How to Form a Real Estate LLC?
Typically, to form a real estate LLC, you need to file Articles of Organization with the Secretary of State before paying the required filing fee. You also need to perform a name availability check. If you form an LLC in your home state of California, it is known as a domestic LLC. If you form an LLC outside of your home state, you will need to register as a foreign LLC within your state.
For instance, if you form an LLC in another state, but your do not reside in that state, you must register the LLC in California as a foreign LLC. If you choose this path, you will have two LLCs and must pay two state filing fees. You will also need to remit payment for a registered agent to use their address for your out-of-state LLC. Two annual report fees must filed too.
However, if you are performing investment activities in another state, technically, that is your state of business operation. Therefore, you would register as a domestic LLC within that state. Do not purchase property out of state with an LLC that was formed in California. Otherwise, you will have to pay double, as described above.
What is a Real Estate LLC?
A limited liability company or LLC does not prevent you from liability or a lawsuit. However, this type of business form will help you get through any fallout.
Benefits of a Real Estate LLC
This legal structure offers tax efficiency and flexibility of a partnership while allowing you to enjoy the liability amenities of a corporation. Therefore, an LLC can benefit an investor as follow:
- Limited Liability – If you are sued, the money damages apply to the assets within the LLC, not everything you own. Therefore, if you work with real estate LLC attorneys in San Diego and you lose a lawsuit, creditors, in most cases, cannot take your car or home. They probably cannot garnish your wages either. Again, you need to make sure you collaborate with a legal advocate who is well versed in LLC law.
- Tax Efficiency – An LLC is especially simple to manage when you file your taxes, particularly if you form a single-member LLC. A single-members LLC is one where you, alone, own the LLC. An LLC is referred to as a pass-through entity. Therefore, the income and taxes are reported by each member of the LLC on his or her income statement. No corporate tax is paid as well. While a single-member LLC does not necessitate filing a business tax return, a multi-member LLC requires the business return.
- Operational Adaptability – An LLC is adaptable. You do not need extensive documentation, and you do not run into issues with respect to issuing stock. Instead, all you need is minimal paperwork to set up an LLC.
Real Estate LLC – Basic Case In Point
When you review the above information, it is easy to see why an LLC may be beneficial to an investor in real estate. Let us look how this type of business structure may be advantageous. Say a tenant slips in the common area of an apartment complex you own. He sues you because he sustains several injuries. Maybe your insurance cannot cover all the penalties and you are required to pay $300,000 to the plaintiff out of your own pocket.
If you own the apartment complex without benefit of an LLC, the tenant can garnish your wages or force you into selling all your real estate, all which can lead to a bankruptcy filing. Alternatively, if you represent yourself as an LLC, the court may make you sell your real estate, but it cannot go after other real estate owned by other LLCs you have formed. Neither will you have to relinquish your primary real estate.
A Step in the Right Direction
Indeed, setting up a real estate LLC can be helpful. However, you need to talk to an LLC attorney first before establishing this business structure. If you do decide to form a real estate LLC, make sure you can easily answer the question as to why you are forming it. If you want to realize the tax and legal benefits associated with an LLC, as explained previously, then you are taking a step in the right direction.
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Where You Might Run into Problems
You just do not want to try buying real estate within an LLC, which can prove to be, at the minimum, a challenge. Here is why: Most residential lenders make it a rule not to issue a loan for a property within an LLC. In this case, you would need to obtain a commercial loan, which features higher rates, increased fees, and shorter terms.
That is why most investors transfer their ownership of real estate into an LLC after they buy the property. However, this plan can present its own risks. If the lending institution finds you are transferring ownership in this manner, it may call the note due because of a due-on-sale clause in the contract.
While you obviously have not sold the real estate, you have transferred title from your name to the LLC. If you do take this investment route, you should obtain permission, in writing, from your lending institution before proceeding. If you want to safeguard yourself from a “due on sale” clause, this is the best, if not only, remedy.
What Should I Name a Real Estate LLC?
If you are choosing a real estate LLC, chances are you will not be listing the business on a website or be making it a part of a marketing campaign. Assuming that the name is not already registered with the Secretary of State’s office, the name usually can be narrowed down to the name of the owner. For example, if your last name is Jones, you might list your LLC as Jones Property Investments LLC or Jones Apartments LLC. A contraction of two adjacent towns, where property is owned, might work too, such as Minn-Paul LLC, for Minneapolis-St. Paul.
LLC Rental Property Pros & Cons
LLCs have advantages and drawbacks for property owners. The main reason an investor or property owner however establishes an LLC is for asset protection. An LLC will shield you from a lawsuit and therefore provides asset protection. Only the assets of the LLC are affected.
Pass-through taxation, which means the LLC, in and of itself, does not pay taxes is another advantage. The income passes to the owner. Therefore, if you are the sole owner of an LLC, you report your taxes as if you were a sole proprietor. If the LLC has more than one owner, a separate tax return is filed. You can also establish an LLC as a C or S corporation if you pay self-employment taxes and wish to lower the tax.
If you are a property owner, you should have insurance in the form of a dwelling policy in place. This safeguards rental property, depending on the terms. The plan pays the replacement cost or cash value of damaged property in case you need to file a claim.
However, the plan may not cover all the incurred costs. If this happens, your assets are at risk. However, if your rental properties are protected under an LLC, the risk is eliminated.
If you already own a house that you rent and carry a mortgage, it is difficult, if not impossible, to move it to an LLC. A lender, as noted, may call in the mortgage as the result of a due-on-sale clause.
A Separate Entity
If you choose to establish an LLC, do not mix the money in your business account with your personal funds. You can lose the protection of an LLC if it is not treated as a separate entity. When it comes to forming an LLC for investment purposes, you need to review the situation with an experienced LLC attorney. Taking time to talk about the advantages and disadvantages will put you in a better position financially and legally.
How to Start a Real Estate Holding Company
You can also form an LLC by establishing a real estate investment company or real estate holding company. Talk to an attorney about the tax status. An LLC, C corporation, or subchapter S corporation all have specific characteristics.
Next, you want to decide on the type of real estate investments you want to pursue. For example, are you going to concentrate on residential or commercial properties? If the properties are residential, will they include single-family homes, apartment buildings, or duplexes? Check to see what investors must deal with in the area where you plan to make investments.
Where do you want to specialize – in foreclosures or tax liens, or properties in thriving markets? Do you want to invest in your local area or out-of-state? As you can see, you have many decisions to make when you set up this kind of company – even more reason to count on the advice of an LLC real estate lawyer.
Why an LLC May Be a Good Business for More than One Investor
An LLC is like a partnership as the business is more casual and the LLC offers liability protection for all the members or owners of the company. This business form also offers creditor protection. A judgment against one of the owners will not permit a creditor to seize the assets of the LLC and negatively affect the business.
While an LLC does come with a tax ID number, it still files as a partnership for taxation purposes. Some investors like this tax model as it gives them the flexibility to subtract losses from rental activity. Other investors prefer to incorporate to avoid self-employment taxation on income that is earned from real estate transactions, such as flips.
That is why you need to consult with an attorney about this business form. See how an LLC can be used to support your real estate investing activities.