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Should you use an LLC for real estate investing?

The formation of limited liability companies (LLCs) for the use of real estate investing has become more prevalent.

While there are definitely benefits to using this method of holding investment properties and managing the subsequent finances through this system, starting an LLC and paying for one might not be practical for beginner investors or investors with smaller portfolios. While initially starting an LLC can actually be inexpensive and quite easy in many states, there are other states that offer more frequent fees that can add up and require time and due diligence. If you’re the casual investor with only a few properties, or whether you’re an investor with investments in properties aimed at appreciation over cash flow, an LLC might be an unnecessary step altogether.

The more bolstered your investment situation becomes, and if you’re constantly dealing with tenants, multiple units, or commercial properties, an LLC could prove to be very beneficial. The protective abilities of an LLC with regards to assets and legal processes cannot be understated. In any situation where something happens on the property of a rental you own and legal action is pursued, if that property is held in your name, you are subsequently liable in that lawsuit and your personal assets would be in play in accordance with the plaintiff’s case. However, If that rental property were owned by an LLC, your own risk exposure would be protected by the company itself, meaning that only the assets owned by the LLC itself would be exposed to potential lawsuits.

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LLCs do more than just make the best out of a multi-property investment scenario. It's also is powerful in a multi-investor scenario, with the LLC serving as an organizational tool.

LLCs can define the ownership percentages and the roles of each owner, and provide clear designations and asset protection for each individual investor involved.

You should be warned, though—there are major differences with regards to an LLC with one owner versus a multimember LLC. As far as the IRS is concerned, a real estate holding company with one owner is treated as an owner with sole proprietorship. Because of this, any relevant income and gain in capital from the LLC pass through directly to the owner normally, and the LLC would only have to pay taxes as an individual.

In most situations, investing in real estate with an LLC is beneficial and its pros outweigh its cons. But as a new investor, it still may not be necessary. If you’re looking for coverage up to a certain amount, umbrella insurance policies usually cover you up to $1M in the event where someone is suing you. Above that mark, you are liable to lose everything, however you can understand how unlikely and infrequent such occurrences are.

If you feel your dealings and investments aren’t at risk with regards to the aforementioned threshold provided from insurance companies, then an LLC may end up costing more than it benefits. Certain direct costs such as setup fees and legal expenses in drafting operating agreements, fluctuate from state to state but can run you thousands of dollars. The point is, depending on where you are in your real estate investing timeline, opening an LLC may be a step for further down the line rather than an immediate necessity.