When contemplating a commercial real estate purchase, buyers must consider a multitude of factors. One important consideration is who should actually purchase the property: the investor individually or an entity formed by the investor? There are many advantages, as well as related costs that come with forming a limited liability company (“LLC”) to purchase investment property and therefore each investor should consult a real estate professional as well as their attorney early in the transaction process.
Personal property protection is one of the main reasons why investors turn to LLCs. When buying a commercial real estate investment property and leasing it to a tenant, there is liability involved. If the tenant is injured at the property, the tenant might attempt to collect damages by suing you as the owner. By forming an LLC, you are better able to protect your personal assets in the event of a lawsuit. Owning property in an LLC acts to limit personal liability to the amount of equity that is held in the entity. Any additional liability above and beyond that amount is the responsibility of the LLC and your other personal assets held outside of the LLC will not be subject to that risk.
An LLC maximizes asset protection, especially for owners who have multiple rental properties. It may be advisable for each investment property to be owned in a separate LLC, so if the owner of the property is sued by one tenant, then only that subject entity will be potentially liable instead of all of your investment properties being put at risk. An LLC might also be considered a form of insurance as it acts to protect your other personal assets from certain legal claims, for example premises liability cases and contractual claims of tenants. However, investment property owners should also get commercial insurance to protect their investment in property from those claims made directly against the owner entity.
Potential Tax Benefits
For tax purposes, an LLC must file a tax return as a sole proprietorship, partnership or corporation because the federal government does not recognize an LLC for federal tax purposes. However, one tax advantage of an LLC is the ability to use pass-through taxation. For example, if you are the only owner of an LLC, you can choose to be taxed as a sole proprietorship. As a result, income and capital gains from the LLC may pass through directly to you and you'll only pay taxes as an individual. Since there is no separate LLC tax, you may be able to avoid unnecessary double taxation. To fully understand the benefits of owning property in an LLC, it is best to consult with your CPA.
Costs and Other Considerations
Investors need to be aware of the additional costs incurred as they establish multiple LLCs to own their real estate. While, separating business from personal records enables owners to stay organized and treat their investments as a business, it comes with increased operational and tax costs. Each LLC will need a bank account in the LLC’s name. A purchaser who forms an LLC to hold their real estate asset will have to pay organizational fees as well as attorney’s fees to set up the entity and then will also incur annual expenses in the form of added tax preparation costs and yearly filing fees. The transfer of real property to the new entity can add additional costs to the setup process, including recording fees and transfer taxes. Investors who already own a financed property and are considering transferring the property into a new LLC need to first discuss the transfer with their accountant, attorney as well as their existing lender. Investors who transfer the ownership from their own name into an LLC could inadvertently trigger a “due on sale” clause in their loan, which means the remaining balance of the loan may be due immediately upon the transfer.
While the benefits of owning property via separate entities are substantial, each investor needs to carefully weigh the associated costs and should always to consult with their real estate professional for guidance to ensure they are maximizing available asset protection and tax advantages.