Although there are numerous reasons to pursue one or the other, it occurred to me that many investors lack an entity and asset allocation plan.
The Benefits of Putting Your Property in an LLC
Whether you’re a single investor with a single rental unit or a group of investors with many commercial properties, you’re probably aware of the benefits of moving your property to an LLC (Limited Liability Company).
Some benefits include:
LLCs assist safeguard an owner’s (members’) personal assets, principal house, cash, and equity in real estate and investment accounts from lawsuit or debt collection. LLCs may also apply for and get a Federal Employee Identification Number (EIN). This allows an LLC to create a distinct credit rating from its members while without impacting the individuals’ personal credit status.
Taxes: After an investor creates an LLC, the IRS permits the LLC to pay federal taxes on property earnings at the federal level as a single proprietor, partnership, S-corporation, or C-corporation. This may save the LLC thousands of dollars in federal taxes each year, depending on the size of the assets and the amount of earnings. It should be noted that this is not always the case at the state level (for example, Californian LLC members pay an 8.4 percent or $800 franchise tax each year).
Is it necessary for each property to establish its own LLC?
Although many real estate professionals believe that placing assets in an LLC is a smart practice, it is not clear whether a single LLC should own many properties or if each property should have its own LLC.
I’ve set up several LLCs for real estate investors and have found that many investors create a new LLC whenever they buy a new property. Other investors, on the other hand, simply update their current LLC to include a newly bought property. Although there are numerous reasons to pursue one or the other, it occurred to me that many investors lack an entity and asset allocation plan.
I decided to poll my real estate acquaintances, both individual investors and owners of major commercial real estate management firms. I’ve also drawn from my own real estate investment folly in the past. We spoke about Series LLCs, 1031 exchanges, and associated ‘downleg’ and ‘upleg’ assets (to be addressed in a future blog). While several variables influenced their entity and asset allocation selections, it became clear that three considerations drove their decision on whether to place many assets in a single corporation or each property in a separate LLC:
Lender Driven – If the property has a real estate loan on it, many lending institutions need it to be the only holding in an LLC. Lenders often ask that the LLC be constituted in a specified state (Delaware or Nevada are common). This gives the lending institution certainty and stability. It allows the lender to fully secure its asset and avoid having secondary assets that are unrelated to the main loan complicate litigation or debt collection. This is also favorable to the LLC owner in terms of avoiding mixing properties that are owned outright with those that have a debt.
Schedule Driven – When an investor had no liens on the property and/or intended to acquire and retain the properties for a lengthy period of time, I discovered that it was usual to have as many as 20 or more real estate assets under a single LLC. If an owner decides to acquire and sell properties in this same LLC, he or she is likely to use a 1031 exchange.
Partner/Investor Driven — When a single LLC owns many properties, it is not unusual for the LLC to have multiple members (typically investors) participating. When selling or adding a property, it might become complex if the Operating Agreement of the LLC is not sufficiently precise regarding administration of the LLC. Some investors may have contributed a firm to the LLC, or they may have committed money based on the valuation of a property that has changed in value. When more than one member is engaged in the LLC, many real estate investors find that owning a single property considerably facilitates the selling of that property from an asset allocation aspect.
The above list is far from complete or thorough. But, taking these three variables into account when acquiring your next investment property or forming your next LLC may save you money and worry in the long run.
