Starting a real estate investment business can be a lucrative opportunity, especially in communities where the housing prices keep escalating. However, if you plan on investing in real estate, there are a few legal steps you should first take to save money on your taxes and ensure your personal assets are protected in case the unthinkable should happen on your property.
Real Estates LLCs
An LLC is the most popular type of business entity that small businesses choose, especially for those who have a real estate investment business. A major reason you should consider becoming an LLC is that it will help protect your personal assets. Here's how:
Protect Your Personal Assets
Let's say you're renting out a house, and your tenants decide to throw a party. After having too much "special punch," they choose to move the party to the second-floor balcony so everyone can gather together to take a selfie. Unfortunately, the balcony collapses under the excess weight and now you have a major lawsuit on your hands.
Was the balcony meant to hold 20 people? No. Are you responsible for their injuries because the accident occurred on your property? That would be up to a judge and jury to decide. However, if you had an LLC in place before the accident happened, your personal property (such as your bank account, home, etc.) would be protected from the repercussions of a lawsuit.
Use a Real Estate LLC Operating Agreement
Many times real estate investors choose to go into business with a partner for a variety of reasons. Maybe one partner is responsible for the funding while the other has experience in property management. Regardless of how the roles are defined, if you choose to become an LLC, you should create a real estate LLC Operating Agreement to protect yourself and your partner while creating legally enforceable rights and responsibilities. There are many reasons why you would want to create an operating agreement:
Document the official name, address, and function of your business
Determine in writing what percentage of the company each member owns
Record how much capital each member is contributing
Agree upon how final decisions will be made
Designate how profits and losses will be distributed
Outline the specific roles and responsibilities of each partner
Delineate a schedule of official meetings to formally discuss the state of the business
Decide whether a partner can sell their share of the business (or purchase another)
Determine how and why the partnership may be dissolved
Additionally, many states such as California, New York, Missouri, Maine and Delaware require the members of an LLC to have an operating agreement. Regardless of where you live, the more information you have detailed in an Operating Agreement, the better.
For example, let's say that one member invested $250,000 in the company while the other member invested $100,000 plus sweat equity in renovating a piece of property. Who owns more shares? Once the property is sold, how will the profits be divided? How will you decide a fair listing price of the property or agree on which offer to accept? If one member gets into a financial bind, can they sell part of their interest in the company? Does the other member have the right to veto who can buy into the LLC? If you had a strong Operating Agreement in place, you'd already know the answers to these questions!
At Incfile, our legal experts can help you write an Operating Agreement that covers the most commonly used provisions, and the document can be customized based on your specific company information when you place your order. If you plan on choosing our Silver package, this add-on is just an additional $40. If you pick our Gold or Platinum package, you get this valuable service at no additional fee. For just a little time and maybe a few more dollars, this crucial legal document can save you immeasurable frustration down the road if it's done right.
Questions About Forming a Real Estate LLC
With your Operating Agreement in place, your real estate LLC will be set up for success. Here are a few other things you should understand to ensure you're using all the advantages that becoming an LLC offers for your real estate business:
Neither the income from a rental property or the appreciation in value when the property is sold incurs tax penalties. You can also use mortgage interest as a deduction. If there are multiple members (you have a business partner), you'll be taxed as a partnership. This means each person is responsible for reporting their share of the profits (or losses) on either a Schedule C, K or Form 1065 with their individual income tax returns.
Where Should I Incorporate?
As a real estate investor, all of your properties may not be located in one state, especially if you have vacation properties. If you're looking to buy properties, you may want to consider which states have the lowest taxes and the most flexibility. For example, Delaware has no sales tax, no personal property tax, and no minimum capital requirement. You might also just want to register where you conduct most of your business to make things easier. Talk with your CPA to determine which locations would be the most beneficial for your circumstances.
What Is a Series LLC?
If you own multiple properties, you may be looking into starting a series of LLCs. For example, if you have several large strip malls that you rent out under a single LLC, all of your assets within your LLC could be at risk if you get sued and are liable to pay out a large settlement. If you have a series LLC instead and each strip mall is filed as its own entity, then only that LLC's assets are at stake. However, not every state allows series LLCs, so check with your state to determine if this option is available to you.
Do Certified Real Estate Agents Who Invest in Properties Need to File an LLC?
The short answer here? Yes. Real estate brokers/agents have a real estate license and tend to pay fees to a larger brokerage firm, but they usually operate as an independent broker. If you are planning on starting a side business apart from the real estate agency that you are associated with, it is advisable that you file your own LLC.
Our legal experts have helped thousands of businesses file their LLC paperwork, and we can guide you through the process quickly and simply. It can feel overwhelming to gather, fill out and file the needed legal forms, but we can help. We take the worry out of the legal process so you can focus on running your real estate investment business. Our business formation service is $0 + state fees and includes a free year of our Registered Agent service.