There are many reasons why limited liability companies (“LLCs”) may be your preferred method to purchase real estate. The main overall benefit of purchasing real estate via an LLC is the ability to own real estate and minimize liability exposure without adding tax complexity. This combination of benefits creates a variety of strategic planning opportunities. The top four reasons to purchase real estate through an LLC are:
- Liability Protection. Although LLCs are generally ignored for federal income tax purposes, they are not ignored under state law. Because the LLC is an entity separate from its owners, operating a business or investment as an LLC generally protects your personal assets from exposure to liabilities related to the underlying business or investment: open a separate bank account, obtain a separate tax ID number, and then operate the business separately.
- Tax Advantages.
- Your tax filings may become simpler. Under federal tax laws, an LLC’s activities are considered to be conducted directly by the LLC’s sole member (owner); accordingly, the LLC does not need to file a separate federal income tax return. If the LLC is owned by an individual (or a husband and wife), then the results are reported on the member’s individual tax return, and if the LLC is owned as a partnership, the results are reported on the partnership’s federal income tax return on Form 1065, with K-1s then being distributed to each partner.
- You may be able to lessen the amount of taxes you owe. Another potential tax advantage involves the exchange of property under the IRS’ Section 1031 like-kind exchange rules. Under these rules, you may be able to swap appreciated real estate for replacement property without any current tax obligation. The property that you give up in the exchange and the replacement property received in the exchange can both be held within an LLC.
- Better than Insurance. In some situations, we advise our clients to simply obtain liability insurance on their real estate, especially if the trouble and expense of forming and maintaining a company outweigh the threat of a lawsuit. However, it may be risky for real estate investors to rely solely on insurance as a means of protection from personal liability, because liability policies typically have limits, exceptions and carve-outs. While the chance of a loss that exceeds policy limits may be remote, if it happens, the consequences would be devastating. Further, if the real estate is engaged in a business that may be more likely to give rise to lawsuits, then the LLC setup is worth the effort.
- Long-term Family and Estate Planning. Owners of LLCs can take advantage of the tremendous flexibility in the distribution of profits and ownership.
- As determined by the LLC’s operating agreement, cash flow distributions do not have to be pro rata according to ownership like an S-corporation, which gives the owners the ability to financially reward the “sweat equity” effort of select members through appropriate distributions of available cash flow.
- Unlike an S-corporation, foreign ownership and investment in U.S. real estate is possible through an LLC.
- Most importantly, for longer-term family and estate planning, LLC owners may easily transfer their ownership in real estate holdings by gifting membership interests to family members or other beneficiaries over time without having to execute, record, and incur costs associated with a new deed and transfer taxes. Furthermore, using an LLC, along with an Operating Agreement, is an excellent, clean method to transfer real estate to or among other family members for current and future generations.
If you are in the market for investment real estate, you should at least consider whether the acquisition through an LLC is the right choice for you. If you would like assistance, or have any questions, please contact Fournier Legal Services at firstname.lastname@example.org or 860.670.3535 for a free consultation or planning session.
Joseph E. Fournier is an Attorney and a CPA who has more than twenty years of experience in a variety of business legal matters, including start-ups and company formations, drafting shareholder and operating agreements, contracts, employment law, commercial litigation, tax planning and audit defense, and mergers and acquisitions (M&A). He also handles estate planning matters, such as business succession planning, wills, trusts, and probate.