Whether you’re new to real estate investing or you’ve been flipping or renting homes for awhile, the question invariably arises, should you form a limited liability company for your properties? A limited liability company is also known as an LLC and it is a legal corporate entity that provides both personal asset protection against personal liability that’s usually afforded to larger corporations, also known as “C corps.” It also provides the tax benefits at a partnership or individual tax rate for capital gains and for income. So corporate income will pass through to an owner’s individual tax return. The owner of an LLC gets the benefit of the protection of a company, but it’s taxed then without the double taxation of a C corporation. Both the asset protection and the tax benefits make the LLC very attractive to real estate investors.
As an attorney, I’m providing asset protection to legally shield my clients and their assets with an LLC. So some real estate investors will rely solely on a homeowner’s insurance policy to protect their assets in the event they’re sued on one of their properties or related to an issue concerning the property. That’s not the best way to go. Having a liability policy or a hazard policy is really only one form of protection. If you look at the insurance companies downtown, they own the largest buildings in any city, and that’s usually because they love to take premium, but they hate to pay on claims. Insurance policies they have their limits. When they’re written by insurance companies, they’re really just contracts. They have exceptions and certain nuances, and it may be difficult to have the insurance company protect you on a claim, and the chance of loss that exceeds a policy limit is actually really troubling. So if you have a hundred thousand dollar policy, that protects you, but you’re sued on your property for whatever reason, for 1 million bucks, well, guess what? The insurance companies only protecting you for $100,000. Your exposure is the other $900,000.
I had a client landlord who had a tenant. One of their tenants mothers came to visit the tenant’s apartment and the mother slipped on the ice and the insurance on the home was for $150,000. But the lady hit her head on the concrete part of a step and ultimately had a closed- head injury. She sued the landlord for $2 million. The landlord’s assets then we’re completely at risk. So he had no coverage. He ended up filing bankruptcy. Had he formed an LLC, he would have been protected by the LLC.
Only the assets of the LLC are really exposed. So long as you work like a corporation and you’re in regulatory compliance and you’re in good standing with your LLC, then your properties basically are protected because you’re acting like a corporation.
The next common question is how many homes or properties should be given to the LLC or placed under an LLC? I suggest three to five properties per LLC, and you can categorize them or divide them up by geographic region or by date or by different co-owners. But whatever you do, you still have to treat your LLC seriously and follow the corporate formalities and rules and regulations of your state. So, if you don’t act like a company again and you don’t abide by what we call the operating agreement. If you don’t do these things, then the corporate protection of the LLC can be stripped away or pierced, and your personal assets will again be legally and financially exposed.