If you’re a real estate investor, you’ve probably heard your peers talk about LLCs and the pros and cons involved in forming a company of this type. They can certainly be advantageous for investors who have millions of dollars worth of property, but is there any reason for the average landlord to set up an LLC?
We’ll investigate that question in this article.
Understanding LLCs
According to the U.S. Small Business Administration (SBA), “A limited liability company is a hybrid type of legal structure that provides the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership.” In this structure, owners of the LLC are referred to as “members.”
Depending on which state you live and/or operate in, membership may consist of a single individual or multiple people. The biggest difference between an LLC and a typical corporation is that LLCs are not taxed as stand-alone business entities.
In other words, all profits and losses are passed along to the members of the LLC and must be reported on personal tax returns.
Benefits of Forming an LLC
As a landlord, you have a number of reasons that might make forming an LLC worth your while. These include:
• Protection of assets.
The biggest benefit is that you’re able to protect your assets by reducing personal liability. This is why most investors and landlords pursue an LLC. For example, let’s say one of your tenants trips on a loose floorboard and breaks her nose. You likely become an immediate target; the tenant may choose to sue you. However, if you are operating as an LLC, you’re personally protected. The tenant can still come after your company, but she can’t come after your personal assets.
• Tax advantages.
Depending on your financial situation and how your LLC is structured, your tax picture may be improved. While there aren’t always specific tax advantages for landlords, it’s worth noting that there aren’t any disadvantages, either. Forming an LLC means you can avoid double taxation and it may allow you to reduce self-employment taxes (if they are applicable in your situation).
• Succession planning.
If you think you’ll eventually want to pass your investments along to your heirs, having an LLC streamlines the process and makes it much easier to effect. You don’t have to transfer individual deeds and deal with the intricacies of a will; you simply add members to the LLC and fill out some paperwork.
Disadvantages of Forming an LLC
Let’s turn to the potential disadvantages of forming an LLC. Here are some of the reasons certain investors and landlords choose to stay away:
• Mortgage issues. Banks and lenders are funny when it comes to LLCs. Most will not approve an LLC for a loan, even if they trust the members behind it. Generally speaking, it’s challenging to finance a property directly through the company. What members often have to do is take out a home loan as an individual, then transfer the title to the LLC before renting the property. If you decide to refinance or sell in the future, you have to transfer the title each time. This can be costly and frustrating.
• Cost. Speaking of cost, the process of forming an LLC can be fairly expensive. In the state of Texas, the cost of filing for a Texas LLC certificate of formation is currently $300. Since it’s a one-time fee, $300 isn’t a big deal. However, if you were to incorporate in another state — say, California — it would cost you $800 per year. For a landlord with a single property, that may pose an expensive premium to have to pay.
• Limited protection. In certain cases, an LLC will not protect you from a lawsuit. These tend to be few and far between, but it’s important to understand that LLCs are not foolproof. In fact, your LLC status may simply complicate the process and make it more difficult for a resolution to be achieved.
How to Form an LLC
In the state of Texas, landlords and investors who own multiple properties should definitely consider forming an LLC. In most cases, it offers a cost-effective way to protect your personal assets and simplify ownership.
If you do decide to form an LLC, here’s how it works:
• You’ll start by choosing a name. According to the SBA, there are three rules when it comes to naming an LLC. (1) The name must be unique to your state. (2) The name must have the letters “LLC” or words “Limited Liability Company” attached to it. (3) The name cannot include words that are restricted by your state (unless approved), such as bank, insurance, or doctor.
• The second step involves the naming of a registered agent. This is the individual (likely yourself) who will send and receive documents officially on behalf of the company. Anyone within the company can be nominated as the registered agent.
• Next, you file what are known as the “articles of organization.” This document includes all required information and legitimizes your LLC under state law.
• The next step is to create an operating agreement that clearly outlines the rules and regulations of your LLC.
• Finally, you need to obtain the appropriate licenses and permits for your LLC. You can find out more about this process by consulting this resource of the SBA.
The actual process of forming an LLC is pretty straightforward, but it may help to hire a professional who can walk you through the various stages. For just a few hundred dollars, you can hire a business attorney who will handle everything and ensure proper protocol is followed.
At Green Residential, we pride ourselves on our ability to manage the big picture while paying attention to the finer details. With more than 30 years of experience and a track record of success, our team has established the Green Residential name as one of the most trusted and highly respected in the industry.
If you’re a Houston landlord or real estate investor, we would like to offer our services. Whether you need help drafting contracts, leasing properties, screening tenants, or even evicting a tenant, we can help.
For additional information, please contact us today. We would be happy to answer any questions you may have.
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