It’s Dim Witted to Not Get Limited: Why You Should Start an LLC for Your Investment Properties
This blog discusses why you should form an LLC if you own real estate investment properties.
What is an LLC?
If you plan on owning investment property, forming an LLC to own the property may be the way to go. “LLC” stands for “Limited Liability Company.” Meaning, the owner(s) of an LLC is/are not personally liable for the company’s debts or liabilities. An LLC is easy to form under Colorado statutes. To create an LLC, a person must file a simple document called the “articles of incorporation” with the state. An LLC can be formed by one or more owners.
How does an LLC help to limit personal liability with my investment property?
Years ago, there were only two types of companies: the corporation and the partnership. Corporations were large, complex companies with limited liability, but with many owners who purchased stock in the company. Meanwhile, partnerships were smaller companies owned by a few people (partners) who were directly liable for the company’s debts and obligations. However, a few decades ago, the LLC became popular because it combined the best of both worlds: limited liability and a simpler business model for small business owners that did not require the issuing of stock.
Nowadays, you can form an LLC to own investment property and if the company is sued, only the company is liable—not you the owner. In other words, if someone did successfully sue your company, for example, if your tenant gets injured from falling down the property’s stairs, only the LLC’s assets are at stake, not your personal assets. Therefore, LLCs serve as a form of shield and protection against your personal assets in doing business.
What is “pass-through taxation” and how does it help my real estate investment business?
Another benefit partnerships had over corporations that was adopted by the LLC model was pass-through taxation. Pass-through taxation means that any income made will pass to the owner, and thus you are only taxed once. Taxes are then paid as an individual. Therefore, the profits and losses of the business “pass through” to its owners, who report them on their personal tax returns just as they would if they owned a partnership or a sole proprietorship. In contrast, income made by corporations is taxed once at the company level and again at the individual’s level (dividends) in what is known as “double taxation.” As a result, the LLC itself does not pay any taxes which helps property investors avoid double taxation.
Can an LLC really help me manage my money more efficiently?
If you create an LLC, you can create a separate business account to keep personal finances and business finances separate. This will help you to run your business more efficiently as it will be easier to keep track of business expenses.
What should I do if I own multiple investment properties?
If you own multiple investment properties, LLCs are still the way to go. You shouldn’t have one LLC cover all of those properties, though. As an investor with multiple properties, you can create an LLC for each investment property. This is beneficial in that you can better protect each property from liability claims. For example, if someone gets injured at one investment property and files a suit, they can only go after that one LLC and it won’t affect the other properties. Thus, an independent LLC for each investment property is a way to further limit your total liability across all of your assets.
Are there any disadvantages to creating an LLC for an investment property?
As with most business ventures, there are always going to be some disadvantages that an investor will need to consider before fully committing to a business decision. Here, one must consider the cost of setting up an LLC. There are costs for forming and maintaining the entity you create. Also, there may be additional costs for tax preparation. These costs only multiply if you create multiple LLCs for multiple properties.
A second issue investors may run into is trouble receiving financing. Lenders usually prefer to have someone personally liable for the loan as opposed to an LLC. This may require you to buy the property entirely in cash, or you can try to deed the property to the LLC after purchasing it in your own name.
Finally, having an LLC doesn’t always fully protect the owner, thus resulting in unclear asset protection. There are situations where an LLC will protect you well, and in some rare situations, it doesn’t. Unfortunately, it is hard to determine what types of rare situations would leave your assets vulnerable to a lawsuit, and sometimes these situations do not arise until a lawsuit appears.
GLO has specialized in real estate transactions, business, and landlord-tenant law and has helped tenants along the Front Range with their residential leasing issues, including setting up LLCs. If you are looking to invest in Colorado real estate, fill out an interest form today to see if GLO can help you.
GLO has prepared this blog to provide general information on legal issues that may be of interest. This blog does not provide legal advice for any specific situation and this does not create an attorney-client relationship between any reader and GLO or its attorneys. GLO engages clients only through specific fee arrangements and signed engagement letters. GLO does not guarantee any results.