31 Mar Determining Whether an LLC is Right for You
You’re not the first to contemplate whether an LLC is the right fit for your real estate business – in many instances, it can be a great solution to operating rental property. A limited liability company (LLC) is a hybrid legal structure that provides the limited liability benefits a corporation has, along with the benefits of tax efficiency and operation flexibility that partnerships offer.
When it comes to whether an LLC is right for you, it’s important to adequately weigh the pros and cons. There are many benefits to limited liability companies, but like any other company in business, they come with a cost.
Let’s break down the pros and cons of having an LLC, and you’ll be on the road to determining whether it’s the right track for your business in no-time.
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The Beauty of Limited Liability
There are plenty of benefits to the LLC, starting with asset protection. Limited liability is a major plus because it protects members from any debts or liabilities the company may have. By designating company assets as legally owned by the company, your personal assets are safe in the event of a lawsuit. This limited liability makes it possible to designate assets accordingly, thus protecting yourself and any business partners from personal liability.
If you have multiple properties, you could consider holding each property in its own LLC in order to separate assets even further. In the event of a liability claim against one of the properties, it will only impact the property in question, and your other properties (and personal assets) will be immune from any potential liability.
Tax Flexibility
In addition to limited liability, LLCs are given a fair amount of flexibility when it comes to taxes. In most instances, the business can avoid paying federal income tax since holding properties in an LLC will pass-through profits and losses to each member. Note that some states apply annual taxes to LLCs, so check your state and local regulations to be sure.
Limited liability companies are also given the flexibility to utilize whatever tax rules are most beneficial to the company, whether it be through partnership, sole proprietor, or corporate tax rules. The IRS will automatically treat an LLC as a partnership for income tax purposes, in which the company will be responsible for preparing annual partnership tax returns (but will not have to pay business earning taxes). If you are the sole owner of the LLC, however, you will be subject to pay taxes as a sole proprietor – in which case you will be responsible for all tax payments and filings.
The option to file for corporate tax treatment is also available, in which the company will be identified as a separate taxpayer by the IRS. All income and deductions will still need to be reported, and the company will be responsible for paying all necessary taxes.
With that said, before you make the call, be sure you’ve fully determined the most apt format for your LLC. You won’t be able to change the filing format for at least five years once selected.
Organization of Owners
Most companies have investment partners, which can bring many benefits, but can also present many hurdles when it comes to ownership and delegations. Another perk of the LLC is the outlining of responsibilities and ownership percentages.
Ownership structure in an LLC is broken down into members and managers – where a member is typically the company owner, and a manager is an appointed position responsible for overseeing the company. Using this structural outline, LLC members can consist of one owner for all assets, multiple individuals, and even corporations.
Ownership amongst members can be expressed via percentage or membership units. Membership units are similar to shares of corporate stock, and both percentages and units offer voting rights and profit shares. This structure allows an LLC to distribute ownership according to member preferences, with money and property contributions being negligible factors. If one member contributes all of the money upfront to an LLC but another member manages all operations, the two parties will split membership interest evenly.
The Costly Side of the LLC
Nothing in business comes for free, and an LLC is no exception – the biggest drawback to holding an LLC is certainly the cost. Each LLC is subjected to a fee upon set-up, as well as additional fees to file returns each year. Registration fees vary by state, so be sure to check your state and local regulations for price specifics.
California LLCs can cost a pretty penny with reporting fees, bi-annual statement of information filings, a $70 yearly filing fee and an $800 annual LLC tax. Companies with income in excess of $250,000 are subject to additional fees as well. The state of New York also has a spendy LLC process, with start-up fees up to $2,000, plus additional filing fees and annual taxes.
You may have heard that Delaware is a hot-spot for LLC formations, the reason being that the state charges only one $300 LLC tax, due annually. As you can see, LLC costs vary greatly by state – so be sure to check your state regulations before determining whether the benefits outweigh the costs for you.
Trouble Financing
Most residential property loan lenders will avoid lending money to LLCs, so obtaining proper financing can be difficult. Lenders that accept LLC properties tend to lack the benefits of traditional residential investment property loans – so a single-family, 30-year fixed mortgage is not a likely option for an LLC. Loans for LLCs are also backed by personal finances, so while you’re legally protected from personal liability, you’ll still be held responsible for the company’s loan.
Commercial financing is often an available option for LLCs, at a cost of higher interest rates and shorter amortization. Commercial investment loans are often used to purchase multi-family homes or office buildings, assuming the lender sees a property’s ability to generate income.
If you’re looking for asset protection but need to ensure proper financing, an umbrella insurance policy can offer additional security. Umbrella insurance can serve as a great alternative to limited liability by covering your business for claims made up to a certain amount, and is typically more affordable than the taxes and fees associated with having an LLC.
Are LLCs too good to be true?
So, with all the pros and cons set out, it’s up to you to determine whether an LLC is right for you. Depending on your state and how many properties you own, an LLC could either be extremely beneficial or a hindrance on productivity. If liability protection is a must-have for you, then an LLC may be a great fit – but if financing is your top priority, it may be a good idea to look at your other options.
