There are many forms of entities under which a real estate investor could invest in the real estate market: partnerships, corporations, REITs (Real Estate Investment Trusts), etc.
While each has its own advantages and disadvantages, one of the most common structures under which real estate investors have been making their investments in recent years is real estate LLC (Limited Liability Company).
Forming an LLC has a clear and crucial advantage for your investment. There is much more to LLCc than just limiting your liability, however, and this blog aims to delve deeper into what an LLC is, and what the advantages and disadvantages of forming an LLC for your real estate investment are.
What Is a Real Estate LLC (Limited Liability Company)?
A real estate LLC is a relatively new structure under which you can invest in real estate properties with the main purpose of limiting your liability (hence the name). Forming an LLC for your real estate investments means that you would be investing as a separate entity rather than you as an individual – an LLC is treated as a separate entity, requiring its own separate bank account, insurance, etc.
There are two main types of a real estate LLC: SMLLC (Single-Member Limited Liability Company) and MMLLC (Multiple-Member Limited Liability Company). And while the difference between the two is apparent from their names, they both provide the same main benefits of forming an LLC.
What Are the Advantages of Forming an LLC for Your Real Estate Investment Business?
While the idea of forming an LLC seems intimidating for most investors, one cannot deny the major benefits that come along when investing as a real estate LLC. And although an LLC might have additional benefits to the ones mentioned here, these three benefits are considered to be the primary reasons why real estate investors lean towards forming an LLC for their real estate investments, and they are as follows:
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Protect Your Personal Assets
The very first and the most important reason for forming an LLC for your real estate investment business is to protect your personal assets. Since an LLC is considered a separate entity from the investor who’s forming it, in case of a lawsuit, the only assets that would face risk would be the assets that fall under the LLC, or the assets that are directly a part of your investment.
This means that if you’re a landlord and some tenant files a lawsuit against you for suffering a personal injury related to your investment property, your personal assets (such as your home, your retirement accounts, your car, etc.) will not be at risk, and the only property that will be at risk is the real estate investment property that is listed under the LLC.
Related: 5 Legal Real Estate Investing Tips to Know Before Buying a Property
This protection allows real estate investors to feel more confident, and reduces the risks related to their investments, and it is a great tool to utilize, especially if you’re an investor with a lot of assets that could be at risk during a lawsuit.
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Gain Tax Benefits
Additionally, a real estate LLC gains the same tax advantages related to real estate investing, and does not suffer from the double-taxation related to corporates. This means that neither the rental income generated by the property nor the appreciation of its value upon selling the property would trigger tax penalties. In addition, SMLLC can also deduct mortgage interest from their taxation.
Related: Everything Real Estate Investors Should Know About Tax Season
Basically, by forming an LLC, you will be subject to fewer taxes than other corporate structures, and you will be awarded more tax deductions.
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Increased Credibility and Leverage
Another advantage of forming a real estate LLC is the increased credibility and the professional impression that you will be gaining when dealing with buyers and sellers in the real estate market. It is only natural that investing as a company sounds more credible than investing as an individual, and the psychology of other investors in the market will shift towards favoring you over others, increasing your sales and making it easier for you to list your investment properties and advertise them.
What Are the Disadvantages of Forming an LLC for Your Real Estate Investment Business?
The advantages of forming an LLC, however, should be weighed against the disadvantages in order to get a clearer picture of what an LLC is. Although some disadvantages of forming an LLC might be situational, it does not mean that they should be disregarded, as they may pose a risk to your investment as well as your credibility as a real estate investor, in addition to the added expenses that come with forming an LLC.
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Corporate Veil
One of the major disadvantages of forming an LLC is tightly related to one of the major advantages – protecting your personal assets. Once you’ve listed your investment under an LLC, as mentioned above, your investment becomes a separate entity from you in order to protect your personal assets. This, however, can be disregarded in the case of mingling your personal finances with your LLC’s finances. Basically, if you use your LLC’s money for personal reasons, a savvy lawyer will be able to pierce the “corporate veil”, or target your personal assets on the basis that you, as the owner of the LLC, have broken the barrier between your assets and the assets of the LLC, leaving you vulnerable to lawsuits targeting your personal assets.
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Fees and Costs
Additionally, forming an LLC can be a costly endeavor. There are several costs related to setting up a real estate LLC, so make sure to consult real estate experts about your state’s laws and regulations related to forming an LLC and the costs and fees related to it.
Should You Be Forming an LLC for Your Real Estate Investment Business?
If you’re still wondering whether or not you should form an LLC for your investment, take this piece of advice: Forming an LLC is, in many cases, the right move to make. The advantage of protecting your personal assets against any possible lawsuits is an invaluable advantage that should not be taken lightly. This is highly important in cases when you have plenty of personal assets with a value of millions of dollars, as the smallest incident in any of your investment properties, no matter how small it is, might cause you to lose the entirety of your assets if you are not prepared.
Related: Should You Form an LLC for your Investment Property?
However, if you are a new investor, and your investments are still small in scale and limited to a single or a small number of investment properties, acquiring an Umbrella Insurance might be sufficient to protect you and your assets against any lawsuits, while avoiding the complexity and extra costs of forming an LLC might be better for you until you grow your business to a larger scale.
Conclusion
Forming an LLC for your real estate investment business is something that you should definitely take into consideration since the very early stages of your real estate investing venture, even if you’re not looking to start investing as an LLC, because it gives you insights on what to expect for your future investments and the challenges that you might have to face. Once your business grows, you might want to start considering your LLC options. But before you do that, make sure to educate yourself on the types of LLCs that exist, and how they differ from one state to another in order to take advantage of the best type of LLC for your individual real estate investment strategy.
For more blogs and guides related to real estate investing and a number of tools that can help you make your real estate investments, make sure to visit Mashvisor.