29 Apr 2014
The pros and cons of using an LLC
One of the decisions you will have to determine when investing in real estate is how you will be taking title to your properties. Limited Liability Companies (LLC) have become a very popular tool that grew out of the limitations of S-Corps and sole proprietors; with the combination of the best of both worlds.
For instance, LLCs have the limited liability protection of a corporation and also the flexibility of ownership and single taxation. As a real estate agent that works specifically with investors, I see clients take title to their assets several different ways; under their individual name, as a married couple, LLCs, etc.
When you are trying to select an entity to use, you are going to have to select one that is able to 1) best protect your assets, 2) save you the most on taxes and 3) help audit-proof your IRS returns.
LLCs embody all 3 variables to a good degree and are usually a good choice for most investors.
Note that I said ‘most’ and not ‘all’.
Let’s take a look at the pros and cons of using an LLC, and if it makes sense for you.
LLCs are the most common entity type that an entrepreneur will set up; it’s easy to form and there are reduced operating requirements with an LLC as compared to a corporation.
They can create personal limited liability and have characteristics very similar to a corporation and partnership. Similar to corporations, LLCs separate the business from their owner(s); and similar to partnerships, it allows more flexibility between its members.
LLCs also have a 1040 flow through tax benefit, which allows you to avoid paying both, corporate and personal taxes, also known as double taxation.
There is no limitation on the number of members allowed in an LLC, whereas some other entities limit the number of their members. LLCs are able to raise capital through the sale of its membership interest rather than shares, as they would in a corporation.
Many investors have chosen to, or been told that they are required to set up 1 LLC for every property they own, however, that is just additional paperwork. If set up correctly, you are able to protect multiple real estate investments under one LLC.
With LLCs, investors also have the option to ‘equity strip’ their properties; in which case they can use one of their LLCs to create liens on a property that has equity, potentially concealing the equity.
LLCs are also cheaper to file than incorporating; with much less paperwork, and allow investors to avoid transfer taxes, which occur if a property is being transferred from one owner to another without an LLC.
When you are creating an LLC, you are essentially creating a separate account that you have to manage—and if you have an accountant, you may have to pay him or her more for having to work with an additional account/paperwork.
In most situations, it’s also harder to qualify for certain loans when using an LLC, and in some states evictions must go through a lawyer.
You are also required to pay self-employment taxes when you use an LLC and some states also require a franchise tax for receiving the benefits of your LLC.
LLCs have many legal and tax advantages, but it is important that you consult with your real estate attorney to make sure that, not only is your LLC a good fit for you, but also for the type of real estate business you are running.
In my opinion, an LLC is a great option for a first time investor because it is easy to manage, compared to a corporation; it has a pass-through taxation treatment of a partnership, and it’s easy to set up.
Do you have an opinion on using LLCs? We would love to hear your comments below.
This article originally appeared on New Western Acquisitions.
Kurt Carlton is a full time real estate investor, former host of the CBS radio show, “Creating Cash Flow” and is an expert on real estate acquisition, finance and management. In addition to acquiring properties, Kurt is also a seasoned hard money lender, named the “Giant of Investor Lending” by HousingWire Magazine. You can connect with him on Twitter.
Photo by: Anna Julia.