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An LLC is a limited liability company, and in some cases, it’s the right decision for a real estate investor with a growing business. It’s important that all real estate investors understand the risks associated with operating a business, and what role an LLC plays as you grow. We’ll break down all of the basics here.
What is an LLC?
LLCs are limited liability companies, which is a U.S.-specific type of private, limited company. LLCs are a legally recognized business structure. Different states have different statutes that regulate how an LLC can operate. When you open an LLC, you will choose which type of LLC you want, which not only impacts your role in the company but also how that company will be taxed by the IRS.
Types of LLCs
There are a few types of LLCs:
Single Member/Sole Proprietor LLC — If you own investment properties by yourself, it’s likely that you are going to pursue a single member LLC taht is disregarded for tax purposes. What this does is separate your business assets from your personal assets.
Multi Member/Member Managed LLC — If you are part of a group, or want multiple managing members in your LLC, this may be the right delineation.
A few additional LLC types exist that include domestic LLC, foreign LLC, series LLC, L3C company, restricted, LLC, etc.
LLC Tax Structures
When you file your articles of organization and operating agreement (more on that in a minute), you will indicate how you want your LLC to be taxed. These are the core real accounting considerations related to your LLC, and ones that you probably want a real estate accountant to weigh in on.
There are four common choices:
- Single Member LLC Taxed as a Sole Proprietor — In this case, you are the sole owner of the LLC and may either report business income/losses on Schedule C, or report passive profits on Schedule E. For tax purposes, you are in a pass through taxation category and the LLC is considered a disregarded entity.
- Multi Member LLC Taxed as a Partnership — If you are in a multi member LLC and have two members or more, you can be taxed federally as a partnership. Each partner reports business income on a 1065 business partnership tax return, paying self-employment taxes on their share of the profit, if applicable.
- LLC taxed as a C Corporation — If you choose to be taxed as a C corp, LLC profits won’t be subject to self-employment taxes, but the LLC will file a Form 1120 and pay taxes on the profits at the corporate tax rate. In the event that LLC profits are distributed out to LLC owners through dividends, those dividends will be taxed at a qualifying rate (double taxation).
- LLC taxed as an S Corporation — If you choose to be taxed as an S corp, you will pay taxes through an 1120S return. You won’t be subject to corporate taxes like you would as a C corp. LLC owners will be taxed based on their shares in the company’s profits, which aren’t subject to the self-employment tax. You must pay yourself a reasonable wage, then the LLC will pay payroll tax on that wage.
Why Open an LLC?
The primary reason to create an LLC as a real estate investor is for legal protection. By operating as an LLC, you limit liability, safeguarding your personal assets from any claims that could come against your business. Many real estate investors open LLCs to also provide additional tax options, add credibility to their businesses, and streamline operations.
How to Open an LLC
Opening an LLC is not difficult. Regardless of your state, these are the fundamental steps to take to open an LLC:
- Pick a name for your LLC (you will likely cross-check it in a state database to ensure no one else has the name you want).
- Create articles of organization and operating agreement. Some people do this with a lawyer, while others use online options which generate articles of organization and operating agreement and let you pay for a registered agent or other necessary parties/services.
- Register your LLC with your state.
- Apply for an Employer Identification Number (EIN) through the IRS website. You can do this quickly and get an EIN number almost immediately.
- Work with an accountant to ensure you understand your tax requirements as an LLC, and that you are filing what you need to/when.
As you open an LLC for your real estate investing business, you’ll want two professionals on deck: a lawyer and an accountant. Ongoing operations will require some coordination between these two individuals or teams to ensure you remain in compliance.
How to do Accounting for an LLC
LLCs are a useful and important way to add structure to a growing real estate investment business. However, they aren’t as simple as “set it and forget it.” They do add a layer of complexity to your personal finances, and you need to be sure that you are doing things right.
Here are some overarching tips:
- Your LLC finances and your personal finances should never co mingle. From day one, you need to keep all expenditures and books totally separate. LLCs offer the benefit of protecting your personal finances because they aren’t your personal finances: make sure it stays that way and don’t be cavalier about how you spend LLC money.
- Know the tax treatment you’ve chosen and make sure you’re tracking everything the right way. Whether you’re a sole proprietor or an S corp or some other configuration, you may be obligated to quarterly tax payments and various self-employment taxes or payroll taxes. You must stay on top of all of this, or risk fines or a hefty tax bill you didn’t expect or save for.
- *Note rental real estate investors generally are not subject to self-employment taxes on the income or gains from their rental activities.
- Set up an accounting method and stick to it. If you don’t already have Quickbooks or some other accounting software, now is the time. You’ll need to keep track of all of your expenditures, have profit and loss statements, and other key documents to track finances in your LLC.
A bookkeeper is probably an imperative at this point in your business development. If you’re looking for accounting services from a real estate CPA, learn more here.
LLCs for Real Estate Investors
Forming an LLC for real estate investments is a sound approach to protecting your personal finances, and you can scale into more complex methods as your business grows. In some instances, you may wish to acquire properties in multiple states. You can use a sophisticated LLC structure to create a holding company, then have LLCs in individual states. In another scenario, you may wish to have large properties connected to their own LLCs. There are a variety of ways to play this and ensure you’re getting the maximum benefit while reducing your risk.
For guidance through the accounting dynamics of your LLC or real estate business as a whole, you can work with a real estate advisor. These are qualified, highly specialized CPAs that work directly with you, getting the full picture of your current business and future goals, and advising you on the right accounting methods not only to stay in compliance or plan for taxes, but also to save money through strategic deductions and build sound practices that grow with your business.
To learn more about advisory with us, reach out today.