Starting A Real Estate Investment LLC
Why have an LLC?
There are mainly two reasons why you want any kind of business structure:
Pay less tax, and protect your assets. LLCs can be especially helpful if there are multiple owners of a property. When you create an LLC, you’ll create an operating agreement that outlines the rights and responsibilities of each member of the LLC.
This can help you seamlessly manage your rental property business and also protect each member of the LLC in case of legal trouble.
Before you jump into creating your LLCs for your real estate holdings, there are a few things to consider. Do NOT make these three mistakes while creating an LLC for your real estate investment company.
1. Forming The Wrong Real Estate Investment Company and/or In The Wrong State
Sometimes people get confused about their real estate investments and what the IRS considers them to actually be doing. You could be a real estate dealer, which means you flip or wholesale properties. You could have a real estate business, which means you rent out property for short stays and provide substantial services, like a motel or some types of vacation rentals. You could be a developer which means you buy property and make changes to it before it is sold or put in service. Or, you could be a regular real estate investor and hold property that has long term renters (commercial or residential).
You first need to know what kind of real estate investor you are. You will use different tax strategies and different types of structures depending on the type of investment. For example, if you're a real estate dealer, you have a business and that means you want an entity that is taxed like an S Corporation or possibly a C Corporation. Flipping houses or flipping burgers…you have a business.
Forming LLC For Rental Property
If you have long term rentals, you will most likely want a single or multi-member LLC for your rental property business. If you are investing from Canada, you'll want an LP (limited partnership).
Bottom-line, know exactly what you're going to do first and then decide the right structure of your real estate investment comany. If you need to close quickly on a property and want an entity right away, your best bet is to use an LLC. An LLC can decide later what type of taxing structure it should have.
The second part of this is setting up the entity in the wrong state. LLC’s are regulated at the state level, so the process of creating an LLC will differ state-by-state. Make no mistake, one way or another you need to have legal authority in the state in which your property is located. If you buy a property in Ohio, you need an OH LLC or you need to authorize your out-of-state LLC to do business in Ohio. (In effect, you'll pay twice that way – once to the state that has your LLC and once to Ohio.)
If you don't get your entity set up or authorized in the state of your property, you won't have any legal standing for possible tenant issues. One way or another, you have to have an entity in that state.
Benefits of LLC For Rental Property
1. If you create an LLC, then the only assets at stake are those owned by the LLC. In other words, your rental property is the only asset at stake and not your personal finances. This is very beneficial in case of you face any law suits.
2. If you create separate LLCs for your rental properties or portfolios, then each property or portfolio becomes a separate legal entity. In this way you can insulate each property from liability claims by setting up separate LLCs for each property. The benefit of setting up separate LLCs is that if someone files a lawsuit pertaining to one of your properties, then the rest of your properties will not be affected by the lawsuit. This effectively separates and protects each of your rental properties from a single lawsuit.
3. Setting up an LLC can lead to paying less taxes. With an LLC, you get the benefit of the company’s income passing through to you as the business owner. Essentially, all income made by the LLC of your rental property will flow through to your individual income tax return. This minimizes the amount of money taken out of your income for taxes.
4. When you create an LLC for your rental property, you should create a separate bank account for your LLC. This makes it easier to claim business expenses when it comes time to do your taxes. It will be very clear to you when you check your bank statements which expenses are business and personal.
2. Real Estate Professional With Wrong Structure
How to become a real estate professional?
The short answer is that if you want to claim real estate professional status (and all the great tax benefits), you have to be a named manager in a manager-managed LLC. If you tried to do-it-yourself with an online LLC set-up or used someone to set up your LLC who doesn't understand real estate tax law, you could have a problem.
3. Not Setting Up Real Estate LLC Operating Agreement
The #1 mistake when setting up an LLC is failure to prepare the real estate llc operating agreement. Most of the online do-it-yourself websites mention it, but don't give you the tools to do it. Remember the manager-managed LLC is the type of LLC you need for your real estate investments if you ever want to take the “real estate professional” status.
Once the entity is set up, that's not the end of it. You need to continue to maintain the LLC with proper state and federal filings. Plus you need to give proper notice in your business dealings. Don't sign contracts with just your name, use your name plus your title (i.e. Manager of ABC LLC).
Are there only 3 possible mistakes? Of course not, but these are the most common.
