As a real estate investor, you are potentially open to legal action in the event of an injury accident on one of your properties. Let’s say one of your tenants throws a party and a guest takes a spill over a balcony. As the owner of the property, you could be named as a defendant in any resulting legal proceedings.
If your real estate property assets are held through a Limited Liability Company (LLC), the amount of any potential judgment against you will be limited to the assets of the LLC. In other words, your home and other personal property are insulated. Plaintiffs can only come after the assets of the business. While liability insurance also provides protection, it usually comes with limits and exceptions. If those limits are exceeded, or the exceptions apply, you’ll be stuck with the balance of the liability—unless you’re also incorporated as an LLC.
Forming an LLC for your real estate investment activities also carries tax advantages. Even though LLC status offers corporate-like insulation from liability, the LLC is taxed like a partnership. Income and capital gains are only taxed as they accrue to the owner, rather than both the company and the owner, as is the case with a corporation. The owner then pays taxes as an individual. This is referred to as “Pass-through Taxation”. Tax liability passes through the LLC directly to the owner(s), as it would in a sole proprietorship or a partnership. This tax structure also offers the advantage of mortgage interest deductions, which is a true boon for real estate investors.
Anyone who has had a casual conversation about incorporating a business has likely been regaled with tales of the joys of incorporating in Delaware. However, for real estate investors, Wyoming or Nevada offer more significant advantages. Chief among them is anonymity. If people don’t know who you are it’s a lot more difficult for them to come after your assets. Even better, neither Nevada nor Wyoming imposes taxes and both permit one person to hold all offices in a company.
Now that you’ve seen the benefits, let’s look at how to form an LLC.
Components of an Articles of Organization
LLC Name - When all is said and done, the name doesn’t really matter, as long as it complies with the rules of the state in which the company is formed. Naturally, if anonymity is your goal, you’ll want to avoid using your name or your family members’. You do have to make sure the name is unique to your organization in your state, as it can’t be the same as any previously registered company there. You also have to be careful to avoid using words like “Bank,” “Insurance,” “Corporation,” or “City.” Different states have different rules in this regard so it’s best to see what applies in your particular circumstance.
Purposes and Powers – You’ll be required to make a statement about what the company does, as well as the nature of the activities in which it will be involved. Most states offer a form of unlimited purposes and powers, meaning your organization is free to engage in any legal business activity.
Resident Agent Address – This establishes a physical location for the business within the state. It should also be the address at which the “Registered Agent,” the individual upon which papers will be served in potential lawsuits involving the LLC, is located. You’ll also be required to provide the name(s) of the owner(s).
Operating Agreement – While not a legal requirement, if you’re in a partnership, an operating agreement is a good thing to have. It outlines how much of the business each partner owns, the rights and responsibilities of each party, voting power, allocation of profit and losses, management of the LLC and rules for meetings and votes. It also establishes rights of survivorship.
Public Notice – Depending upon the state in which you establish, you may be required to publish a notice in a local newspaper stating your intention to form the LLC. There are also requirements governing the frequency of this publishing.
Licenses & Permits – Depending upon the nature of the laws in the city and state within which you establish your enterprise, you may be required to get a business license or tax registration certificate, a federal employer ID number, and other relevant permits.
Given the liability protections and tax advantages, forming an LLC to cover your real estate investing activities makes good sense. Depending upon the state in which you choose to establish your company, the fees can be quite affordable, particularly when measured against the potential liability should your company experience a misfortune resulting in legal action.
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