Picture the scenario: you’ve found your dream real estate investment property, contacted an experienced private money lender about securing funding, and have decided you’re going to pivot towards the BRRRR method after renovations.
There’s only one problem. You aren’t legally protected against liabilities that come with renting your investment property out. Fear not, you can protect yourself by setting up either an LLC (limited liability company) or a real estate trust (also known as a “realty trust”).
But, which structure is better? To help identify the pros and cons of each ownership structure, we are putting this guide together. Let’s get started!
What is an LLC in Real Estate?
An LLC (limited liability company) is an increasingly popular business structure for property investors.
An LLC is an entity that you can own solely or partially. An LLC separates your personal assets from your business assets. Therefore, if you run into financial or legal trouble, your assets can’t be seized to pay off debts.
Without setting up an LLC – or a real estate trust – you are personally liable for anything that goes wrong with your property.
PRO TIP: If you want to fund your investment project through private money, you need to do so via an LLC, real estate trust, S corp, or C corp. Private money lenders will rarely release funds to someone using their own name.
For further protection, you need to get insured. Check out our blog on insurance for house flippers for more information.
How to Set Up a Real Estate LLC?
Besides expunging members from personal liability, there are a couple of other reasons for LLCs’ growing popularity in the world of real estate: cost and easy setup.
How much does an LLC cost? The average fee is about $132.
As for setting up a real estate LLC, you just need to follow these 6 simple steps:
- Look up your state’s local regulations on forming an LLC
- Pick out a business name (but check it doesn’t already exist)
- File an “Articles of Organization” document
- Create an Operating Agreement for your LLC
- Obtain any necessary business licenses and permits
- Apply for a Tax Identification with the IRS
If you decide to set up an LLC, start this process as soon as you find the property you want. This is because you become personally liable the moment you make the purchase. So don’t delay!
Why Use An LLC For Real Estate Investing?
Now you know the process, let’s look at why you might want to use an LLC for real estate investing.
We’ve touched on this already. However, we can’t stress its importance enough. So, for those at the back, we’ll include one more example.
Say you’re investing in a commercial or multifamily property, with many rooms and possibly tenants, you don’t want to be held personally liable for anything that happens to those properties or tenants. The limited liability you get from an LLC shields you from that.
Who doesn’t like saving money? A real estate LLC only files an informational tax return. This is because it’s eligible for a pass-through income taxation rate.
That means you can tax any business income through your own personal tax rate, rather than a corporation rate. A lot of the time this is more favorable and can save you a tidy sum during tax season.
Looking for other ways to save on taxes on your next fix and flip? Check out our Expert Tax Strategies for Flipping Houses.
LLCs offer more anonymity than realty trusts or sole ownership does. This is beneficial if you want to keep your real estate investments on the down-low.
LLC Owners are able to completely shield their identity by designating a third-party registered agent on behalf of the LLC. This registered agent will appear as the property owner’s representative and the identity of the owner will be shielded.
What is a Real Estate Trust?
A real estate investment trust is a legal vehicle set up to own and, most of the time, operate income-producing real estate. Therefore, real estate trusts are more commonly used for commercial or multifamily properties, not one-off fix and flips.
There are two types of trusts: irrevocable and revocable trusts. What’s the difference between the two? Allow us to explain:
- Irrevocable trusts – The creator has no control over the trust’s assets. The trust’s beneficiary is the only person who can make changes or dissolve the trust.
- Revocable trusts – Both the creator and the beneficiary can make changes.
Similar to LLCs, real estate investment trusts allow individuals to pay less in taxes.
Why Use a Real Estate Trust?
So, why might you set up a real estate trust rather than an LLC? Let’s take a look:
Defining the Relationships of Multiple Property Owners
As trusts are usually used for larger real estate investment, it’s more likely that they’ll be several owners for one property.
A trust provides a form of legal documentation and protection that is useful for defining the relationship and interests of those involved.
If you’re looking to ensure your investment property avoids Estate Taxes, you can do so by transferring it over to an heir.
Putting money in a trust decreases the value of your personal assets and is, therefore, a sure-fire way to begin estate planning.
The Downside of a Real Estate Trust
The major downside to real estate trusts is the frequent changes in rules and regulations.
The rules around how much can be put into a realty trust for estate planning purposes change frequently. Therefore, partners of realty trusts can never be sure of the modifications just round the corner. Moreover, there are frequently additional legal fees to manage on top of the original fees.
So, LLC or Trust For Real Estate Investment?
A real estate trust is only a good option if you’re a big-time property investor who has a portfolio with a number of large commercial or multifamily properties. However, in other aspects of real estate investment, we consider an LLC a more suitable entity.
An LLC gives you the flexibility and freedom to set your own terms and conditions, gives you limited liability, and various tax benefits. Moreover, it is inexpensive to set up and well suited to all types of real estate investments.
Either way, we urge you to ensure that you are protected from liability by holding your property in an LLC, Trust, or any other investment vehicle!
Contact us when you are ready to secure funding for your next real estate investment!