If you plan to invest in real estate, you must protect your personal assets from issues involving your real estate dealings. Liability insurance is the simplest way to gain protection, yet it can be expensive and subject to exceptions and limitations.
One alternative is to form a Limited Liability Company (LLC) to hold the title to your real estate investments. An LLC provides liability by separating your personal assets and finances from your business ones without the burdens associated with forming and maintaining a corporation.
LLCs provide the following advantages over other forms of protection.
- Personal Asset Protection – Your personal assets are protected from lawsuits against the LLC. Without this protection, a person injured on one of your properties may attempt to sue you for damages and claim both business and personal assets.
It is extremely important not to blur the line between LLC and personal assets. Actions such as paying personal expenses with LLC funds can remove the protections in the eyes of the law and allow your personal assets to be accessible to judgments and creditors of the LLC.
- Simple Management – Corporations have specific requirements for directors and officers, but an LLC allows greater flexibility in the management structure. You do not also have to hold annual formal corporate meetings with recorded minutes.
Realize that “simple management” does not mean “no management.” Whatever structure you decide to use, document it within an operating agreement and follow those rules with diligence.
- Tax Benefits – Profits from LLCs are passed through and taxed on an individual level, in a similar way to partnerships and sole proprietorships. Using an LLC instead of a corporation avoids restrictions associated with S-corporations (see below) as well as the double taxation of C-corporations – once as corporate income and another as dividends on the personal level.
- Ownership – Compared to an S-corporation that gives similar pass-through tax-benefits, an LLC has fewer restrictions on ownership. There is no limit to the number of owners and no U.S. citizenship requirement. Owners may be businesses as well as individuals.
- Inheritance – By including family members as co-owners of the LLC, you can shield them from inheritance taxes. Assets are passed on to your family members and control is maintained.
The procedure for setting up an LLC differs by state, but generally, it will involve the steps below. Templates, databases, and reference materials for creating your LLC should be available at the Secretary of State’s office for your state.
- Name – The name must be distinct from other LLCs operating in your state. Your LLC will be afforded the same protection.
- Articles of Organization – The articles of organization must be filed with the appropriate state agency (usually the Secretary of State’s office). This typically includes the LLC's name and operating address, the names and addresses of co-owners, and the choice of contact person (the “registered agent”) for the LLC.
- Operating Agreement – Not all states require them, but it is wise to have a formal agreement that outlines the structure of the LLC, the collective obligations and rights of co-owners, and respective percentages of interests and profits/losses to be shared.
A lawyer is not necessary to set up your LLC paperwork, but it is strongly recommended that you consult with one.
LLCs are not for everyone, as some real estate investors may be fine with simple liability insurance and others may need benefits specific to corporations, such as the ability to issue stock. Research your options in detail, and you are likely to make the best choice – but ask a professional if you need assistance.
How to calculate Tax Brackets.