In the past, real estate investment vehicles were structured as limited partnerships or general partnerships. However, limited liability companies (LLCs) have now taken over. Since 1977, LLCs have become established and accepted vehicles for real estate investing.
That doesn’t make them the ideal solution for all investors. It is important for investors to understand the characteristics of an LLC to determine the best practice in structuring each investment.
Nature of LLCs
LLCs are a lot like traditional corporations, in the level of protection they afford to equity holders. They are not subjected to the same tax liabilities, though. LLCs aren’t required to pay entity-level taxes. Therefore, using an LLC allows you to utilize debt-financed depreciation deductions as tax benefits to yourself (flow-through tax treatment).
LLC offers flexibility. The management and equity holder financial relationships are determined by involved parties in most cases. Where corporations must adhere to a very strict relationship format, LLCs do not. Furthermore, LLC membership is much more flexible. Unlike corporations, LLCs offer membership to trusts, partnerships, corporations, individuals and others. There are no statutory restrictions on membership.
Anyone holding equity in an LLC is deemed to have membership interest. This includes the rights to participate in entity management as well as information rights.
Non-economic rights cannot be transferred to anyone that is not a member of the LLC, but economic interests sometimes can be transferred (such as sharing in distributions and participating in profits and losses).
LLC allows some protection against taxes. Under federal income tax rules, most LLCs are classified as partnerships, which makes LLC not liable for either federal or state income taxes. Cash and property distributions will not create tax implications for the business itself. They are passed on to the owners, who report their allocated share of the company’s taxable income or income loss on their personal taxes.
An LLC can either be managed by all members together or a designated individual or a small group of individuals termed the “manager”.
Any rights or duties can be doled out as members see fit, but only the manager is can create legally binding agreements for the LLC as a whole. The ability to distribute rights and responsibilities as necessary provides considerable flexibility.
Third Party Liability
Members of an LLC are considered equity holders or managers and cannot be held personally liable for obligations or debts to third parties. Even active participants in management of the LLC cannot be held personally liable. Any personal misconduct by a member or manager however, carries repercussions.
Is an LLC Right for You?
LLCs make excellent real estate investment vehicles with their pass-through tax liability nature and no personal liability on part of the members.
However, that doesn’t make it the right choice for your specific needs. An LLC is a good option, but you’ll need to carefully consider your investing needs and goals and any potential partners that would form the LLC with you.
This article has been edited and condensed.
Sohin Shah is an entrepreneur and one of the early adopters of crowdfunding. He successfully crowdfunded Valuation App from 57 backers in 2012 and went on to start iFunding which is now one of the leading real estate crowdfunding platforms in the world. He is extremely passionate about entrepreneurship and loves discussing new ideas. Connect with @SohinShah1 on Twitter.