Forming an LLC for real estate investment

By: Andrew L. Schwartz

Related Attorney(s): Donald N. SperlingBeth McIntosh IrvingKevin P. Fay

Media Type: Alert

Limited Liability Companies (LLCs) have become one of the most preferred types of business entities to hold title to an investment of real property. The limitation of liability, coupled with potential tax benefits and overall flexibility, make ownership of an investment property through an LLC a desirable option. Some of the benefits are outlined below.

Limitation of Liability
LLCs can protect their owners (called “members”) from several risks associated with property ownership. For example, with proper planning, LLCs can limit personal liability in lawsuits and disputes related to the property as, generally, a member of an LLC is not liable for the debts and obligations of the LLC solely by being a member. In short, if the property is owned by an LLC, the members’ risk exposure is insulated by the protection of the LLC. In most cases, only the assets owned by the LLC, as compared to all the members’ personal assets, are exposed to potential lawsuits. In effect, this limits a member’s exposure to his/her investment in the LLC. In order to maximize liability protection, the separate identity of the LLC needs to be respected. This means, without limitation, that the LLC should hold title to property in its name (and not in the name of any of the members). In addition, the LLC should have a separate bank account that pays only LLC obligations (no personal obligations of the members should be paid out of the LLC account).

When you compare this to the option of obtaining liability insurance for the property, consider that some liability policies typically have limits, exceptions and carve-outs that you won’t find with an LLC.

Another advantage of investing in real estate through an LLC is avoidance of double taxation. In a single-member LLC, absent an election to be taxed as a corporation, the IRS classifies the real estate holding company as a “disregarded entity.” This means that income, gains, losses, deductions and credits from the LLC pass through directly to the member, who pays taxes at individual rates.

Absent an election to be taxed as a corporation, multi-member LLCs are taxed as partnerships, meaning the LLC files an informational tax return but does not actually pay taxes itself. Profits and losses are passed through to its members who report their portion of the LLC’s business income or losses on their personal returns. Thus, as compared to a “C” corporation, where profits are taxed once at the corporate level and again upon distribution to the stockholders, an LLC can offer significant tax savings, both on rental income and on disposition of the property at a gain.

While “S” corporations also offer pass-through taxation, LLCs offer several distinct advantages. For example, nonresident individuals are prohibited from owning shares in an S corporation; this restriction does not apply to LLCs. Further, S corporations are limited by the “single class of stock” requirement which mandates that profits and losses be split pro rata based on ownership. An LLC taxed as a partnership offers significantly more flexibility with respect to allocation of profits and losses among members. Finally, as compared with S corporations, owners who “come on board” after formation of an LLC can receive faster write-offs of their investments.

Management and ownership
As compared with corporations, LLCs offer tremendous flexibility with respect to management and member voting rights. With no requirement to have officers and directors, the LLC can be managed by its members or managers. This avoids the need for formal meetings although the decisions of the members and/or managers should still be documented.

Transfer/Recordation Taxes
In certain instances, Maryland law may allow an individual to transfer existing property to an LLC without having to pay transfer and recordation tax. This exemption alleviates one of the major burdens for re-titling an asset from the name of an individual into the name of the LLC.

As described above, using an LLC to own real estate offers many advantages. Contact a member of our real estate law department at 301-340-2020 to review the best options for your investment strategy.

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