What is an LLC?
A limited liability company (LLC) is a distinct legal entity that can provide legal protection and tax benefits to company owners. LLCs can be owned by a single individual or by multiple individuals, so you can use an LLC whether you are investing on your own or going in with partners.
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Why do I need an LLC to invest in real estate?
Most hard money lenders like ABL lend to entities, not individuals, because the LLC demonstrates that the transaction is for a commercial purpose opposed to a consumer purpose. Lending to commercial enterprises allows lenders to avoid onerous state and federal regulatory complexity which drives up costs. If you want to use a hard money loan to use hard money to fund your investment project, setting up an LLC is an essential first step.
Benefits of LLCs
There are advantages to setting up a real estate LLC rather than owning the property individually or in your operating company.
Limited Liability
An important purpose of an LLC it is the potential limitation of liability to its members. In a field like real estate where there can be many unforeseen circumstances, limitation of liability is an important factor to consider.
Pass-Through Taxation
Unlike a “C” corporation where profit is taxed before it is divvied up among the owners, then taxed again as income when the owners receive it, “S” LLCs are not taxed independently of their members. Instead, the income passes directly to its members. This means that the LLC members will only have to pay taxes on the LLC income once.
LLCs can choose to be taxed as C Corps or S Corps
Easy to Start
LLCs require less paperwork than corporations. Additionally, the owners are not typically required to hold annual meetings or keep official minutes. While LLCs are not free to start, the fees are typically lower than the cost of starting a corporation, mostly because less documentation therefore results in fewer filing and legal fees.
Disadvantages of LLCs
Tax Related Paperwork
When you own real estate in an LLC, as opposed to individually or through your own company, you are required to file tax forms with the IRS. You should consult with a CPA if you are not familiar with the required paperwork, but the most common required tax filing for LLCs is called a K-1.
Other Regulatory Paperwork
The state that your LLC is registered in will require an annual filing to show that the LLC remains in operation and there will be an annual fee requirement. This information will be available on the state LLC registration website.
Setting Up Your LLC
So, how do you open an LLC? Follow these steps to apply for your LLC.
Step 1: Choose a name.
In choosing a name when you form a real estate LLC, think about simple monikers that convey what your business is all about. For example, ______ Properties or ______ Investments. You can fill in the blank with your name or a word or combination of words. For example, if you invest in cities and focus on eco-friendly new construction, you could call your LLC “EcoCity Investments, LLC.”
There are some restrictions in naming your LLC. First, it must contain either “LLC,” “L.L.C.,” or “Limited Liability Company” in the name. Second, there are some words you cannot use and others you need special permission for (in New Jersey, these words and phrases include Urban Renewal, Realtor, and D.C.), and third, it cannot be in use by another company in your state.
Once you choose a name, you can often reserve it so that another organization doesn’t take it before you put together the articles of organization.
Step 2: Choose a registered agent.
The registered agent is the individual who receives all official communication for your LLC. The registered agent must reside in the state you are registering your LLC in. In general, it is best to designate yourself or a partner as the registered agent for your LLC. The exception would be if you are registering your company in a state none of the LLC members reside in.
Step 3: File articles of organization.
Depending on your state, these may instead be called the certificate of formation. This document can usually be obtained at your state’s business office. Most often, these documents require: your LLC name, your registered agent, a statement of purpose, the management organization, and your principal business address. Additionally, at least one of the LLC members will need to sign and date the articles before filing.
The filing fee varies by state, and most states have annual or biannual fees to maintain your LLC. For example, New Jersey has a one-time fee of $125 and an annual fee of $25. Find the filing fee for your state here.
Step 4: Make an operating agreement.
If your LLC is located in New York, Delaware, California, Maine, Missouri, or Nebraska, you are required to develop this document to establish your company. If you are not located in one of these states, it is still necessary to develop an operating agreement if there is more than one member of the LLC.
An operating agreement is a clear blueprint for your operations going forward. The agreement contains six main sections: Organization, Management and Voting, Capital Contributions, Distributions, Membership Changes, and Dissolution. It lays out who the company members are, their roles and ownership shares, management procedures, monetary contributions from each member, a description of the profit distribution practices, the process for changing LLC membership, and the procedure in case of dissolution. Additionally, members may include any other aspects of business operations that they deem necessary.
You can create an operating agreement that meets your state standards with eForms; the site also provides documents detailing the specific legal requirements for LLC formations in your state.
Step 5: Publish a notice in the local paper.
Some states require new businesses to publish notices of their formation in the local paper. Check your business office to see if a public notice is necessary and, if it is, what exactly is required for the publication.
Step 6: Obtain necessary permits and licenses.
Now that your LLC is officially registered, you need to make sure that your entity can legally operate in your state. Real estate investors do not typically need licenses to do business; however, if you set up an LLC, your state may require you to obtain a general business license that can be renewed yearly. Once again, this information can be obtained at your local business office.
Step 7: Open an LLC bank account.
Hard money lenders like ABL require that your LLC has a bank account that is separate from your own personal account or business account. Separation of bank accounts may help to shield you from liability and will allow the lender to establish clarity with respect to money flow.[su_divider top=”no” divider_color=”#e4e4e4″ size=”1″ margin=”5″]
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