With the economy strong, more and more people are investing in real estate. I am getting plenty of questions about whether those properties should be held through a limited liability company — an LLC. So, should you own real estate through an LLC? Well, there are certainly plenty of advantages (and disadvantages) to setting up and LLC to protect your property investments.
Privacy — An LLC offers a layer of privacy since the only public information available is the entity name and number, agent of service process plus agent's address. So looking for your LLC, a searcher might only find a name like Sagebrush Group, LLC, rather than your personal information.
Limit Personal Liability — Legal actions against the properties will be directed at the LLC, rather than the owners of the LLC. However, this is not an absolute rule (see below).
Taxes — If properly structured, the LLC can be set up as a “pass through” entity which allows for certain deductions and allows income tax at the individual rather than the corporate rate. While the new tax law makes changed they are complex and only apply to limited situations. For most homeowners, the new tax law makes no changes.
Management — Delegating management responsibilities is much easier than either the corporation or partnership structure. LLCs can be easily managed by owners or third-party managers.
Fees — In most states, LLCS pay a lower state registration and maintenance fees that corporations. An in Arizona, once your LLC is formed, there are no future filing fees unless you make changes to the basic structure such as new members or address changes.
Flexibility — LLCS offer a tremendous flexibility when distributing profits. Cash flow distributions do not have to be pro rata according to ownership like in an S corporation. That means owners can financially reward the sweat equity of select members through appropriate distributions of available cash flow.
Foreign Ownership — Foreign ownership and investment in U.S. real estate is possible through an LLC.
Transfer of Ownership — LCC owners can easily transfer ownership in real estate holdings by gifting interests in the membership of their heirs each year. Over time, it is possible to pass ownership to loved ones without have to execute a record a new deed on the property. That allows property owners to avoid transfer and recording taxes and fees.
Yes, there are a few:
“Piercing the Corporate Veil” Just because you set up an LLC does not mean you cannot lose the protection of the entity. Failing to follow corporate formalities (meetings, resolutions, minutes) or using the business bank account as your piggy bank might lead to a loss of the protection. Personal liability applies for negligence.
Your Own Negligence. If you are acting on your own and injury someone or property as a result of your own personal negligence, the LLC form may not help you. For example: failing to have adequate, failing to property conduct a background check on an onsite property manager, or failing to properly or timely repair a dangerous condition on the property.
Insolvency and Bankruptcy. If the LLC is becoming insolvent you cannot make distributions to yourself if that will leave creditors holding the bag. They may be able to come after you personally. Also, if the LLC files bankruptcy based on a 2003 Colorado case, you may lose the protection of the LLC when the Trustee takes over.
Mortgage Issues. Mortgages contain “due on sale” clauses. Transferring a property from your name to an LLC without the lender's permission could trigger that clause and prompt a call on the loan.
Insurance Issues. If you owned the property in your own name and then transfer it to an LLC there may be an impact on your liability coverage. Some carriers will permit naming the LLC as an “additional insured” on your policy, but others may require the policy to be rated as a commercial policy which can be much more expensive.
Do the Advantages outweigh the Disadvantages? Well, here's a lawyer's answer: “it depends.” Probably the answer is yes, but each situation deserves its own analysis. Forming an LLC is easy. Doing it properly and complete is not.
Discussing the process with experienced business attorney is a good idea to avoid any unanticipated consequences.
If you wish to discuss how these issues apply to your investment properties, please call us any time!