This is a guest post is brought to you by: Scott Smith, Esq., lead attorney and founder of Royal Legal Solutions.
I'll admit upfront that as an asset protection attorney, I'm a big fan of the LLC structure. That said, if you're thinking about forming an LLC, it's important to be well informed on both the advantages and drawbacks of the entity. I ultimately recommend that most of my investor clients form an LLC as a form of asset protection, in no small part because of the benefits pointed out in this excellent Real Estate CPA infographic. I also believe investors should do their homework on pretty much everything. So in the interest of having a full perspective of the LLC entity, I'll play devil's advocate. Here are some of the cons of moving investment properties into an LLC.
LLC Cons to Consider
Your unique situation will influence which asset protection tools are best for you. Here are the most important factors you should consider.
Taxes and Fees
While on balance, LLCs save investors money far more than they cost, their financial burdens are something to be aware of. Depending on where you form your LLC, you may have to pay annual fees on top of filing fees.
California residents have even more financial matters to worry about, as they must pay an annual $800 Franchise Tax.
Fortunately, there are ways around these fees. Did you know that you can form an LLC in any state? You're not required to own your company where you live. Check out my video and article on the best States to form LLCs in for a detailed explanation of how any investor can avoid these fees.
More Appropriate Company Options for Some Investors
There is no one-size-fits-all strategy for managing real estate. Naturally, some investors will find other types of entities more appropriate to their needs than LLCs. For instance, S-Corporations and C-Corporations offer certain features that the LLC structure does not. Those who are using peer loans or crowdfunded means of funding their investments may find that more "old school" potential sponsors of real estate ventures (and some shareholders) have more confidence in these types of corporations. That said, they are heavily regulated and may require you to hold meetings, take minutes, structure payroll certain ways, and conform to a variety of complex tax requirements. Corporation structures in general are most appropriate for larger companies with the ability to meet their many legal and operational compliance requirements.
On the other side of the spectrum, some investors feel their liability risk is so low that they can own property in their own name with adequate insurance. Generally, they are mistaken. 90% of real estate investors will be sued within 20 years of investing. There are unique situations where owning an LLC is a disadvantage, such as when one is living in their only rental property and thus qualify for Homestead Exemptions that an LLC would give up. But these are by far the exception to the rule. Insurance is absolutely essential, but is not the same as asset protection.
The Series LLC both solves the issue of recurring fees, as it only has a one-time filing fee but can be scaled up indefinitely without additional costs, and offers a straightforward, streamlined way to run your business. It also happens to form the foundation of an excellent asset protection plan that is appropriate for a wide range of investors. This structure can be effective whether you own one single-family home or are growing an empire of multi-unit complexes.
Bottom Line: Is it Worth it To Move Your Property Into an LLC?
Despite the drawbacks mentioned above, moving investment properties into an LLC is absolutely worth it. If you're holding property in your own name as a Sole Proprietor, you're risking everything you own if a lawsuit strikes. The asset protection benefits of an LLC alone make it worth its few downsides. But of course, your situation may be unique, which is why it is always best to consult with appropriate professionals before establishing any business entity.
Scott Smith, Esq. is the lead attorney and founder of Royal Legal Solutions, one of the country's only asset protection firms that exclusively serves real estate investors. If you have questions about defending your real estate investments, schedule your personal asset protection consultation now.