LLCs: Should you, shouldn’t you, when is best, what will its formation do for you—these are just a few of the questions real estate investors have when I broach the subject of forming a limited liability company, or LLC. To make things a bit easier, I’ve decided to compile all the important information you need to know about LLCs for real estate investing, and answer everyone’s burning questions.
First, let’s break down just what an LLC is: a limited liability company is a business structure that combines the pass-through taxation of a partnership or sole proprietorship with the limited liability of a company. Tax benefits and limited liability—sign me up!
Now, there are two trains of thought regarding forming a limited liability company. On the one hand, beginning your real estate venture by structuring your real estate business under an LLC mitigates your risk, and protects you and your personal assets from debt collectors should your investment business go up in smoke. By forming a limited liability company beforehand, you can increase your liability coverage amount, should accidents or injuries occur in your properties, and it also sets the ceiling of your out-of-pocket loss, after exhausting your insurance, for liability cases at the amount of equity you have in your LLC. Being cautious and making smart choices are certainly great ways to keep your business rolling down the path of success.
But, on the other hand, there may be some real estate investing folks out there who are looking for a great deal on financing terms. Personal borrowers can often negotiate better financing terms than an LLC can. But, this is because a lending institution knows that you will be personally liable for that debt—meaning that, should you be unable to pay the loan back, they can go after you and much of what you own to collect what they are due. That’s an unsettling prospect for most people. If you choose not to take advantage of the better financing terms you may receive as a personal borrower by forming a limited liability company first, you protect yourself from being personally liable to repay the debt in event of foreclosure—and, knowing that 7% of loans foreclosed between 2004 and 2014, it is a real concern. Of course, whether you choose to form an LLC first or after you acquire property is up to you, and dependent on your unique situation—but personally, I believe forming a limited liability company first is more advantageous.
If you didn’t see this article before purchasing property, and would now like to transfer that property to your newly formed LLC, limiting your personal liability, you can do so through a quitclaim deed. If you’re going to do this, be sure to review your mortgage documents with the help of your attorney to ensure that you are not in violation of a Due on Sale Clause—cross all your T’s and dot all your I’s, as they say.
So, we’ve already touched on why an LLC for real estate investing is advantageous, but in case you don’t believe me, or still don’t quite see the value, let me throw a few statistics at you that highlight the benefits. For starters, anywhere from 36-53% of small businesses—including real estate investors—find themselves involved in litigation in any given year. If you become a figure in this unfortunate statistic, but have formed an LLC, you and any other owners can only be sued within the constraints of what the LLC owns. Also know that the median and average premises liability verdict is approximately $98,160 and $643,099, respectively—those are some hefty figures! You don’t want to be personally on the hook for that amount, and with the forming of a limited liability company, you won’t be.
To make matters worse, 6% of premises liability cases involve punitive and actual damages—so, you might be paying out for real damages and money to punish you for any egregious wrongdoing—ouch. If the liability case happens to be one of the 5% that involve a wrongful death, those punitive and actual damages can be quite expensive.
Real estate investment is often about making big and bold moves, but that doesn’t mean you need to act recklessly—protect yourself and form an LLC for real estate investing. Need assistance and guidance in forming an LLC? No problem! I have the experience and real estate-savvy you need to make the right choices—contact us today to discuss how we can help you.