Real estate investors have a choice of legal structures in which to hold their investments, but the limited liability company (LLC) is by far the most popular. There are good financial and legal reasons for this, including many that especially apply to owners of multifamily properties. While an LLC may not be a necessity for every multifamily owner, every investor should be aware of the merits and drawbacks of the real estate investment LLC.
Why Create a Real Estate Investment LLC?
The thumbnail description of the LLC is that it offers the protection from personal liability that a corporation does, but without the double taxation. This means that owners of an LLC cannot be held personally responsible for the legal problems of the organization. If an LLC owns a property and loses a court case involving that property, the LLC’s money and property can be seized, but the owners’ personal assets will not be affected. An LLC is similar to a corporation in this regard, but, unlike a corporation, it is not taxed. The income an LLC generates is taxed as the owners’ personal income only. The LLC is not unique in these features. S corporations and limited liability partnerships also provide those benefits, but the LLC offers a combination of other features that have won investors’ favor.
Flexibility is one of the biggest appeals of the LLC. Unlike a corporation, an LLC is not required to have a board of directors and can be managed by a third party if its owners choose. Profits do not have to be distributed in accordance with ownership shares, making it possible to distribute profits like salaries. Membership interests in an LLC (that is, partial ownership, since an LLC is not divided into shares) are easier to transfer than corporate shares, as well.
Multifamily real estate investors have particular reasons to form LLCs. For example, a major benefit is that LLCs can be parties in 1031 exchanges. If the owners of an LLC agree to an exchange, it can proceed the same as it would with an individual owner. If not all of the owners want to be part of the exchange, the nonparticipating owners can exit it through a maneuver called drop and swap.
Some real estate investors choose not to form an LLC, deciding that liability insurance is sufficient protection against possible legal liability. However, given that multifamily real estate investors regularly deal with a large number of residents, which increases the potential for legal conflict, liability insurance is often not considered sufficient. Additional liability protection is provided when LLCs create subsidiaries. This is a common practice among real estate owners. If a property is owned by a subsidiary LLC, liability is confined to the subsidiary and will not affect properties in other subsidiaries, while all subsidiaries funnel their profits through the main LLC to its owners.
Like owners of other pass-through companies, multifamily real estate investors with membership interest in LLCs are eligible for a 20 percent deduction on income from the LLC under the 2017 Tax Cuts and Jobs Act, since income from real estate investments is qualified business income. That provision of the act is set to expire in 2025.
How to Form a Multifamily Real Estate LLC
Like corporations, LLCs are regulated on the state level, so there can be variations in the details of their formation and operation. In some cases, states require an LLC to pay unemployment, disability, and payroll taxes.
The basic steps to forming an LLC are comparatively simple:
- Choose a name for the LLC and submit articles of incorporation to the appropriate state body.
- Appoint the members and managers of the LLC.
- Apply for a local business license and state taxpayer identity number (if applicable).
- Apply for an IRS Employer Identification Number (EIN).
It is a good idea for an investor to have a lawyer form an LLC, since an inadvertent mix of personal and business income will defeat its entire purpose. While forming and maintaining an LLC means paying fees and taxes other than income tax, its popularity is solid evidence of its utility. A professional financial advisor can help examine the pros and cons of forming an LLC for each individual investment case.
At CWS Capital Partners, we are a fully-integrated multifamily real estate investment management firm that offers everything from due diligence and risk management to transaction support and property management. We specialize in assisting our clients with 1031 exchanges, acquisitions, repositioning, and development. We own and manage luxury multifamily investment communities in major markets around the country, and we employ a team of experts who can help you hone your investment strategy.
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The information provided here is for your general informational purposes only. It should not be considered a recommendation or personalized advisory advice. CWS has made this third party information available from authors it believes are knowledgeable and reliable resources. However, its accuracy or completeness cannot be guaranteed and sentiment may change due to legal or economic conditions.
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