If you are a real estate investor or thinking of becoming one, it is imperative that you understand the legal issues involved in order to protect your assets.
One of the most important decisions you have to make regards the legal structuring of your real estate business — or what is more commonly known as an LLC.
LLC is short for limited liability company, a newer form of business entity that offers benefits that partnerships and corporations do not guarantee. At its heart, it is meant to protect real estate investors from themselves and the malicious intentions of others.
LLC can seem like an intimidating topic when you’re entering the real estate scene. This is probably because it is the foundation upon which your entire real estate company will be built.
In truth, there isn’t much to it, really.
A limited liability company is an entity that you can either own solely or partially.
The main objective of forming a real estate LLC is to draw a line between your personal and business assets. This way, in the event that you run into any legal or financial trouble, no one can seize your personal assets to pay off the debts you owe.
Likewise, it is not easy to use the assets listed under the LLC for your own personal use or gain.
A good LLC setup is one that proves your business is not simply used as a vehicle to hold your personal assets, but rather, to conduct business.
To prove you are using your LLC for business purposes, there are certain things that need to occur to establish this such as, for instance, filing tax returns.
Limit your Personal Liability
Real estate investment can be a rather lucrative endeavor. Typically, there is a whole lot of money involved in each deal, often more than the average individual can cover on his or her own accord.
With this in mind, it is extremely important, as an investor, to make sure your personal finances (finances not tied to your business) are protected, otherwise a lawsuit could wipe your accounts and personal assets clean.
The good thing about LLC, and what has got to be its most interesting aspect, is that it limits personal vulnerability to potential lawsuits related to any respective property.
When your real estate business is under LLC, should you get sued, your personal finances, personal residence, and other personal assets will not be at risk.
Enjoy the Perks of Pass-through Taxation
When it comes to tax, many corporation owners usually pay a double tax. They are required to file both their business-income and personal-income tax statements.
This is not the case with a real estate LLC, which excludes you from paying taxes at the business level. This is thanks to pass-through taxation, which traces back to a 1988 revenue ruling which allowed real estate investors to avoid double taxation by holding property through LLC.
This pass-through taxation allows any real estate LLC member to report business profits or losses at a lower rate through individual tax returns. Not only that, as an owner of a single-member LLC, you enjoy more deductions because you can use, say, your mortgage interest as a deduction come tax time.
Ease of Establishment
Establishing an LLC is easy. The process itself is simple and straightforward. Just about anyone can do it.
According to SBA.gov, all you need to do is choose a business name, file the articles of organization to validate your LLC, create an LLC operating agreement (if your company will have multiple members), and lastly, obtain licenses and permits.
When it comes to management responsibilities, a real estate business structured as a limited liability company doesn’t have too many restrictions binding it as is common with partnerships and corporations.
It is not mandatory for a real estate LLC to hold regular meetings or even maintain in-depth business records. As regards the distribution of cash flow, this is a prerogative of the LLC member(s).
Builds Credit for your Business
The ability to build credit for your business is an often underrated benefit of establishing a real estate LLC.
When you make up your mind that this is the right corporate structure for your real estate business, you can obtain what is called an employer identification number (EIN). What this does is allow your business to build credit without affecting or using your personal credit.
This can be a powerful tool for you as a real estate investor since it gives you the opportunity to establish an exceptional credit rating for your business.
Assuming your personal credit profile is in good standing as well, this essentially means you have double the borrowing power