How to Form a Real Estate LLC

If you are planning to invest in real estate, or you’re already investing, you may be considering forming a limited liability company (LLC) for your real estate holdings. Often, people set up LLCs for purposes of real estate investing with other people to pool money, or just for their own individual real estate investments.

Reasons to do so include pass-through taxation, personal asset protection, and the structural flexibility of LLCs. If you’re considering creating an LLC for your real estate investments, you should make sure you do so correctly.

What is an LLC?

An LLC is an increasingly popular business structure for startups, offering liability protection for ownership and greater flexibility than a corporation, particularly in terms of taxes. The LLC itself does not pay taxes. As a “pass-through” entity, income passes through the business to the owner or owners, who report it on their personal tax returns.

An LLC is created by filing paperwork with your state, and nominal fees are involved. An LLC offers its owner or owners, who are called members, considerable flexibility in terms of management.

You can choose your management and operational structure and decide how you want to be taxed. Your LLC can have a single member or multiple members, all of whom have personal liability protection, meaning your personal assets are not at risk if you cannot pay business debts or are involved in a lawsuit.

Benefits of Having a Real Estate LLC

The most important advantage of having an LLC for real estate is personal liability protection. If someone is injured on your property, or another dispute occurs related to the property, your personal assets are protected if your LLC is sued. 

In addition to personal liability protection, the property is protected to a certain extent if legal action is taken against the LLC. A creditor can’t force the sale of the property to get money, though they may be able to obtain a lien against the property.

An LLC offers benefits over a corporation for real estate investments in terms of taxes. Since LLCs are pass-through entities, the LLC itself will not pay taxes. Income and losses are passed through to the members according to what is stated in the operating agreement and reported on members’ personal tax returns. This is in contrast to a corporation, which is a taxable entity, meaning the corporation itself is taxed. Shareholder dividends are also taxed. This is referred to as double taxation.

However, the 20% tax reduction that applies to LLCs through the Tax Cuts and Jobs Act does not apply to LLCs for investments because you are not considered to be running a business. Having a real estate LLC also gives you some credibility as an investor and a company, as opposed to just owning properties in your own name.

Disadvantages of a Real Estate LLC

It may be more difficult for you to get financing for your investment properties. Some types of financing, such as FHA loans, are only offered to individuals, not companies. This is because the lender knows you’re not personally liable for the debt. A financing company may also charge a higher interest rate for an LLC over an individual.

In addition, if you transfer a property from the LLC back to you, or if you transfer a property that you own already into the LLC, you may trigger a due on sale clause from the lender. This means that your mortgage loan may be due in full immediately upon transfer. Here’s more detail on transferring property to your LLC. 

How to Form a Real Estate LLC

1. Choose Your State

The first step is to choose the state in which you plan to do business.  If you live in one state and your property is in another state, you will need to form your LLC in your home state and probably form a foreign LLC in the state where the property is located.

LLC processes and requirements vary by state, so visit your state’s website for details. Generally, you can form your LLC with an online application. If you plan to have properties in more than one state, you will need to register a foreign LLC in all the states where you will have property.

2. Choose Your LLC Name

Your business name is extremely important. It should reflect the brand you plan to build, tell customers what you do, and be memorable. Once you’ve chosen a name, you’ll need to make sure that it’s not already taken. You can do a search on your state’s website, and on other state websites if you’re doing business in more than one state. You should also check the US Patent and Trademark Office to make sure the name hasn’t been trademarked. 

3. Choose a Registered Agent

A registered agent is the person or company that sends and receives legal documents on behalf of your LLC. The registered agent can be a member of the LLC, or you can choose a third party such as an attorney, or a company that offers registered agent services.

Most states require you to have a registered agent. The agent must be a resident of the state where you do business, or a corporation authorized to do business in your state.

4. Determine Your Management Structure

There are two types of management structures:

• A Member-Managed LLC is managed by the members of the LLC. This is usually chosen by smaller LLCs with few members who will be involved in various management roles. 
• A Manager-Managed LLC is managed by people who are not members of the LLC and are employees of the business. This structure is often used when an LLC is larger and has multiple members.

5. File Articles of Organization

The articles of organization is the form you file to create your LLC. These forms vary by state but can generally be filed online. You’ll need to fill out the LLC name, the name and address of the registered agent, the names of the LLC owners, and in some states, the way the LLC will be managed. Fees are generally around $100.

6. Draft an Operating Agreement

An operating agreement is not usually required but is highly recommended. The operating agreement should clearly define the following:

• The percentage of each member’s interests in the LLC
• How profits and losses will be allocated to each member
• Each member’s rights and responsibilities
• The management structure and management roles of members
• The voting rights of each member
• Rules for meetings and voting
• What happens when a member sells their interest, becomes disabled, or dies

It’s a good idea to have an attorney’s help when creating your operating agreement so that you can be sure you’re covering all bases to protect all members and avoid future issues.

7. Apply for Business Licenses

It’s important to make sure you’re in compliance with all laws at the local, state, and federal levels. There are no federal licensing requirements to invest in real estate, and most likely not at the state level either. Check with your state and local governments to see if there are any licensing or permit requirements.

8. Obtain an EIN

EIN stands for Employer Identification Number and is like a social security Federal Tax Identification Number (FTIN), or sometimes for corporations a Tax Identification Number (TIN). An EIN is required if your LLC has more than one member, if you plan to hire employees, or if you choose to have your LLC taxed as a corporation.

The application is free and can be found on the IRS website. The application is form SS-4, and it can be mailed to the IRS or submitted electronically, and once your information on the application has been validated, the EIN is assigned immediately.

9. File Annual Reports

Your state may require you to file annual reports for your LLC, which may involve a fee. Check your state for requirements.

Now you can start purchasing properties in your LLC name. You will probably have to personally sign for mortgage loans for your properties, however, so that both you and the LLC are obligated to pay the loan.

In Closing

Real estate LLCs offer many benefits, but there are a few disadvantages to consider as well. It’s a good idea to seek the advice of your tax advisor before forming your real estate LLC. Doing so will ensure you and your properties are protected.