This material has been prepared for informational purposes only and is not intended to provide tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.

Tax law has historically been explicitly friendly to real estate investors. However, there are avenues you can take advantage of that were not specifically created for real estate investing, but can be beneficial, nonetheless.

The LLC, since its inception in 1977 in Wyoming and countrywide adoption in the 1990s, has grown in popularity for real estate investors. In fact, according to the Rental Housing Finance Survey from the Census Bureau and Department of Housing and Urban Development, 15% of all rental homes in 2015 were owned by LLCs.

LLC Benefits

The reason LLCs have become popular with real estate investors are the tax, liability, and anonymity benefits on offer. From a high level, an LLC assumes the liability protection of a corporation while retaining the tax characteristics of a sole proprietorship or partnership.

Taxes

An LLC effectively functions as a sole proprietorship or partnership for tax purposes (depending on the number of partners in the LLC). Unlike a corporation, sole proprietorships and partnerships are not separate taxable entities – they are what is called a “flow-through entity.” The income or loss for the partnership is allocated to each partner and taxes are paid separately on each individual’s tax return. This avoids the double taxation that corporations are beholden to (taxes are paid at the corporate level and at the personal level when funds are distributed to owners).

Liability

True to the name, LLCs offer liability protection from creditors because they are recognized as separate legal entities regarding debt and obligations.

If your business is sued or becomes insolvent, only the assets within the LLC will be vulnerable and you will not have to worry about being personally held liable. A secondary benefit to this is that your business and personal finances, two things that do not mix well, stay separate. This separation simplifies things and makes managing your finances easier.

Separate LLCs can also be created for each individual home you own to further limit liability, and an LLC can be created as a holding company to own all the LLCs. This way, only the single home for each LLC will be liable should something happen.

Easier to invest with partners

Traditional partnerships are made up of general partners and limited partners. The general partners can participate in managing the entity, while the limited partners cannot. However, general partners can be legally called for repayment of any recourse debt.

In an LLC, the owners (termed “members”) are a hybrid type partner – benefitting from the corporate limited liability and the traditional partnership “flow-through” taxation. In essence, LLC members are treated as limited partners regarding debt, while retaining full management rights. The “operating agreement,” which is the governing agreement in an LLC, outlines the rights and obligations of each partner including income allocation, cash flows, deductions, and capital contribution requirements. Having all the conditions outlined in a document can increase operational efficiency by removing ambiguity and having all partners up to speed on the goals, processes, and structure.

Privacy

Most states require the identification of a registered agent to receive legal notifications. This can be the only name you have to “put down” when creating an LLC, and it does not necessarily have to be one of the members of the LLC. While this does not prevent lawsuits or avoid taxes, it offers a degree of anonymity not found elsewhere. The operating agreement mentioned earlier is also a private document that is not filed with the state.

Cost

Setting up and maintaining an LLC is not free, however. LLCs are created at the state level and cost will vary as such, but initiation costs can be hundreds of dollars and in most states a franchise tax must be paid every year. This can add up if you own many LLCs, but the liability and tax advantages should outweigh these costs. However, you should always consider all details before making a tax or legal decision.

Financing a home through an LLC

There are some additional processes when trying to get a conventional mortgage through an LLC. Lenders will want to see your LLC’s operating agreement, your employee identification number (showing that your LLC is recognized by the IRS for tax purposes), bank account information for the LLC, and rental home history including profit and loss statements and payment history.

Can I transfer my home to an LLC?

While certainly doable, be careful about any “due on sale” clauses in your mortgage contact. While transferring a home to your LLC is not a traditional sale, it could still trigger the sale clause and make your entire mortgage due. Once your lender has confirmed you can make the transfer, a Quit Claim Deed will allow you to change the owner information on the previously recorded deed, thereby transferring title to your LLC.

How Doorvest helps overcome lending obstacles

Lenders ask for more information and put in additional processes when financing through an LLC. We know how to structure the deal so financing can proceed smoothly and efficiently. We set up the deal, communicate with title and escrow, and can talk with the lender to find out what information they will need at closing.

The Federal Housing Administration requires an appraisal, and strongly recommends a home inspection be done to ensure there is not any deferred maintenance that will reduce projected cash flow. Our aligned incentives, extensive renovations, and 150-point third-party inspections make sure there are no unexpected maintenance issues to delay or stop the financing process.

If you are transferring your home to an LLC after the fact, our platform will provide lenders with profit and loss statements and tenant lease and payment history.

Doorvest ensures the deal is set up correctly from the onset so you can close on time and have peace of mind that nothing will fall through at the last minute.