Why a Real Estate Investor Should Form a Limited Liability Company

Why a Real Estate Investor Should Form a Limited Liability Company

Jan 18, 2020 | Business Law, Real Estate Law

What is a Limited Liability Company

Whether you’re new to real estate investing or you’ve been flipping or renting homes for a while, the question invariably arises: should you form a limited liability company for your properties? A limited liability company is also known as an LLC. It is a legal corporate entity that provides personal asset protection against personal liability that’s usually afforded to larger corporations, also known as “C corps”. It also provides 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 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.

Insurance Policies Have Exceptions

As a real estate attorney, I provide asset protection to legally shield my clients and their assets with an LLC. 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 in your downtown area, they own the largest buildings, and that’s usually because they love to take premiums, but they hate to pay on claims. Insurance policies 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 really troubling. So if you have a $100,000 policy that protects you, but you’re sued on your property for whatever reason for $1,000,000, guess what? The insurance companies are only protecting you for $100,000. Your exposure is the other $900,000.

I had a client, a landlord who had a tenant. A tenant’s mother came to visit the tenant’s apartment and she slipped on the ice. The insurance on the home was for $150,000. But the person 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 are at risk and he had no coverage. He ended up filing for bankruptcy. Had he formed an LLC, he would have been protected by the LLC.

Only Assets of LLC Are Exposed

Only the assets of the LLC are exposed. So long as you work like a corporation and you’re in regulatory compliance and you’re in good standing with your LLC, your properties basically are protected because you’re acting like a corporation.

Number of Properties in LLC

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, 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.

Create Operating Agreement

If you don’t act like a company and you don’t abide by what we call the operating agreement, then the corporate protection of the LLC can be stripped away or pierced, and your personal assets will again be legally and financially exposed.

 

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DAVID SOBLE

DAVID SOBLE

Real Estate & Finance Attorney

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