Select a business name: Before you select a name, it is vital to go through the rules for naming your company as per your state. This can be found on the Secretary of State website. After that, select your business name that no one else is using and that can be easy to remember as well.
- File the “Articles of Organization”: As soon as you name your business and figure the address of it, it important to file a document called the “Articles of Organization” with the LLC office of your state, typically the Secretary of State. You can get the form from the Secretary of State website, or contact Inc Paradise to help you in it. As soon as the document has been filled, it can be submitted in person or by mail with the filing fee to the Secretary of State.
- Make an Operating Agreement: Even though the LLC Operating Agreement is not a legal document that should be filed with the state, but it is important to note how the LLC would be organized and operate internally. The document can have the scheme for selecting the managers, how the losses and profits are distributed, and rights and duties of members.
- Publish your intent to file: Since it is needed by a few states, find out if you need to publish your business intent file or not through your local newspaper. If not, your LLC would be considered as an official business as soon as your Article of Organization has been approved by your Secretary of State.
- Get the relevant licenses and permits: After you have set up your LLC, you can move ahead by getting the business permits and licenses that might be needed. Along with that, ensure that you do not forget to get the tax identification number from the IRS for your company.
How Does A Real Estate LLC Compare To Other Legal Entities?
If you are already a businessman, you might already know about the various number of business entities available to choose from instead of starting a real estate investment LLC. And even though the LLC for a real estate investment business is the most recognizable entity, it is an option from several others.
As a matter of fact, due to it being the most common type, many business owners decide that starting a real estate investment LLC is better just because they do not know much about the other options. And others who know, just assume that an LLC is the best way to go. But it is always a good thing to know the truth and the reason for yourself as to why you need to make a choice. Depending on situation and visions, a different type of entity might be better for you instead of starting a real estate investment LLC.
But the truth is that there isn’t even one entity that offers all the best benefits and has no risks at all even though starting a real estate investment LLC is favored a lot. And partnerships and corporations share almost similarities that many don’t know, tend to miss or ignore. The following would you a bit:
Even though this is not taken as a separate legal entity, it is the simplest form of business. When you start a business, this is the default for it if you do not choose any other business entity. But in this one, there is no separation between the business and the individual. Here are the following advantages of it:
- The business is reliant upon one individual.
- The profits and losses are reported in the owner’s personal tax return. Hence, no extra tax filing is required.
- Lowest initial costs of all legal entities.
- There is no paperwork to get started.
An S Corporation is another business entity that is created under the state law, and is much like the C Corporation (explained below). Nonetheless, in this entity, you need to elect to be treated as a pass-through entity for tax purposes. And due to the nature of a pass-through entity, the S Corporations are not subjected to double taxation. Here are the advantage of this type of entity:
- Thanks to a special tax election, this type of entity avoids double taxation.
- S-Corporations have many same benefits that are used by the C-Corporations (mentioned below).
Alone as a legal entity, the c-corporation protects their owners from the personal liability for corporate obligations and debts. By default, the c-corporations are taxed on multiple levels, that is they have to pay the income taxes and corporate taxes. Here are the advantages:
- Corporations transcend the life of their owners, which means that they would continue to exist even if the owner dies.
- It is easy to transfer ownership in this type of entity where the owner just has to sell the shares of the company.
- There is no limited number of shareholders that the company can have.
- The owner has the choice of either acting as a passive investor or being the manager of the company.
- Owners are liable only up to the amount that they have invested in the c-corporation.
Real Estate LLCs vs. Liability Insurance
Are you still not sure if starting a real estate investment LLC is right for you or not? Are you planning to get an insurance policy instead? Well, even though the LLCs offer a lot of benefits to the real estate investors and their industry, this does not mean that they are the right choice for every investor.
Moreover, it is important to keep in mind that the real estate investment industry is diverse where it is impossible to find a legal entity that would protect all the businesses. With this, there are many investors who feel that the lawsuit threat does not warrant the commitment need to start an LLC. And for the people who think like this, it is better to look for an affordable liability insurance.
On the other hand, those entrepreneurs who rely entirely on the insurance for protection are following an ill-advised risk. It is normal for average liability insurance policy to have addendums, exceptions, and limitations that convolute coverage. So, liability insurance does not cover all the corners and hence, there are possibilities where a lawsuit can be filed where the policy would not be able to protect everything you have.
In short, if the policy does not cover a situation for your business, then it can cause you a devastation and loss in business. And with laws working towards making things better for the real estate investors, you can now easily move ahead by starting a real estate investment LLC even though it might not do everything. But the fact that it does a lot to protect you and your business is the thing that you might need.
In short, they provide a lot more protection as compared to the liability insurance. But other than the benefit, by starting a real estate investment LLC, you would have the real benefit of having a peace of mind. This would allow you and other investors to sleep comfortably knowing they are safe.
What’s next after Starting a Real Estate Investment LLC?
You have set up your LLC, what is the next step? Well, here are the things you need to do:
- Get the Employee Identification Number (EIN).
- Obtain all the relevant business licenses and permits.
- Open a separate business bank account.
- Apply for a business credit card.
The steps mentioned above are ways in which you can protect your business in more than one way in the future. Hence, it is better that you start by obtaining the employer identification number (EIN), which is also called the federal tax ID. It is basically a unique number that is provided to every business by the IRS for tax purposes. You would need to mention your business entity type and also the date it was incorporated.
Even though the EIN is needed by the IRS, you would also need it for opening a business bank account, build credibility with it as a sustainable business and protect your business against any identity theft. The business permits and licenses are not the same as the filing for starting a real estate investment LLC. You would have to be diligent in your efforts for running a business that is legitimate and file for a business permit or license on your own accord. Inevitably, not having them would cause you a high penalty and can even lead to the shutting down of your business.
To ensure that you follow all the rules for running your business, it is better to contact an attorney who can assist you with it. Also, contact the government and your local municipality to know all the recommendations that you need to follow. After all has been done, you would also need a separate bank account after starting a real estate investment LLC. It is important since it would help you keep all the finances separately and would protect your personal assets.
Along with opening a bank account, it is obvious that you would also need a credit card. Just make sure that it is a company credit card so that you can maintain the “corporate veil” that protects your personal assets, keeping your business and personal assets separate. Moreover, keeping the company credit card would eliminate the change of record-keeping confusion.
Start An LLC For Real Estate Today!
Being a real estate investor, you know that this business and industry is prone to risks. And it is obvious that there is no way you can avoid all the risks that comes with it. Nonetheless, if you have the right education and select the right business structure, you would be able to eliminate many risks. In short, starting a real estate investment LLC would help protect you and your company from many risks that you might have to face otherwise.
Now that you are aware of all the details regarding the choice in starting a real estate investment LLC, you can make a better decision. And if you are planning to open a real estate investment LLC, IncParadise can assist you in setting up your LLC and registering it with the government.