How to Form an LLC for Real Estate Investing
A limited liability company, or LLC, is one of the most common corporate forms in American businesses. It is relatively easy to set up and allows individuals or small groups to do business under one corporate name. Investment LLCs, where you form a corporation that just holds and moves assets, are particularly popular. An LLC can also protect you from personal liability if the investment goes wrong. When it comes to the high risk/high reward world of real estate investing, this is an extremely valuable quality.
Consider working with a financial advisor when investing in real estate.
What is a Limited Liability Company (LLC)?
An LLC is a legal person that can legally own assets, incur debt, pay taxes, and otherwise operate financially in the same way as an individual (an idea known as a “legal person”). When a person does business as an LLC or any other legal entity, it is the organization that earns and spends money, executes business decisions, and otherwise takes all actions of the business.
Corporations exist for many reasons, but the two most important are debt and shared enterprise. Working as an LLC allows multiple people to operate a business together.
For example, many law firms operate as an LLC. This means that the lawyers involved can jointly share income, costs, clients, cases and all other business operations through the company they have created. They don’t need to negotiate to deposit checks into personal accounts or split bills among individuals. Instead, the company can collect and make payments and then split the profits among its members.
Perhaps more importantly, like most forms of business, an LLC also allows you to separate the responsibilities of the business from its management. An LLC essentially acts as a barrier between the people running the business and the business itself. This means that when the business incurs debts, leases, contracts, lawsuits, risks, and other liabilities, only the LLC itself owes payments. LLC creditors can sue anything the business owns to collect a debt, but they can’t sue anyone’s personal property.
This becomes especially important if the business goes bad. If an LLC owes more money than it can pay, it will often have to go out of business and make all possible payments with the money it has left. Once this process is complete, however, it’s over. No creditor can pass these payments on to the people who started or ran the business.
Readers should note that this is how debt and limited liability companies usually operate. However, in some cases, such as when individuals use an LLC to manage their personal finances or in cases of fraud, creditors can sue the individuals behind the business. The details of this process are beyond the scope of this article.
Debt protection is one of the main reasons people use an LLC. It protects you, personally, from being sued in the event of a business malfunction. Liability is limited to company assets only.
Using an LLC to Invest in Real Estate
For individuals, an LLC is especially valuable when it comes to investing in real estate. Real estate is one of the most popular forms of major asset investment for individuals. Whether you want to flip houses, rent apartments, or just rent a vacation home, it’s common for people to put their money into real estate.
The problem, however, is that real estate is often a speculative and risky market, even if the return potentials are quite high. So when real estate is doing well, you can make a lot of money. When things go wrong, however, you could hold a mortgage worth more than the market will pay for that house.
This is where an LLC comes in. When you form a real estate LLC, the company buys each property, not you. In fairly literal terms, the LLC will own the property.
It also means that the company also owns all the liabilities and debts of the property. If someone gets hurt and sues on the property, for example, they can’t touch your personal property. If the LLC ends up holding an underwater mortgage, the bank can’t come after your personal accounts. In short, your money is entirely separate from the liabilities of the LLC. However, this is also the reason why many banks do not lend directly to a newly formed LLC.
The most your real estate LLC can ever pay is the money it holds. If he owes more than that, a creditor can get a lien on the business property. In rare cases, creditors can force the LLC to liquidate and sell the property to pay its debts. But what they can’t do is get your money back, place a lien on your home, or liquidate your assets.
For investors who own more than one property, it is common to form a separate LLC for each property. This further separates the responsibility. If someone is injured at Property A, they cannot sue for any income from Property B. Liability is limited to the specific property involved, while all other properties remain isolated.
As long as every investment property you own is in an LLC, you can protect your personal assets from creditors and prevent cross liability between properties. However, this generally does not work for your primary residence. For several reasons, placing your primary residence in an LLC rarely protects you from liability and debt on that asset.
How to Create a Real Estate LLC
Forming a real estate LLC is not difficult, but it is location specific. Starting any new business is highly dependent on the local laws of each state. Each jurisdiction has its own process. While the outlines are generally the same, the rules specific to each location are different. If you want to start an LLC, follow the next steps.
More importantly, just like when making a legal decision, research the rules for your individual state. We cannot guide you exactly on what steps to take in every state and territory, so be sure to check your rights and responsibilities yourself. Given the scale and consequences of real estate investments, ideally consult a lawyer.
If you have multiple members of your LLC, draft a written operating agreement between the parties. Among other things, this should specify each member’s role in the organization, its governance structure, how the LLC will divide its net income, and how it will divide all financial obligations.
Start with your state’s agency that deals with business formation. This is often handled by the Department of State, Secretary of State, or similar office. With the appropriate agency in your state, search for the necessary documents. These documents are generally referred to as your “articles of incorporation”. Once you have these forms, you will know the specific information needed to form your corporation. Most states will require you to have information such as the original members of the LLC, their addresses, their role in the business, the structure of the LLC, any legal process service agents, and any addresses from which the LLC will operate.
Also with your state’s relevant agency, research available business names. Select a name for your business based on what is available. Once you have a name for your LLC, go to the IRS and apply for an Employer Identification Number (EIN). Your LLC will use this EIN to pay its taxes. Complete the necessary paperwork for your state’s statutes. File it with the competent body. Pay the filing fees associated with these forms. This is usually several hundred dollars.
Using an LLC allows you to separate your business and personal responsibilities. When it comes to real estate investing, this means you can buy and operate real estate investments without putting your personal money at risk. It’s a smart approach, and one that many professionals use themselves.
Tips for investing
Investing in real estate can be one of the most lucrative long-term investments you can make, but it’s usually the most expensive. That’s why it can be a very good idea to work with a financial advisor if you want to get involved. Finding a qualified financial advisor doesn’t have to be difficult. SmartAsset’s free tool connects you with up to three financial advisors who serve your area, and you can interview your matching advisors for free to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, start now.
If you’re investing for your future, you might want to figure out how much you could earn over time. SmartAsset’s Investment Calculator can help you do just that.
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