Many “average” Americans are dipping their toe into the world of investment real estate. Not satisfied with owning REITs, many non-real estate professionals are turning to buying vacation homes, single family rental properties, small multi-family dwellings and even small commercial buildings.
If you are in this group (or thinking of joining this group), I want to give you three letters to remember as you begin your journey – LLC.
LLCs is an acronym for limited liability company. It is a form of entity recognized by states as providing liability protection for its members. At the same time, it receives different tax treatment than traditional corporations. It also is much more flexible than corporations when structuring relationships between members. The following is a very high level discussion on some benefits of forming an LLC. While forming LLCs can be done by laypersons, you should consult an attorney or CPA before taking that step.
TAX TREATMENT – When an individual forms an LLC, the feds disregard the entity and tax the individual as if no LLC existed. If more than one unmarried persons form an LLC, again there is entity protection like a corporation and the individuals are taxed as partners by the feds. So, instead of filing a separate corporate tax return, the members file form K-1s as part of their individual return. The benefit of this is that there is no double taxation as there would be if the investor(s) had created a C-Corp. Moreover, the members can have a much more flexible relationship than had they formed an S-Corp.
LIABILITY PROTECTION – This is the main reason to form the LLC. Say you want to purchase a rental house. If you purchase it in your own name, all of your personal assets are subject to risk in the event that something goes wrong. If you and your renters get into a lease dispute, they may sue you and your individual assets are on the line. What if someone gets hurt on the property and your insurance coverage is not enough to cover the loss? Again, your assets will be at risk. If you form an LLC, you have just created an entity that is separate from you. Its assets are only those that the LLC owns – usually the property. Thus, if something goes wrong, usually only the property is at risk and not your life savings. This can be worth a lot of sleep at night.
While LLCs may not be for every real estate investor, they are certainly three letters that need to be discussed when buying investment property.