The short answer to the question is yes, real estate investors can certainly buy an investment property through an LLC they create. However, that doesn't mean that it's the right move for everyone, and it isn't practical to do in all cases. Here's an overview of why buying a rental property through a limited liability company, or LLC, could be a smart move for you, the downsides you need to consider, and what you need to know before deciding to pursue an LLC-owned rental property of your own.
What is an LLC?
LLC is short for limited liability company. It's a business structure that is a type of pass-through entity. This means that any profit or loss generated by the LLC flows through to its members and is taxed on the individual level.
An LLC can be created with one person (a single-member LLC) or in partnership with other individuals. The exact process of forming an LLC for your real estate investments and the ongoing reporting obligations vary considerably by state, so check with your state government for the specific procedures you'll need to follow.
Advantages to buying real estate through an LLC
Your liability is limited
As the name limited liability company implies, using an LLC, rather than operating your real estate business as a sole proprietorship, can limit your legal liability by protecting your personal assets. While there are some exceptions, such as in cases of extreme negligence, the only assets at stake in legal actions against an LLC are those that the LLC owns. For example, if your LLC owns two rental properties, those are the only assets that would typically be at stake if a tenant were to sue you. You can also create a separate LLC for each property you own, further enhancing your asset protection if someone files a lawsuit.
Investing with partners is easier
You don't have to have an LLC to buy an investment property with someone else, but it can be more convenient to do so through one, especially if each owner has a different percentage ownership, as this will be stated in the LLC operating agreement.
It allows for pass-through income
There are tax advantages through LLCs. Unlike corporations, LLCs pass their income through to the owners. Pass-through taxation avoids the potential of being taxed at the corporate level in addition to paying individual income tax on your rental profits.
It keeps your business separate
Using an LLC to buy an investment property can be a great way to keep your business finances separate from your personal income. If all income is paid to the LLC and all property expenses are paid from the LLC using a separate bank account in the LLC's name, that can make it much easier to keep track of your rental income and expenses.
You'll be anonymous
In most states, it isn't impossible for people to figure out who an LLC's owners are, but it does keep you mostly anonymous. In other words, if you own an investment property yourself, your name is on the deed as the owner of record. If an LLC owns real estate under its business name, that's the name that's listed on the deed, and LLC members are not disclosed. If you own a property through an LLC and hire a property manager to deal with the day-to-day operations, the tenants typically never know the names of the individuals who own the property.
Drawbacks to using an LLC to buy real estate
Despite the benefits, using an LLC to buy rental properties isn't the right move for everyone. Here are a few things to consider before deciding to create an LLC to buy your next investment property.
Personal liability isn't always nonexistent
To be perfectly clear, an LLC doesn't imply that you'll have no legal liability whatsoever in any case. In some cases, you could still be held personally liable even though assets are owned by a business. Talk to an attorney if you're concerned about how much legal insulation an LLC provides you.
Setup costs can be high
Depending on where you live and how comfortable you are with doing legal paperwork, it can cost quite a bit of money to set up an LLC. And most states have annual fees associated with keeping an LLC operational. While it's cheap to set up an LLC in certain places, it's important to do your homework when it comes to cost versus benefits in your state.
Financing can be difficult
We'll discuss this in the next section, but it can be difficult and/or costly to obtain financing for investment properties through an LLC. Obviously, this isn't an issue if you plan to pay cash, but it's still important to know for future investment properties.
The pros and cons of buying real estate through an LLC