Real estate investment comes with challenges, potential pitfalls, and financial risks. One of the best ways to mitigate those possible risks is to set up a real estate LLC or limited liability company.
When set up correctly, a real estate LLC can safeguard investors from outside interference and protect them from personal liability in less-than-stellar investments.
Those who own LLCs, be they entrepreneurs or small business owners, separate their own property and personal finances from the business entity. LLCs offer security that many property owners find attractive for tax purposes, from personal taxes to property taxes on real estate holdings.
However, setting up a real estate LLC requires more than just signing a few documents. Let’s break down how to set up a real estate limited liability company in six (or seven) straightforward steps.
Why Set Up an LLC for Real Estate?
A real estate LLC is a specific corporate structure that transfers legal liability for your investments into a distinct corporate entity.
In the process, legal liability for your real estate investment properties, such as homes or rental properties, is moved away from you and your fellow investors.
As a result, you and your fellow investors purchase, own, and sell real estate and conduct other business in the name of your LLC rather than in your legal name.
If an outside entity makes a legal claim against you, you avoid personal liability as the claim is made against your LLC instead.
For instance, if someone tries to sue you for a poor investment, any legal fallout or consequences will only affect the LLC and its assets, not your own. This protects your home, property, cash in your bank account, and other personal assets from being taken away.
In addition to limiting personal liability, setting up a real estate LLC could provide you and fellow investors with many vital benefits, such as:
Income tax and other tax benefits depending on your state, which you can claim on your tax return
More financing options. Commercial-use loans, designed for the purchase or refinance of investment properties, are offered by local private lenders and are usually only available to properties owned by a single purpose LLC or Corp.
Because of these benefits in the above-mentioned liability protections, it’s wise to set up a real estate LLC if you plan to derive most or all of your income from your real estate investment activities.
Other business entities, such as sole proprietorships or C corporations, are not as advantageous or don’t have the same asset protections as your real estate business.
Step 1 — Check Your State Regulations for Forming an LLC
First and foremost, research the local state regulations that impact how you can form an LLC. The process for making an LLC varies a little from state to state, particularly in fees, regulations, and required paperwork.
Most investors incorporate within the state where they conduct all or most of their business. But note that you don’t have to do this.
You can technically form your LLC based in a state such as Nevada or Delaware, which both have relatively relaxed business laws, even if you don’t do most of your business in those states.
However, if you have a physical presence or do business across multiple states, you must register your LLC as foreign in each state.
Your state’s LLC formation rules and fees can be found on its Secretary of State website.
Don’t forget to check with your lender: If you are creating a new LLC for an upcoming property purchase that requires financing, ask your lender if they have any requirements related to the structure of the real estate LLC.
For example, some lenders will require that the LLC documentation states that the LLC is a single purpose entity intended for the sole purpose of holding title for the subject property.
Other lenders may require that the LLC is registered to do business in a specific state.
For this reason, it’s best to check with your lender before filing your paperwork to save time and avoid closing delays.
Step 2 — Choose a name for your LLC
Next, you need to choose a business name for your LLC. There are a few limitations to keep in mind.
First, your LLC name must be unique. You can research this by checking LLC name record websites. Many landlords opt to use the property address as the LLC name.
A property address is usually unique enough to allow you to claim it with no issues. Also, when you or your tenants receive correspondence addressed to or from the LLC, it will be easier to identify the property in question.
You can also choose to tie it into the name of your existing rental business or file a DBA (doing business as) so the brand name can be used, even if it is not the legal name of the LLC.
Step 3 — File Your Articles of Organization
The Articles of Organization are the blueprint documents for a business like an LLC. In short, the Articles of Organization should include the business owners, business structure, company name, start date, primary address, and description of activities for a business.
Depending on local regulations, some states might require other information in the Articles of Organization.
Regardless, you must file your Articles of Organization with the Secretary of State’s office and ensure they are filled out adequately. You’ll also have to pay any filing fees associated with starting an LLC.
This step could take a few weeks before you hear back, so plan accordingly.
Step 4 — Draft an Operating Agreement
The next step is to make an Operating Agreement. The Operating Agreement is the legal document that breaks down how the business is divided among its members and how decisions are made among leadership.
For instance, if you and the other partners in the LLC will make decisions equally and share equal voting power, that needs to be spelled out in the Operating Agreement so there aren’t any legal disagreements.
In addition, an LLC Operating Agreement describes what happens if a member leaves the company, especially regarding who gets their ownership share and who gets their voting power.
On top of that, an Operating Agreement protects business members by anticipating scenarios that could harm the business collectively.
Not all states require an Operating Agreement, but you should still draw one up because of the above-mentioned importance.
You can file the Operating Agreement with the Secretary of State’s office, but you’ll also need to keep a copy of the document at your business premises.
Step 4b — Publish an Intent To File (Sometimes Needed)
Depending on your state's rules, you'll need to publish an intent to file in a local newspaper. New York, Nebraska, and Arizona require you to publish an ad in a local newspaper if you plan to form an LLC. You have to print the advertisement over three to six weeks.
After that timeframe, the newspaper will send an Affidavit of Publication. You have to submit this to your Secretary of State's office. You don't have to perform this step if you are not forming an LLC in one of the above three states.
Step 5 — Obtain Licenses and Permits
To form a real estate LLC, you need to obtain specific licenses and permits, which can vary depending on your state of operation. Practically all states have license and permit requirements to meet before you can conduct business as a separate legal entity.
These typically include sales tax permits, professional licenses, and general business licenses.
By checking out the US Small Business Administration website, you can determine the likely licenses and permits you need to acquire and any associated fees you’ll need to pay.
This allows your LLC to be taxed as a corporate entity, which is an integral part of its being recognized as a legal business company that protects you from liability. This will only take a handful of days and won't cost much.
At this point, you formed your real estate LLC and can start conducting business as a company.
Is a Real Estate LLC Better than Liability Insurance?
Many of the protections offered by a real estate LLC are technically covered by liability insurance. Liability insurance protects you and your fellow investors from legal fallout from your real estate investments in exchange for you paying a monthly premium.
In many cases, liability insurance can be more affordable than a real estate LLC and associated fees. That said, most liability insurance policies include limits or exceptions to the types of protections they provide.
Therefore, if you are sued or some other legal action is brought against you outside your insurance policy’s terms, you could still be held personally on the hook for financial issues.
Because of these limitations, a real estate LLC is a more comprehensive option to keep your name and personal assets protected from claims against you.
Additionally, a real estate LLC could be made more affordable if you have enough investors funding the company alongside you. The larger your investment team grows, the more attractive a real estate LLC will likely become.
Real estate investors should consider setting up a real estate LLC if they want to protect themselves from liability and possible lawsuits if things go awry in any way. A real estate LLC keeps personal assets like bank accounts, investments, and homes safe no matter what.
Of course, you could also make wise investments by relying on financial advisors and lending experts like Vaster.
Our knowledgeable loan officers can help you secure the funding you need to make your investment moves while accounting for your timeline and budget constraints. Contact us today to learn more.