If you’re just getting started as a commercial real estate (CRE) investor, you might be wondering whether you should use an LLC, or “limited liability corporation,” for the purpose of making investments. The answer depends on your long-term CRE investment strategy, how many properties you plan to buy, if you could benefit from investing with others, and if you want the tax structure an LLC offers.
What is an Investment LLC?
Investing in real estate is one of the most common reasons people form an Investment LLC. You can set up an individual LLC or have a partner or a group of people as the LLC’s members. Limited liability corporations have become the preferred choice of business incorporation — there is simplicity in being part of an LLC versus a corporation or general partnership that many find appealing.
There is also security and structure in investing through a limited liability corporation because an LLC generally has an operating agreement that documents how the company will be run, roles and responsibilities, a management structure, how capital will be invested, and other financials. The operating agreement also includes details about how and when members can sell their shares and/or leave the company; often requiring unanimous permission of remaining members. The rules that pertain to your LLC can offer stability, certainty, and peace of mind.
Whether your Investment LLC is a one-person company or a group, the most beneficial reasons to form an LLC are to protect personal assets, realize unique tax benefits, and if in a group, have access to more capital.
Investment LLC: Personal Liability Protection
If you purchase a triple net lease property or any other type of CRE as a private individual, you could be held personally liable if you are unable to make mortgage or contractor payments, or if an accident occurs on the property. That means that any assets you hold individually or jointly will be fair game in the event you are sued or enter a foreclosure.
In the past, there were only two ways to avoid being held personally liable: form a corporation or a non-LLC partnership. However, a general corporation is complex and taxation is heavy, and in a general partnership, each partner is not only responsible for both their debts and obligations, but also for the partners’ debts and obligations.
Under an LLC, you and your partners benefit from personal asset protection. This means if your company is ever sued or pursued by debt collectors, you would only lose what you invested into the LLC. All personal assets are protected.
Investment LLC: Tax Benefits
As an individual investing in real estate, in most cases, you will pay federal and state property taxes, capital gains taxes, and income taxes.
A limited liability company is typically exempt from federal taxes. Any of the LLC’s profits or losses “pass through” the business to its members, which is why an LLC is called a pass-through entity. Yes, the LLC will have gains, losses, and potential dividends, but each member is responsible for reporting their portion of the gains or losses on their individual federal tax returns. This tax rule can be different if your LLC reports as a C-corporation rather than an S-corporation, sole proprietor, or partnership.
Additionally, there is the opportunity to utilize the 20% qualified business income (QBI) deduction, which is available to investors who are part of a pass-through entity. This tax code is not available to individuals who invest without the protection of an LLC, S-Corp, or sole proprietorship.
Investment LLC: Access to More Capital
An Investment LLC allows many people to combine their capital and finances for greater purchasing power. You could buy more commercial real estate and diversify your portfolio, such as with various triple net lease properties around the country, or buy one higher-value property, such as a manufacturing facility or large-scale industrial facility. Whatever your strategy, having access to pooled money offers more options.
With access to more funds also comes the ability to use your Investment LLC for other types of investments in addition to real estate, such as stocks and bonds, cryptocurrency, mutual and index funds, NFTs, and EFTs.
Which Type of LLC Should I Choose?
- Partnership
- Sole proprietorship
- S-corporation
- C-corporation
- Series LLC
The type of Investment LLC, or business entity, you choose will be determined by how many people are in the company and what type of tax structure is most favorable for your goals. Unless you elect differently, an LLC with multiple members will be taxed as a limited liability partnership. A one-person LLC is taxed as a sole proprietorship and both can be taxed as an S-corporation (S-corp) or C-corporation (C-corp). For any type of LLC other than a C-corporation, members claim and pay taxes on their individual tax returns.
In a series LLC, there is a master LLC and individual LLCs under one umbrella. Each individual LLC holds separate properties in what is essentially an entirely different entity, termed a “series” LLC.
Each series LLC is its own business with a separate name, address, bank account, letterhead, and tax account. The first property in the series is the “first series,” the second property is the “second series,” and so on. Each series can have its own members, allowing total flexibility. Some investors use a series LLC in another state because it may be cheaper or their state doesn’t recognize the series LLC.
It is important to keep each series completely separate from the others. If anything is shared between each series, or each series is without its own name, address, bank account, or any of the other specifics, they will be treated as one LLC. This means the members will no longer have protection from each other in terms of liability.
Should you choose to be a C-corporation, you would be double taxed — once at the corporate level and again when shareholders divide the company’s funds. Since a C-corp is subject to double taxation, starting out it usually makes sense to be a partnership or S-corporation.
As with anything in business, there are a few exceptions and different scenarios with each type of LLC, so be sure to speak with your attorney before you make any final decisions.
Foreign Real Estate Investment LLC
Foreign ownership and investment in US real estate can also be run through an LLC. When the property owners are ready to transfer their ownership, they can do so in a way that effectively eliminates the necessity of paying transfer and recording taxes and fees, which are often significant. Passing on the ownership is done by giving a piece of the property yearly to heirs until eventually all the LLC (if so desired) is owned by the family member.
How to Start Real Estate Investing with an LLC
Once you and your attorney have completed the LLC paperwork and it is filed with the government, the next step would be to open and fund a brokerage account through a reputable company, which can be done online, with or without external account management. Once the account is funded, you can start investing. Just be sure to leverage the long-term capital gains tax percentage by holding your investments for more than one year.
To Wrap it Up — Real Estate Investment LLC: What to Know to Get Started
Now that you have a solid idea of the different types of real estate investment LLCs and why it might be a good idea to form one, you can start your investment journey with the protection an LLC offers.
Westwood Net Lease Advisors works with many families, partners, and individuals who set up Investment LLCs to buy net lease properties with great success. If you would like to speak to a net lease advisor with no obligation, feel free to contact us today. Our buyer representation, from before the property search through closing and thereafter, is free. 314-997-5227
