5 Major Benefits of using an LLC in real estate transactions
Most people purchase a home utilizing their name. Maybe you’ve heard of forming a limited liability company (“LLC”) to buy the house and were curious, should I do that? Using LLCs for real estate investments is critical and also has benefits for traditional home buyers. LLCs provide liability protection, privacy and estate planning benefits. But is it right for you?
Placing assets, like real estate, under your own name can be a disaster in the making. Investors should seriously consider LLC formation.
Investment property is usually defined as real estate that is primarily purchased to buy and sell for a profit in the future or to produce rental income. Many investors with real estate investment properties own them personally. That can be disastrous. A more prudent way to own real estate for investment purposes is to transfer ownership to a LLC. This method not only protects its owner-member’s personal assets (cash, equity in real estate, primary residence, investment accounts, retirement accounts, etc.) from litigation, but it also allows for flexible profit distribution among its members and has estate benefits as well.
Unfortunately, many real estate investors realize the consequences of failing to use a LLC when it’s too late and they’ve lost everything. Consider the following if you own any real estate investment properties or are thinking of becoming a real estate investor:
Privacy and Safety
Property transactions in this country have historically been quasi-public in nature. Deeds and other records are public documents, providing a level of disclosure about the property’s history, value and ownership. LLCs allow people to replace their names with a company name, concealing their identities and other information about them.
Although states vary in the level of transparency required by individuals forming the business entities, a LLC can be used in any state to conceal who owns and controls real estate or other assets. Individuals forming LLCs do not have to disclose, in most cases, members or beneficial owners behind the entity. You might be concerned about privacy or personal safety and use a LLC to hide the address of a property you own. This is beneficial to law enforcement officers, foreign political dissidents, public figures and celebrities, or others worried about threats.
The primary reason to form a LLC for the purchase of real estate is for the legal protection it provides. If the owner has a personal creditor, for example, the creditor generally cannot make a claim on the property owned by the LLC. A LLC is particularly valuable when a lawsuit is commenced against the property owner. Should any tenants, their guests, or anyone on the property sustain any injuries, the owner will usually be sued. And if the property is owned in your personal name, your personal assets are at risk. Not just the property itself, but your other assets would also be vulnerable.
Here are some of the more common situations leading to lawsuits:
Resentful or disgruntled Tenants: These days, it only takes disgruntled tenants a few mouse clicks to find an attorney willing to file a lawsuit. If you don’t own the property via a LLC, you will be personally named in a lawsuit. This is why it’s always important to form a LLC, hold title via the LLC and execute a lease between the LLC and the tenant. We can help you with this.
Nuisance Lawsuits: These days, attorneys will file lawsuits against real estate owners for any reason. In a sense, these attorneys end up extorting real estate owners into settling these nuisance lawsuits in exchange for avoiding hefty attorney fees or protracted litigation. Too often, property owners are “bullied” into settling such frivolous lawsuits. Examples include suing for violations of the Americans with Disabilities Act.
Fire: Each year, fires in the U.S. cause thousands of deaths, billions in property damage, and countless lawsuits. If a fire starts on your personally-owned investment or rental property and spreads elsewhere, you may be held liable and your personal assets could be used to pay for damages.
Tenant Guests: You should also be concerned about lawsuits by guests of your tenants. When something happens to a tenant’s guest, the property owners are often the first named in a lawsuit. Remember, plaintiffs are always looking for deep pockets and real estate investors and homeowners are targets.
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 the 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.
Protect Your Other Investments
When you hold title to a real estate investment or home under your own name, everything else you personally own is exposed. Let’s say you own two separate homes that you lease out to two tenants (property 1 and property 2). The tenant in property 1 sues you and is awarded a $500,000 judgement. Since you own both investment properties under your own name, both properties can be used to pay the proceeds of the lawsuit. This is why it’s essential to hold each of your real estate investments or homes in separate LLCs.
Insurance Protection is not Enough
Today, insurance coverage may not provide enough to cover all damages. Therefore, it’s crucial to have a LLC in place to ensure that you are protected if the amount of the judgment exceeds the amount of the insurance coverage. Also, insurance policies don’t cover everything. Insurance policies often have exclusions.
Protect Yourself from Co-Investors and Partner
Jointly holding real estate investments with others can lead to major and costly complications in case of a partner’s death, incapacity, or divorce.
Death and Incapacity: You can end up at the mercy of disinterested family members who decide to cash out the value of your deceased partner’s ownership. Even worse, you could be caught in the middle of a family dispute, or even litigation, involving how or to whom your partner’s share of the investment is distributed. Such scenarios can be avoided via LLC formation. A LLC operating agreement is essentially an extremely detailed contract which allows co-investors to dictate what happens when a co-investor passes away.
Divorce: With so many marriages ending up in divorce these days, it’s important that you consider what happens if you jointly own an investment property with someone who is married. The spouse of a divorcing property co-owner can wreak havoc by effectively becoming an active owner with decision making powers.
Disputes: With so many variables and decisions associated with real estate ownership, it is inevitable that disputes will arise between property co-owners. Having a LLC with an operating agreement in place allows you to dictate the exact protocols that must be followed in case of a dispute or if one owner wants out.
From a tax perspective, most LLCs are classified as “pass-through” companies. A “pass-through” means the company’s income is passed through to its members and claimed on those members’ individual tax returns. Therefore, it is subject only to capital gains rates on the ownership units of the member, and not to corporate capital gains taxes, so there is no double taxation.
LLCs can also help you minimize your estate taxes in connection with passing assets to your family members. Current federal gift tax exemptions allow tax free transfers of up to $14,000 per year. Fractional interests in your LLC can therefore be gifted to your children without having to re-title the property deed. It is important to note that the LLC operating agreement must allow the transferred interest to have immediate value to the recipients to qualify for the gift tax exclusion.
Estate Planning Benefits
LLCs are also great vehicles for estate planning and work great with trusts. It allows for the transfer of ownership in the property in a more seamless manner than if personally owned. Trusts are created to dictate what happens to your assets when you pass away without going through the probate process. It is much simpler to pass your real property to family members or other persons upon your death, if the real property is owned via a LLC.
Also, in many circumstances property owners gift certain percentages of their real estate to children or other family members. For real estate not held in a LLC this process can require updated deeds every time percentages of ownership change. In cases where real estate is owned in a 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. This saves you time, money, and aggravation.
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 a LLC and provided you with perspective on the pros and cons of ownership structures when purchasing property for investment purposes.