Many Wealth Academy members are starting businesses or investing in real estate. And some are doing both at once! Starting a limited liability company (LLC) for your real estate investment portfolio is a common option for business owners and real estate investors. Below is a list of just a few pros and cons of creating an LLC for real estate investments. Be sure to consult your advisory team to help you make decisions best suited to your location, financial situation, and wealth building goals.
- Protection from personal liability. Limited liability means that you, as the owner, will not become personally liable for the company’s debts or liabilities. Generally, if an owner/investor is sued, only the business assets would be at risk.
- Tax benefits. The LLC structure can offer significant tax benefits, particularly because it eliminates double taxation. Double taxation refers to being taxed at the business level and personal level. Instead, an LLC becomes a pass-through entity for tax purposes. This means that profits or losses flow through to each member of the LLC. Members then report income or loss on their individual tax returns and pay taxes based on their personal income tax rate.
- Simple transfers. An LLC can be sold through a relatively simple transfer of membership interests. Real estate owned under an LLC can stay under the LLC, while under control of new members. An LLC may also allow foreign members outside of the U.S. This can make it easier for an investor to raise capital outside of the country, and offers foreigners another way to invest in U.S. real estate.
- Professionalism. Owning rental property under the name of an LLC gives a real estate investor a more professional business appearance. This leads to potentially increased credibility with tenants, lenders, and vendors. An individual or business looking to lease property may be more comfortable renting a piece of real estate from “Smith Properties LLC” than from “Joe Smith.”
- Financing. While it may be possible for an LLC to obtain a rental property loan, most lenders will also ask for each member to personally guarantee the loan. That means if the LLC defaults on the loan, the lender is able to hold each member jointly and severally liable for any outstanding mortgage debt.
- Due on sale clause. Transferring rental property from an individual to an LLC may trigger the due on sale clause. Most mortgage documents require the existing loan to be paid off if the property owner changes. This is the case even if the rental is transferred into a single-member LLC. You may want to seek a waiver from the mortgage lender before transferring real estate from an individual’s name into an LLC.
- Tax obligations. Some cities, counties, and states charge a transfer tax when real estate ownership changes. Additionally, an LLC is still required to file an annual tax return, even though it is considered a pass-through entity. Members of an LLC may also be required to pay self-employment taxes for Social Security and Medicare on any income earned.
Before making any decisions for your business and real estate portfolio, be sure to thoroughly research the laws in your state. Some states, such as Delaware, have more favorable laws for business owners. Other states are less business-friendly, such as California. Depending on your business operations, you may not have to register your business in the state where you reside, or even where the investment property is located.
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