Advantages of Forming an LLC
Creating an LLC for your investment activities has several financial, administrative, and legal benefits. Here are some of the main advantages you can enjoy:
Enjoy Simple Setup
Setting up an LLC is relatively straightforward and provides a low barrier of entry for aspiring real estate investors. Each state has its own rules regarding LLC formation, but here are the basic steps to expect:
Pick a company name. To operate as an LLC, you need to establish a company name under which you’ll do business. Check the business name registry in your state to ensure the name is available.
File your formation documents. Submit LLC formation paperwork with your local secretary of state. These documents are commonly known as the articles of organization or a certificate of organization, depending on your state.
Draft an operating agreement. An operating agreement summarizes the overall regulations and expectations for your LLC, including the entitlements of LLC members.
Get your EIN. Register your business with the IRS to acquire your employee identification number (EIN). You use your EIN to open a bank account and do taxes.
You can complete these steps on your own or work with a filing service to handle the technical details of your entity formation. Research the regulations in your state to ensure you understand any additional expectations, such as choosing a registered agent.
Save on Taxes
One of the main features of an LLC is pass-through taxation, which allows you to only use your personal income tax return to pay for earnings. This can provide significant savings on your capital gains through real estate sales while still providing you with personal asset protection. You have the option to be taxed as an individual, a partnership, or a corporation depending on your financial goals.
Setting up an LLC can make you eligible for extra deductions, such as a 20% income tax deduction. In addition, you can deduct expenses related to your real estate business, such as renovations, insurance, mortgage interest, and any other business costs you incur while buying, selling, and managing properties.
Reduce Your Personal Liability
Investing in real estate and managing properties often comes with significant risk, and LLCs provide personal liability protection to owners and investors. Having insurance on your property can provide some protection as an individual investor, but forming an LLC ensures that the company itself is fully responsible for legal and financial matters. Even if a claim extends beyond your coverage from homeowners’ insurance, you won’t be personally liable for those expenses.
Here are a few situations where operating as an LLC may come in handy:
If someone gets injured on your property and files a lawsuit to pay for medical expenses, they would sue the LLC, not you personally.
Legal disputes with any tenants would occur through the LLC, and any payouts would come from the LLC’s assets instead of your personal savings.
If the LLC is unable to pay off debts, creditors can only pursue the LLC’s assets, not the personal belongings of LLC members.
Incorporate Other Investors
When you purchase investment properties as an individual, bringing in co-investors can involve complex paperwork. You may need to change the deed on your property and rely on approval from your lender. With an LLC, you can simply make an adjustment to the operating agreement to incorporate a business partner. This involves detailing the percentage of the property each person owns and how the LLC members plan to divide any profits. Seeking counsel from a financial or legal advisor can help you draft a fair and functional agreement.
Develop Credit as a Business Owner
Once you establish an LLC, that entity can start building credit as a business. Even if you have excellent credit as a private individual, having business credit can increase your credibility with business partners and lenders. After developing good credit for your business, your LLC may be able to qualify for non-recourse loans, which you don’t have to personally guarantee. This can allow you to take out much larger lines of credit than you could as an individual, increasing your ability to scale your investments and purchase more valuable properties.
Because the LLC also assumes business risk, any potential hits to your business credit won’t influence your credit as an individual. You can take reasonable business risks with your LLC while enjoying peace of mind regarding your individual credit and finances.
Manage Rentals Easily
Operating as an LLC can provide you with a convenient framework for overseeing any rental properties. Many of the administrative details of property management are simplified when you use an official legal entity, such as an LLC. Here are some of the main benefits:
Simple management options: You can use the LLC structure to appoint a third-party manager, allowing you to outsource administrative duties to a professional.
Increased professionalism: Rentals that operate under an established entity can appear more professional to potential tenants or contractors.
Easy property transfers: If you ever decide to sell a rental property, you can consider selling the whole LLC to a new party, allowing current rental agreements to stay intact.