Why Use An LLC for Real Estate Investments
There are a number of reasons why the limited liability company, or LLC, has become increasingly popular for the purpose of owning of real property. The benefits and protections afforded by an LLC often far outweigh the costs and burdens of forming and maintaining an LLC. While each situation is different, there are a number of clear and common reasons to use an LLC over a corporation.
One of the most obvious benefits of an LLC, like a corporation, is that it limits the personal liability of its members. However, unlike a corporation, where shares of stock are attachable by judgment creditors, interests of LLC members are not attachable. In an LLC, the owners’ exposure to liability is insulated by the protection of the LLC.
Another advantage of an LLC is the benefit of pass-through taxation, whereby the business income “passes through” the business to the owners’ individual tax returns. Pass-through taxation applies to a single member LLC or one formed with two or more members, which are by default taxed as a partnership. Single-member LLCs are taxed as a sole proprietorship, and thus no separate tax return is required. These tax classifications enable real estate owners to avoid double taxation on the income generated by the property and the appreciation in the value of the property upon disposition. Single member LLCs also provide the convenience of not having to file a separate tax return and the activities of the LLC can be reported on Schedule C of the individual return.
Furthermore, in a 1031 Exchange, a single member LLC can dispose of real estate held under one LLC and purchase under another and still meet the statutory tax deferral requirements as the transaction is tracked by the federal identification number of sole member and not the identity of the LLC, yet the non-tax liabilities of the selling LLC are not transferred over to the purchasing LLC.
An LLC also affords owners of real property, especially foreign nationals or foreign corporate entities, a significant degree of privacy. While anyone can access general information about the LLC via the formation state’s website, such information is generally limited to the entity name, date filed, entity address, jurisdiction, the name and address of the agent for service of process and the entity filer. Neither the agent for service of process nor the filer need be the owner themselves. New IRS rules, however do require that owners of LLC report owners name and federal identification numbers on transfer tax forms in transactions in excess of $3,000,000 in NYC and $1,000,000 in Miami. For most transactions below those thresholds, privacy is still preserved.
The management and organizational structure of an LLC further simplifies ownership of real property. An LLC management structure has fewer restrictions than a corporation. When delegating management responsibilities, an LLC has considerable flexibility and can establish any organizational structure agreed upon by the members, including management by owning members or appointment of a member-manager or a third-party manager, who has no ownership interest. This is all generally spelled out in the operating agreement. An LLC membership can also consists of members who are individuals, corporations, trusts or virtually any other type of person or entity, without changing the tax status of the LLC, including foreign nationals and corporations.
It is less cumbersome to form and maintain an LLC. An LLC registers its existence by filing the articles of organization with bare minimum information, mostly online with the Secretary of State and paying a fee. This filing typically spells out the LLC’s name, the location of its principal offices, its purpose, the planned duration of the business, and any other statutorily-mandated information. Though the filing requirements are similar to those for corporations, after filing, corporations must then hold an organizational meeting to elect corporate officers, to determine authorized classes of shares, and to draft and enact bylaws that detail the company’s internal management. The board of directors meets regularly to discuss and finalize business strategies, finances, and policies and may call special meetings when emergency action is needed. Corporations are also required to convene an annual shareholders meeting. In addition, corporations typically must file annual reports and pay yearly fees to retain their corporate status. In most states, these meeting and reporting requirements do not apply to LLCs, although LLCs often have annual fee and filing obligations.
In most cases, business entities distribute profits based on an owners’ percentage ownership interest. In a general partnership, partners normally share profits equally. Corporations may pay dividends to stock holders. An LLC, on the other hand, retains the flexibility to determine profit allocation under the terms of the LLC’s operating agreement that is not proportional to the ownership interest. Profits can be allocated based on both labor and capital contributions. Thus managers of real estate or developers in new projects may be compensated for their management and operational expertise before profits are distributed to members.
As a result of these advantages most savvy investors hold real estate in an LLC, and so should first time investors.
Balram Kakkar, Esq. CEO, NMLS # 3500
Panam Mortgage & Financials Services, Inc., NMLS # 3360