The primary reason to form an LLC is for the legal protection it offers. If the owner has a personal creditor, the creditor generally cannot make a claim on the property owned by the LLC or other corporate entity. Should any tenants, their guests, or anyone on the property sustain any injuries, and if the property is owned in the client’s name, the owner’s personal assets are at risk. Example: An owner has a rental property that is occupied by a young couple. They have a holiday party and one of their guests falls down stairs and is hospitalized. The guest sues the owner for his injuries, stating the stairs were hazardous. If the guest successfully wins the claim against the owner, any judgment in excess of the liability insurance can be satisfied with the owner’s personal assets because they are exposed.
From a tax perspective, an LLC formed with two or more members is classified as a “pass-through” company. A “Pass-through” means its income is passed through to its owners and claimed on those owners’ individual tax returns. Hence, it is subject only to capital gains rates on the ownership shares of the member, and not to corporate capital gains taxes, therefore there is no double taxation. LLCs with just one owner-member, however, are taxed as a sole proprietorship and no separate tax return is required. Actual tax dollars saved from holding real estate in an LLC opposed to personally holding the properties is zero.
Estate Planning Benefits
The formation of a LLC for the purpose of holding investment real estate has estate planning advantages as well. It allows for the transfer of ownership in the property in a more seamless manner than if personally owned. In many circumstances property owners wish to gift certain percentages of their real estate to children or other family members. For real estate not held in an LLC this process can require many trips to the county courthouse to update deeds that will require changes every time percentages of ownership change. In cases where real estate is owned in an LLC, the owner-members can simply issue membership certificates to the child or family member and no changes need be made to the deed with the county.
Whether you own twenty properties or one, owning them personally can be a major liability. All of your hard work and planning that lead to the ability to own real estate could be wiped out with one misfortune. Hopefully the insight provided in this article has helped you better understand the benefits of forming an LLC and provided you with perspective on the pros and cons of ownership structures when purchasing property for investment purposes.
Disclaimer: The above information is provided as general information, not as legal advice, and does not create an attorney-client relationship. Before making any decisions regarding legal matters, individuals should consult with a qualified attorney.