Buying Real Estate as an LLC
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Table of ContentsWhat are the benefits of buying a house using an LLC?Diverse OwnershipTax BenefitsPersonal Liability ProtectionAcademic Research
What are the benefits of buying a house using an LLC?
Many people believe that a limited liability company (LLC) is reserved for individuals actively carrying on business. In reality, an LLC is a useful entity to simply hold assets. A common practice is forming an LLC and purchasing real estate through that entity. There are numerous benefits associated with this type of ownership structure.
In this article we review some of the primary benefits of employing this ownership structure.
When using an LLC to purchase real estate, the entity is the record owner of the real estate. The deed will be in the name of the LLC and filed with the local register of deeds of office. The LLC can then be owned by one or more individuals or another company. This allows the owners of the LLC to easily trade or transfer ownership interests without executing a new deed and paying a recording fee. This can be useful when one of the LLC owners slowly acquires a greater ownership interest in exchange for work done or services supporting the LLC or underlying property.
As discussed, the LLC is the record owner of the real estate. The real estate can then be treated as a business interest. As such, the expenses associated with owning and maintaining the real estate can be treated as a business expense. For example, if the LLC has a loan and pays interest on the property, the interest can be deducted against any income generated by the real estate. Also, any maintenance to the house is a deductible expense. If the LLC owners make material improvements to the property (such as a new HVAC unit), the cost can be depreciated, which is a deduction on the income tax return.
Further, the LLC may choose to be taxed as a partnership or as a corporation. This allows the owners to elect the tax treatment most favorable. As of 2021, C-Corporations are taxed at a flat 21% rate, while S-Corporations and Partnerships are taxed at the individuals personal income tax rate.
Further, the LLC may qualify to elect S-Corporation tax status. As of 2021, S-Corporations are afforded a 20% deduction for recognized income for income tax purposes. Note: Availability of this deduction will depend upon whether the LLC is a pass-through entity and not a specified service business earning over a threshold amount.
Finally, if the LLC members (owners) are involved in actively managing or maintaining the property, they can receive a salary for their efforts as employees (only if organized as an S-Corp or C-Corp). The objective is to receive as low a salary as possible. The remainder of income from the property with be treated as unearned income. It will not be subject to Federal Insurance Corporation Act (FICA) taxes. This combination can provide considerable income tax benefits.
Personal Liability Protection
Holding real estate in an LLC can shield the owners of the LLC from personal liability for any debts and obligations of the LLC. Imagine a scenario where the real estate is being rented to earn income for the LLC. A visitor is injured when present on the real estate. He subsequently sued and obtains a judgment against the LLC. The individual could collect her judgment against the assets of the LLC. If the value of LLC assets is not adequate to pay the judgment, the individual cannot seek to recover against the personal assets of the LLC owners. This is known as limited personal liability protection. It is important to remember that the LLC members must adhere to numerous formalities to make certain that a creditor cannot pierce the veil of protection afforded by the LLC and reach LLC member personal assets. These formalities include adequately funding the LLC for operations (and not drawing off all funds or assets), maintaining separate assets for the LLC (including holding a separate bank account for profits, and not using LLC assets for personal use or personal assets for LLC purposes). In the case of real estate, the LLC owners should also maintain appropriate liability insurance for accidents occurring on the property.