03 Aug Pros and Cons of forming an LLC for real estate investments
Looking into an LLC (Limited Liability Company)
This legal structure contains the limited liability of a corporation bundled with a programmed tax flexibility. The members become the preferred term for the owners of an LLC. Whatever profits and losses the LLC incurs goes through the legal structure first before going on to the members. This may mean fewer restrictions on profit sharing inside the company. This can also contain limited liability protection for members from business decisions. Aside from these advantages, costs and paperwork can be lessened while granting more flexibility.
A Certificate of Formation stating the Articles of Incorporation comes with the filing of an LLC. The name of the company, the business address, the registered agent become the registered information in the Certificate of Formation.
Let’s review the Pros and Cons of an LLC for Real Estate Investments
The LLC may help protect the personal assets from liabilities that may arise from certain real estate investments for the concerned investors. This has become the common practice for a number of decades in particular states.
Liability insurance can grant some protection from potential lawsuits. But, there are some risks connected to this approach. There are liability policies that, in general, may state exceptions and limitations, but these do not completely protect investors from litigation. The LLC has a broader feel and has inherent benefits with its protective power.
What are the Pros?
When there are legal judgments related to an LLC’s investment properties, there are limits imposed on personal asset exposure.
Taxation benefits can be offered through a pass-through. Even if S corporations have a similar benefit, there are other requirements and restrictions that they need to comply with and limit their usefulness for those investing in real estate.
It is allowed for the LLC to have foreign ownership and investment in U.S. real estate.
The gifting of membership interests accomplishes the transfer of ownership for real estate holdings. Executing and recording a new deed may not be required. This frees up property owners from paying transfer and recording taxes plus other connected fees.
The owner or a third-party manager can run LLC’s. Corporations must have officers and a board of directors.
Profit distribution options can be flexible as well. Members of an LLC can plot out their own distribution scheme. “S” corporations must follow pro rata cash flow distributions.
What are the Cons?
Even with the advantages, not all real estate investors are willing to handle the management of a company. Some would prefer obtaining liability insurance so their personal assets are protected.
For the personal liability protection to take effect in an LLC, separate bank accounts need to be maintained and owners must legally observe corporate formalities. This means acquiring the services of a registered agent and keeping company records in good standing so the LLC avoids default.
The LLC needs to be formed first for real estate investors who are looking to use this channel before any property investments are purchased. It is more convenient to transfer the purchased property through the LLC rather than seeking consent for the transaction from your lender.
Those in a single-member LLC may not have the same level of liability protection compared to that of a corporation.