A limited liability company (LLC) is a popular business structure, particularly for real estate investors. Starting with the basics, an LLC offers you the best of both worlds. It gives you the limited liability of a corporation without the double taxation. So, you do not file a corporate tax return. Your share of the profits is merely reported on your individual tax return.
The LLC has become a more favorable option than an S corporation (a corporation with less than 100 shareholders) particularly for smaller and less complex businesses, such as where the owner is personally involved in the management. This could very well be the right structure for you to consider when making real estate investments
Limited liability + tax benefits
Instead of forming an LLC, you could purchase liability insurance. This may not protect you as fully as you think, though. Insurance companies put in exceptions that you may not be comfortable with, or your policy limit may still leave you on the hook for a large amount of money. You may still choose insurance since it provides you a degree of protection, but an LLC also shields your personal assets.
In these times, there are a lot of lawsuits, even though some may be bogus. For instance, you may not be there when your renter throws a big bash, and someone gets hurt. But, the injured party may still sue you, the owner. Under an LLC, your assets outside of the business are protected.
Keep in mind; this protection is not so clear if you have to file for bankruptcy. There is a concept called “piercing the corporate veil” that allows a creditor to disregard the limited liability and hold the owners personally responsible for the debts. This applies to corporations and LLCs. The bankruptcy judge has to determine that the company and owners are not separate.
We have already mentioned that income from an LLC is only taxed once. A corporation pays its own income taxes, and any dividends passed on to you are also taxed to you as an individual. An LLC does not pay its own taxes. It passes through the income to you, and you only pay individual taxes.
Many foreigners have chosen New York City real estate as an investment. It is seen as a safe haven, and an appreciating dollar means there is the potential for capital gains. These investors face the same choices, such as whether to hold the property in their own name, a corporation, or an LLC. An S Corporation is off the table for foreigners. Also, an LLC has been used as a way to hide your identity. But, last year, the U.S. government required title companies to hand over the buyer’s identity for purchases of $3 million and up.
While an LLC provides liability protection, there is an added level of complexity when it comes to taxes. You need to check your home country’s tax laws to see if it makes sense to form an LLC. The IRS typically requires you to withhold taxes on income from your real estate business under the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA). This includes rents, and ultimately the proceeds from the sale of the property. This seems complicated, but your buyer’s agent can assist you in this matter.
There are also estate tax reasons for a foreign investor to form an LLC. For a non-resident alien, you usually want to avoid direct ownership. One way to do this is have a foreign irrevocable trust own a U.S. LLC.
An LLC is fairly easy to form, and you do not need a Board of Directors. If you are the only owner, the IRS classifies your real estate company as a sole proprietorship or a disregarded entity. Income and capital gains flow directly to you, and you pay the taxes once while getting liability protection. If you have more than one member, you are a multimember LLC and are taxed as a partnership. This only means you file an informational return, but the LLC does not pay a separate income tax.