1. Protection from liabilities.
LLCs protect you from liability claims. Anything that’s a claim against a property—like, “Hey, I slipped and fell”—an LLC is an entity that can stand between you and that. The party will come after the LLC, not you personally.
Full transparency: there are ways around this. The most important one to mention is liability insurance. Now, I’m not saying insurance takes the place of an LLC—but you are not fully exposed if you don’t have an LLC but you do have insurance.
2. Provides tax write-offs.
Because it’s an entity with its own tax return, LLCs allow you to write things off (i.e., business-related expenses like your cell phone bill). You can try to write them off on your personal tax return, but it looks a little squirrelly to the IRS that it’s not a company claiming those business expenses. It makes things cleaner from a financing and tax perspective to write them off under an LLC.
3. Allows you to sell shares of the company.
An LLC operates as a business entity. As long as it’s registered properly with the SEC, you can sell shares—or in the instance of LLCs, what’s called “interests”—of the company to other investors who want to invest with you. Or you can sell the LLC altogether as a business that owns things.
There are times when an LLC is not appropriate though. So, when exactly shouldn’t you form one?
When NOT to Use an LLC
1. Don’t use an LLC if you’re house hacking.
Don’t use an LLC when house hacking, because it may prevent you from getting the financing you want. If you’re looking for low money down, Fannie Mae- or FHA-backed mortgages, this property can’t be in an LLC.
For these purposes, banks can only lend you that money under your personal name. Just get a really good insurance policy.
2. Don’t use an LLC if you don’t have 20 to 25% for a down payment.
If you’re buying a property for $100K, if you’ve got $20 to $25K to lay down plus some for closing costs, there’s no reason why you would not go out and start up an LLC. You can get commercial financing on these properties or financing from some other lender. If you encounter lenders who won’t do it, find another one, look on BiggerPockets, or walk into a small community bank.
More LLC Pro Tips
Here are a few final thoughts on the topic.
Avoid setting up your LLC online (unless you’ve been doing it for a while). Instead have a lawyer help you.
And absolutely have a lawyer help you create an operating agreement with the LLC. You can do this online, too, but I highly recommend NOT going that route—especially if you have partners.
A good lawyer can set up an operating agreement for you for less than $1,000. It’s worth it.
Bottom line, if you’re going to build a business around real estate investing, run it as a business. An LLC is a company.
If you’re looking to make this a side hustle or just something you do a little bit, then do it in your personal name and own one or two properties. That’s OK.
But, if in the future, you intend to build a big portfolio, set up an LLC. Operate as a business. Do it now—five years before you get to that point. I promise you, moving properties out of your personal name and into an LLC is not easy—it’s doable but difficult.
One last thing, set up the LLC where the property is. Don’t favor Nevada or some other state over others. The LLCs that own certain properties should be set up in the state the property physically exists in.
You’re going to have to pay a tax return in that state. So just set it up there.
The reason people talk about state-based LLCs is because they believe specific types of LLCs will prevent certain claims from jumping over the LLC and getting to you personally.
However, I’ve never seen any state-based LLC prevent anyone from getting ahold of a person specifically if that’s what they’re trying to do. Plus, that’s what insurance is for. Avoid the tax headache of setting up an LLC outside of the state the property is actually in.
I’m not a lawyer or CPA—neither is BiggerPockets. You should absolutely consult a lawyer or CPA about this subject. A lot of the information that I’ve gone through here today is my opinion, so it’s important to consult a professional.