Why real estate
investors are forming LLCs?
values are soaring as investment-driven demand for
residential and commercial property continues to expand
at a record clip. Historically low interest rates and
erratic Wall Street share prices are also helping to
fuel this amazing phenomenon.
At this moment, a growing percentage of newly acquired
properties are going into Limited Liability Companies
(LLC's) which offer critical self-protection and tax
saving features. The LLC is certainly helpful in the
current legal climate of blame, litigation and
Even so, too many real estate businesses are still being
conducted as sole proprietorships and general
partnerships. And others are still being operated under
older business forms such as limited partnerships which
may fall short in providing all the protection that is
While there certainly are important considerations in
favor of limited partnerships, many of the features of
the LLC provide additional advantages which should be
carefully considered. The following questions and
answers should provide helpful guidance in making this
How does this
When starting a new
venture, it is always best to start out with a new
company. For real estate purposes, the most advantageous
form of doing business is a limited liability company.
It offers asset protection to owners in the same way
that a corporation does, and for tax purposes it is
treated as a partnership if there is more than one
Of course, if you have to personally
guarantee loans on the properties, no entity will offer
you indemnification from these debts. However, you will
get personal indemnification from most forms of lawsuits
if you properly respect the form of entity, by not
commingling personal and business activities.
One advantage of an LLC over a
corporation is that the owners pay tax on the profits of
the partnership and therefore avoid two levels of
taxation. While it is true that a corporation can elect
to be taxed as an S-corporation, to avoid the two levels
of taxation, the shareholder cannot deduct losses beyond
their investment in the S-corporation.
In an LLC that is taxed as a
partnership, the owners can use the debts of the
partnership to claim losses in excess of their
investment. Therefore, an LLC becomes the superior
choice when there are leveraged assets.
Each separate property can be owned by its own,
individual LLC, thereby shielding not only the owners,
but their other properties from cross-liability.
Income and expenses are all passed through, for income
tax purposes, to the owners in any proportions that the
owners themselves agree to and specify.
All owners may have a say in management without
adversely affecting tax treatment or the owners' shield
There are no restrictions on the number of owners (2
or more) or on the nationality or business status of the
owners (they can be individuals, partnerships or other
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Q: How does an LLC differ from an S Corp. or a Limited
A: Like a partnership, the LLC is an unincorporated
business entity. It is really a cross between an S Corp.
and a Limited Partnership, basically taking the best
The LLC differs from a Limited Partnership in one
significant area: unlike a limited partnership where the
partners are shielded from liability only if they do not
participate in the operations of the business, the
owners of the LLC are shielded completely, irrespective
of their active or inactive status. (The only exception
to this is in professional LLC's where the lawyer or
doctor or accountant may still have malpractice issues,
individually, based upon his or her own actions in the
Like a partnership, the members of the LLC enter into an
agreement in which each is assigned duties and shares of
the profits. All income and expenses of the LLC are,
like a partnership, transferred to the individual
owners. The LLC pays no tax of its own. Rather, each
owner is taxed as if he or she were a sole proprietor of
their respective shares.
Q: Why is the LLC particularly suited to the real estate
A: Real estate businesses are invariably linked to the
individual properties owned. The income, expenses,
problems, and liabilities of the properties vary
greatly. Because of this, businesses in this field
always seek to shield their better properties from those
that are troublesome, especially in the area of
liability. All of the assets of a business can be lost
if the problems in one area result in judgments.
To prevent one property from placing all of the adverse
properties at risk, owners should place each one
separately into its own LLC. In that way, both the
owners and the properties can be shielded.
Q: Who can own an LLC?
A: S Corporations include the requirement that each
owner/ member must be a US citizen or resident and a
person (as opposed to another company), and that there
be no more than 75 owners. This is not so of the LLC.
The LLC is governed by state law, and most states allow
any number of in LLCs, and, any of them can be people,
corporations, partnerships or other LLCs. And none of
them are required to be citizens or residents.
Q: Are there drawbacks to the LLC?
A: The only drawback to the LLC is in the area of Social
Security Taxes and fringe benefits. For an LLC, as
opposed to a C Corporation, since all income and
expenses are passed through to the owners, all such
payments are subject to social security tax, no matter
how denominated. Different and varied rules may apply to
the LLC owners, so it is advised that accounting
professionals be contacted.
Q: Why select the LLC over the Limited Partnership?
A: Aside from the tax and liability issues, there is
another important issue that argues in favor of
selecting the LLC over the partnership; that is, the
issue of control. Under the limited partnership, there
is no liability protection for the partners who actually
participate in the operation of the business. Thus, if
two or more partners want to have an equal say in how
the business operates, then there will, in fact, be no
liability protection. Under the LLC, however, the
liability extends to all participants, irrespective of
their say in operations.
Q: On balance, is the LLC the preferred form of entity
for residential and commercial real estate businesses?
A: The LLC is by far the most protective and efficient
business form for real estate companies, both
residential and commercial. Here is why: