One of the most important things you can do at the outset of your career as a real estate investor is to form a limited liability corporation, or LLC. When you put your properties under the ownership of an LLC, it will help you tremendously and spare you some major headaches. There are several advantages to LLCs, but the chief one is that it protects you legally. If you are ever sued for something that happens at one of your properties, you won’t be personally liable and your personal assets are protected. While the requirements and procedures vary from state to state, forming an LLC is a pretty straightforward process, and you can file the paperwork for your LLC online.
Beyond the liability advantages, there are strong tax advantages to operating as an LLC. A real estate LLC can save you thousands of dollars. It allows for pass-through taxation, which means that the business won’t be directly taxed. Instead, investors report their LLC’s profits or losses on their personal tax returns. With pass-through companies, the owners and/or shareholders directly receive the business’s profits and losses. Business income is considered their personal income and is taxed on the person’s individual taxed return. In most cases, this will result in a lower rate for business owners and avoids double taxation.
While there are many different types of LLCs, these are the most common:
A Single Member LLC, is just like it sounds: an LLC with one member. In Single Member LLCs, the LLC business is not taxed. Instead, the owner is taxed through their personal federal tax return. Single-member LLC’s are the most popular and affordable. Also, there is also significantly less paperwork required.
In a Partners LLC, members elect to be taxed as a traditional partnership. Their tax liability is determined by their share of ownership. It is up to the members to allocate how much of the LLC they own, and what gains and losses they are responsible for.
In a Corporation LLC, members act as shareholders. The corporation pays taxes on its income, and as a shareholder you only pay taxes on any dividends you receive. Corporations can also pay its members through tax-deductible salaries. Even very large salaries for small business owners have been upheld as deductible expenses. Most small corporations, in fact, do not pay any dividends, and yet distribute all of the disposable income to the owners in this tax-deductible way.
Ultimately, the type of LLC you choose is up to you. Wile they vary in complexity, the most important thing to know about LLCs is how they protect you legally. For newer real estate investors, putting your rental property in the name of an LLC can be challenging when they’re seeking financing, as lenders are uncomfortable offering financing to a new LLC. It may take a couple of years to establish your LLC’s creditworthiness, but as soon as you are able to, put that property in the name of your LLC.