Investing in real estate is a great way to build wealth, and it’s a strategy that is increasingly used by businesses, rather than individuals. Because of this trend, many individuals who are interested in investing in real estate for the first time may be wondering whether they should buy an investment property in their own name or in a limited liability company, or LLC.
Unfortunately, there’s no simple answer. There are a multitude of factors that your client should consider, such as whether they have prior experience in real estate investing, what they intend to do with the property, whether they have an exit strategy and the risks associated with owning property. Reviewing the pros and cons of investing in real estate should prepare you to help your client make this decision.
The Benefits of an LLC
An LLC is a business structure that limits liability, meaning that the LLC’s assets and liabilities are separate from the business owner’s personal assets. If something happens to the business, such as a lawsuit or bankruptcy, only the business assets are liable, thereby protecting the business owner from losing their home or car, for example.
Should your client choose to purchase real estate and become a landlord, the primary benefit of holding property under an LLC is that the tenants can sue only the LLC and not your client should something happen. There are exceptions in extreme cases of fraud or neglect, but the bottom line is that the rental properties would be the only assets at stake in case of a lawsuit. It’s even possible to form separate LLCs for each property to further reduce liability.
There are other advantages of holding a property under an LLC. For one, it’s easier to invest with partners in an LLC or to add an additional member by selling a percentage of the LLC. There are also tax advantages to be had by working with an accountant or a lawyer. Finally, forming an LLC allows the owner to separate their real estate income from any other income, making it easier to keep track of real estate activities.
The Challenges of an LLC
Despite the benefits, there are reasons to avoid an LLC, especially if your client is investing in real estate for the first time. Although LLCs eliminate personal liability for properties, if your client falls into financial difficulty, their bank may decide that their personal mortgage and property take priority over their commercial properties.
This is why mortgages for an LLC are more difficult to obtain, interest rates are generally higher and larger down payments are expected. Also, your client won’t be able to obtain a residential loan and take advantage of various government programs designed to promote home ownership. In many cases, the bank will not approve a mortgage unless your client provides personal assets as collateral, which defeats much of the purpose of forming an LLC.
One must also consider the expense and hassle of setting up an LLC. The filing fees range anywhere from $40 to $800 depending on where the property is located. There is also the cost of hiring a lawyer to make sure that the LLC is set up properly, and you absolutely want to advise your client to go through a lawyer rather than trying to set it up themselves. Your client will also need to pay an annual fee to maintain the LLC. While these costs are generally small compared to the cost of buying a property, it is something to consider.
How to Buy Real Estate in an LLC
Fortunately, buying real estate under an LLC is not significantly different from buying real estate as an individual. However, it is important that your client have their LLC set up well before they buy a specific property. A delay while your client scrambles to form their LLC may lead the seller to look elsewhere.
Once your client makes an offer and it has been accepted, they will need to go to a lender and discuss the details of getting a mortgage. In addition to the challenges mentioned earlier, your client will need to submit personal documents proving their own income, as the LLC will not yet have income or tax records as proof it can pay. When the mortgage is approved, the property will be titled in the name of the LLC.
If you’re still unsure of how to advise your client, consider the following questions:
· How much property does my client intend to own? If they intend to own a single property and rent it out, buying as an individual could be simplest. If they plan to own multiple properties, the increased protection of an LLC becomes more significant. It’s important to note that while it is possible to transfer a property from an individual to an LLC, doing so while it is still mortgaged can be risky depending on the initial lending conditions.
· How much money does my client have? The lending requirements are stricter when buying a property as an LLC, and a larger down payment is required, so your client should have enough money saved up for this purpose if they intend to buy as an LLC.
· What is my client’s long-term plan with this property? Do they intend to cash out their property someday, or do they plan to leave it to their children? An LLC can make it easier to pass properties on to heirs if certain steps are taken in advance.
Owning real estate under an LLC does offer certain advantages, but there are challenges to consider as well. Starting an LLC requires time and money, obtaining a loan can be more costly and it can be challenging to maintain. If your client is just starting to invest in real estate, it may be easier for them to buy properties in their name, without an LLC. A person who has significant cash on hand and major ambitions of owning a real estate empire may do better with an LLC, while a person looking to own and perhaps rent out one or two properties may be better off on their own.