Founding a limited liability company (LLC) or a corporation protects real estate assets from liabilities such as lawsuits and credit issues.
LLCs offer various other general benefits that are comparative to other entity forms. Those entities aren’t fundamentally unique but still, apply to LLCs when holding real estate investments. Some of the benefits an LLC can provide are
Managed by owners. When delegating management responsibilities, LLCs enjoy much greater flexibility than either a corporation or partnership. While corporations are statutorily required to have officers and directors, the LLC can be managed by their owners or third-party managers.
Lower State Registration. In the many states that require increased fees based on the authorized number of shares, LLCs may pay lower state registration and maintenance fees than corporations.
Flexibility. Owners of LLCs can take advantage of the considerable flexibility in the allocation of profits, as determined by the LLC’s operating agreement.
Cash flow distributions. These do not have to be pro-rata according to ownership like an S corporation, which gives the owners the ability to financially reward the effort of select members through appropriate distributions of available cash flow.
Foreign ownership. Unlike an S corporation, international property and investment in U.S. real estate are possible through an LLC.
Passing Ownership. LLC owners can also quickly transfer their ownership in real estate holdings by proactively gifting the company’s membership interests to their heirs each year. Over time, it is entirely possible to effectively pass the purchase of real estate owned by an LLC to loved ones without ever having to execute and record a new deed formally. This enables property owners to avoid transfer and recording taxes and fees, which can be substantial in many states.
Although not every company will seek these particular benefits, it worth noting that LLCs can offer steep rewards to companies that choose to take advantage of them.
Two Types of Corporations
There are two types of corporate entities, the S-corporation and C-corporation. Like the LLC, both corporations separate corporate shareholder assets from corporate assets. This protects shareholder’s personal assets from professional liabilities and vice versa.
Corporations do well to protect against liabilities, but real estate that goes into either type of corporation never comes out tax-free. Even subdivided transfers are taxed, based on the appraised transfer of assets. Subdividing isn’t possible in a corporation with the same tax benefits as the LLC. This is a significant disadvantage for real estate investors.
- The S-corporation allows shareholders to pass the income to personal taxes, whereas the C-corporation files business tax returns, further separating personal and business assets.
- The S-corporation helps mitigate some of the self-employment taxes because owners can classify money partly as income and partly as a distribution.
- The income segment is considered for self-employment taxes, whereas the distribution is treated as ordinary income.
- C-corporations provide owners with IRS Form K-1 to record dividend payments from the company; thus, self-employment taxes are entirely avoided.
- ends up double taxing the profits, once at the corporate tax rate, and then as a dividend distributed to the owners.
What options ends up being best for you depends on what your goals are. After reading this article, hopefully, you have a better idea of whether to use LLC or a Corporation when investing in real estate.