Why should an Investor purchase real estate in the name of an LLC?
Some of the benefits of holding real estate in an LLC include limiting potential liability (including the investor’s assets) and enabling the investor to obtain tax savings.
Regarding protection of assets, the LLC is a separate legal entity from its owners, so it limits personal liability. For example, if a lawsuit arises involving the real property, the investor’s personal assets would not be subjected to the lawsuit. Another example may include if the LLC is sued for debt owed by the LLC. In that instance, the LLC would be responsible for the debt, as opposed to the investor personally. Of course, there are exceptions to the investor not being personally liable, including if they: Directly injure someone; Personally guarantee a debt; Fail to comply with State and Federal tax requirements; or Intentionally do something fraudulent, illegal, or reckless that causes harm.
Regarding tax benefits, an LLC enables businesses to avoid being taxed directly, with investors reporting the company’s profits or losses on their personal tax returns. Generally, this will result in a lower rate for business owners and the avoidance of double taxation. Done correctly, real estate LLC tax benefits can also include thousands of dollars’ worth of annual savings.
Although real estate LLCs offer many benefits for investors, there are a few drawbacks. For instance, the “due on sale” can be problematic for LLCs. The due on sale clause of a mortgage prevents an individual from transferring property in their name to their LLC. An investor would be wise to seek approval and/or a waiver from the mortgage company prior to transferring real estate to the LLC. Other potential drawbacks of an LLC may include the following: Registered agent (Unlike a sole proprietorship or general partnership, an LLC is required to have a registered agent for the purpose of receiving official documents, such as lawsuits and subpoenas); Texas taxes (The two types of business taxes for an LLC in Texas are sales tax and the Texas franchise tax. All businesses are subject to sales tax. The only types of business entities that are not subject to the franchise tax are sole proprietorships, and general partnerships where the partners are all natural persons (no partner is a corporation, LLC, or other type of business entity)); Federal self-employment tax (The self-employment tax for an LLC in Texas is the same as for an LLC formed in any other state. Unless the LLC elects to be taxed as a C corporation, all of the LLC’s profits are passed through to the members. The members will need to pay self-employment tax on their share of the profits, even if they do not actually receive a share of the profits); and Difficulty raising capital (Unlike a corporation, an LLC cannot issue shares of stock to raise capital. Any new investor would need to become a member of the LLC).