If you’re starting a real estate business, you’ve probably at least considered forming an LLC. The LLC is a popular option for all sorts of businesses looking for asset protection, and it has a handful of other major advantages as well. Read on to learn more.
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A real estate LLC is a formal business entity that protects the personal liability of its owner(s) in case the business is sued. There are a few different ways these businesses can function. You can either use one LLC for all of your properties, create separate LLCs for each one, or form a series LLC (where permissible) to maintain separate LLC segments under one umbrella company.
It’s important to form your real estate LLC before your company ever begins the process of transacting business, because if you start conducting business before forming your LLC, your early transactions may not be covered by the LLC’s “corporate veil,” which is the layer of protection between your business assets and your personal assets.
Additionally, it’s often simpler to complete real estate transactions through an already-existing LLC than it is to transfer them later. This is another reason to form your LLC before you ever start acquiring real estate, as it is typically much harder to transfer ownership of a property from a sole proprietorship or a general partnership to an LLC because a lender will likely have to consent to that transfer. It’s not that this is particularly difficult, but it’s one more easily avoided hoop to jump through.
As we already mentioned briefly, the LLC protects your personal assets. If you own rental properties, for example, this protection could make a massive difference. Let’s say that you have a rental property with a rooftop balcony, and your tenant falls off of that balcony. It’s not unlikely at all that this individual would choose to sue your business for not providing a safe environment.
If you have an LLC, that tenant can only sue you for your business assets. However, if you simply own the property as a sole proprietor, the tenant can also sue you for your own personal assets, like your home, car, personal bank accounts, etc.
Another major advantage of the LLC for a real estate business is the flexible taxation awarded to LLCs. The default method of taxation for an LLC mimics the way a sole proprietorship or general partnership is taxed, and it helps its owner(s) avoid the “double taxation” paid by most corporations. (Double taxation is when the corporation itself pays taxes on the corporate level, and then the shareholders also pay taxes on their dividends, thus taxing the same money twice.)
With the pass-through method used by most real estate LLCs, there is no corporate-level tax, as taxes are only paid by the LLC’s owners on their personal returns. In addition, the Internal Revenue Service allows real estate LLCs to deduct rental property mortgages and loans taken out for the purpose of property improvements as business expenses, which can also save owners a considerable amount of money.
We also appreciate the ability to form separate LLCs for each property, or to form a series LLC with separate segments for different properties (series LLCs are only recognized in certain states, so check with your state to make sure this is an option). This allows you to insulate each property in your portfolio from the others from a liability standpoint, which allows you to minimize risk in case there’s a lawsuit involving one individual property.
Finally, it’s often simpler to complete real estate transactions through an already-existing LLC than it is to transfer them later. This is another reason to form your LLC before you ever start acquiring real estate, as it is typically much harder to transfer ownership of a property from a sole proprietorship or a general partnership to an LLC.
Finally, an LLC structure can enhance the credibility of your real estate business venture. Informal business entities don’t have exclusive assumed business names and typically operate under the personal name(s) of their owner(s). For instance, if your name is Johnny Smith and you’re a realtor, your company’s name is also “Johnny Smith,” which obviously isn’t a great name for a real estate business.
In this scenario, you could register a DBA (doing business as) name to give your business the ability to operate under an assumed business name, but DBAs have no exclusivity regarding their naming rights in many states. This means that if another realtor wants to use your DBA name as their own, they’re not only allowed to do so, but they can actually register a formal business entity with that name, preventing you from continuing to use your own assumed name.
With an LLC, you not only have the rights to exclusive use of a business name, but you will also have either the phrase “limited liability company” or the letters “LLC” in that business name. This provides your business with a jolt of respectability because customers respect the professionalism displayed by an LLC. Also, they typically feel more comfortable writing checks to a business entity rather than to an individual.
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Forming an LLC for real estate is a similar process to forming an LLC for any other purpose, but it’s still worthwhile to briefly cover the steps involved. Remember that if you want a more in-depth look at the entire process, you can check out our comprehensive “How to Form an LLC” article.
The first step to form a real estate LLC is to choose a name for your business. As an LLC owner, you have the exclusive rights to your business name, as long as you choose a name that is not already in use in your state. Keep in mind that you’ll need to include either the phrase “limited liability company” or the letters “LLC” in your business name.
Next, you should designate a registered agent. This is a person or business entity that takes on the role of accepting document deliveries from the state on behalf of your business. Every time the registered agent receives a delivery, they will notify you, then forward it to you. This ensures that you never miss any important deliveries like service of process and that the state always has a reliable point of contact for your business.
The third step is to compose a document usually called the Articles of Organization, which is the form filed with the state to officially form your real estate LLC. This is a relatively uncomplicated document that provides the name and address of your LLC, the location and identity of your registered agent, the names of your LLC owners, and the fact that you will use this LLC to pursue real estate business activities.
You will also need to acquire a federal tax ID number (also known as an EIN — Employer Identification Number). This is essentially a Social Security Number for your real estate business, and it allows you to hire employees, open business bank accounts, file taxes, and more.
You should then draft an operating agreement, which is an internal document that describes how your business will function. This is not legally required in most states, but it’s still vitally important because it can help prevent member disputes down the line.
Another crucial step is to open a business bank account, which will help you keep your personal and business finances separate. This is one of the most important aspects of maintaining your corporate veil, and if you fail to keep your finances strictly separated, you run the risk of losing your personal asset protection.
Finally, you’ll need to acquire any relevant permits and licenses to operate in compliance with local, state, and national laws. Most jurisdictions do have licenses for real estate sales and rental, so you’ll need to comply with the laws in your area to qualify for a broker’s license.
In our opinion, there are far more advantages than disadvantages when it comes to forming an LLC for real estate.
The flexibility of this business model, paired with its ability to shield your personal liability, makes it an excellent choice for real estate businesses. In addition, the ability to deduct a rental property mortgage and/or loans for improvements to your properties is another big benefit.
Whether you choose to form a real estate LLC or a different business entity — or whether you opt to create your own LLC or use a reputable service — we wish you the best with your business endeavors, and we hope this article helped you improve your understanding of how to start an LLC for real estate!
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There are quite a few potential liability issues for a realtor that make the personal asset protection afforded by an LLC indispensable. The most common lawsuit filed against real estate agents is misrepresenting a property to a buyer, although this is far from the only liability risk. Breach of fiduciary duty, fair housing law violations, false advertising, and other potential perils for realtors. In short, you should never operate a real estate company as an informal business entity.
Everyone’s situation is different, and we are not here to provide legal advice. That said, the limited liability company has some concrete advantages over the corporation that makes it the preferred option for most small businesses.
Corporations tend to have more complex formation and maintenance requirements, and they don’t have the taxation advantages of an LLC. The corporation has some advantages of its own (for example, it’s easier to attract investors to a corporation) that make it worth a look but the LLC is a simpler and more flexible business structure.
You certainly can! Every state allows entrepreneurs to serve as their own registered agents. However, while the role of the registered agent can seem like that of an unnecessary middleman, there is more complexity to this position than some people realize.
For instance, you would need to be present and available at your business location during all standard business hours. In addition, if you serve as your LLC’s registered agent, you may need to make your home address a matter of public record. Not only does this have privacy concerns, but there’s also the matter of unwanted junk mail as well.
The DIY route is always an option for LLC formation. However, LLC services are so affordable that there’s really no good reason not to use one these days. In addition, some of these companies often throw in free bonus features that make them an even better bargain.
Some people like to form their LLCs in states with favorable legal settings. For instance, Delaware is often seen as the most business-friendly state, as it has an entire court system that’s dedicated solely to business matters. As for Wyoming, this state has some of the most generous anonymity laws for LLC ownership.
However, for most people, your best option is to simply form your business in your home state. Forming in a different state can be a tremendous hassle, and it can add some unnecessary complexity to tax issues as well.
The costs of LLC formation can vary quite a bit depending on which state you’re forming one in. For in-depth information about LLC formation costs in your specific state, take a look at our comprehensive guide to state-by-state expenses.
Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
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