Do You Need To Start an LLC for Real Estate Investing?

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Do You Need To Start an LLC for Real Estate Investing? Do you need to start an llc

One of the questions I get asked all the time is whether or not you need an LLC to start real estate investing. As with most things worth pondering, the answer is “it depends.” Limited Liability Companies definitely have a place in your asset protection strategy for investments. At the time of this writing I am a member of four different LLCs:

  1. For my wife and I’s rental portfolio.
  2. For a large partnership deal.
  3. One for the Military Millionaire community and online dealings (although this one may be converted to an S-Corp soon – but that is a topic for a later date)
  4. The most recent one to take down a deal with a member of The War Room Real Estate Mastermind group!

As my portfolio continues to grow and evolve, I am certain that I will add more LLCs and eventually even more complicated asset protection strategies. 

*Disclaimer* I am not an attorney or a tax professional. I am your average guy who has done some research, so I definitely recommend that you consult a professional before making a final decision. 

What is an LLC?

So, what is this LLC thing people keep talking about? I’ll break this down Barney style in a moment, but here are some technical definitions first. 

As defined by Investopedia: “A limited liability company (LLC) is a business structure in the United States whereby the owners are not personally liable for the company’s debts or liabilities. Limited liability companies are hybrid entities that combine the characteristics of a corporation with those of a partnership or sole proprietorship.”

As defined by the Internal Revenue Service: “Depending on elections made by the LLC and the number of members, the IRS will treat an LLC as either a corporation, partnership, or as part of the LLC’s owner’s tax return (a “disregarded entity”). Specifically, a domestic LLC with at least two members is classified as a partnership for federal income tax purposes unless it files Form 8832 and affirmatively elects to be treated as a corporation.

For income tax purposes, an LLC with only one member is treated as an entity disregarded as separate from its owner, unless it files Form 8832 and elects to be treated as a corporation. However, for purposes of employment tax and certain excise taxes, an LLC with only one member is still considered a separate entity.

In layman’s terms, a limited liability company is an entity that allows you to own assets, or businesses, without them being tied to your personal name and/or assets. This makes it easier to reap the benefits of tax deductions, and minimize your personal exposure to liabilities if something goes wrong in the LLC. 

When You Might Need an LLC

You may want to create an LLC when you do not want to accept the amount of risk associated with your asset(s). For example, suppose you had a tenant slip on your stairs and break his back. Then he decides to file a lawsuit claiming that the guardrail at your apartment was unstable and that you knew about it. If the court were to rule in his favor and say that you owed significant damages to the tenant but you don’t have the money to pay them, you could be exposed to significant risk.

Theoretically, a court can force the sale of your property in order for you to use the profit to pay your tenant’s damages. However, when you have a large mortgage on a property and only a little equity, that is less likely to occur because forcing the sale of your property still wouldn’t result in you being able to pay the damages. 

If you own this rental property in your own name, a court could force you to sell personal assets like your primary residence, cars, etc., in order to pay the damages. On the other hand, if you own this property inside of an LLC and there are no other properties in that LLC, your liability would be minimal because you have no assets worth selling, and they can’t come after you personally…because the home is owned by an LLC, not you.

How much risk? 

You need to determine what amount of risk you are willing to take and then separate your property acquisitions accordingly. Personally, in Missouri, I assume that somewhere between $500,000 and $1,000,000 is the maximum amount of property that I would want in a single LLC. After I own $1,000,000 in a single LLC (probably around 8-10 single-family homes), I start a new LLC to purchase more real estate. As my portfolio grows, I will probably assume more risk in each LLC, but time will tell. 

This will be different for everyone, but I just wanted to give an example of how to think of this.

Tax Advantages

Having an LLC also makes it easier to document your income and expenses for the business. If you own assets personally and run all of the income and expenses through your personal bank account(s), it can get tricky to handle your taxes. 

On the other hand, if you own your assets in an LLC and have a separate bank account set up for your LLC to handle all of the income and expenses for your portfolio, taxes become quite simple.

You will file an annual tax return for your limited liability company using all of the income and expenses from that entity, and then the bottom line from that return will be transcribed onto your personal tax return as an income or expense from a business entity. 

On the backend, your personal tax return will be filed, and you will pay or receive a return, based on your total tax flow from LLC through the personal tax return. 

When You Don’t Need an LLC

There are many occasions when you don’t need an LLC to begin investing. In fact, there are probably more situations when you don’t need an LLC than when you do need them. Wanting an LLC might be a different story though, as it is always more of a personal preference thing in my opinion.

For starters, you don’t need (actually, you can’t have) an LLC when purchasing a primary residence. If you intend to house hack a duplex as your first investment as I did, your lender won’t let you take the title in an LLC. Instead, if you use a VA loan, FHA loan, or another primary residence loan, they will require you to take the title in your personal name. 

A lot of people begin their investing journey with a house hack, which is my personal favorite strategy, so an LLC would be pointless to worry about at this point. 

An LLC is probably unnecessary for your first purchase in general, depending on how expensive it is. That isn’t to say you couldn’t, or shouldn’t, set up an LLC, but I wouldn’t let it stop you from buying your first deal. 

How to Set Up an LLC

Setting up a limited liability company is actually quite simple. There are a few documents required in order to be considered a legitimate LLC, and at least in my state, you can file everything online in a matter of minutes. 

Hell, for my first LLC I basically took an editable version of my property manager’s LLC formation documents, changed some names and dates around, and filed that!

That being said, for legal reasons, I must reiterate that you consult with an attorney and get your LLC drafted professionally. Don’t try to blame me if you file some dumb crap with your state, get sued, and your LLC doesn’t hold up in court!

Naming Your LLC or Filing a “Doing Business As” (DBA)

You can name your LLC anything you want, provided that name isn’t already in use in your state. As mentioned above, I am a 50/50 owner in four different LLCs. Two of these LLCs have very legitimate and professional names, and two of them make bankers laugh and ask “Really?” when they hear the names. 

The beauty is that it doesn’t matter what you name your LLC because you can file a “Doing Business As” or DBA with your Secretary of State in order to operate under a different name. You could be 123 LLC doing business as Mickey Mouse Estates and brand everything as Mickey Mouse Estates, but your LLC is still “123 LLC” for tax purposes.

Articles of Organization

The articles of organization are a short, concise list that outlines the initial statements required to form a limited liability company. 

In my experience, this is a one or two-page document and really the only thing that changes is the name of the LLC, name(s) of the member(s), date of organization, and primary purpose of the LLC.

Operating Agreement

An operating agreement is a key document used by limited liability companies to outline the business’s financial and functional decisions. This includes regulations, provisions, exclusions, members, initial (and subsequent) capital investments/distributions, etc.

Essentially, the operating agreement is the long document that dictates how the LLC will operate in all facets of its business. This is where you outline responsibilities, conflict resolution, the whole nine yards. This is the one where you need to pay the most attention.

The Best Clause Ever

You can get as detailed as you wish in the operating agreement. On my most recent LLC formation my partner (a Recon Marine) and I even included this ridiculous clause at the bottom of our conflict resolution section: 

“In the event that above resolution attempts do not solve the member deadlock, fate shall be determined by a duel in which both members will be armed with a paintball gun, three paintballs, and a face shield. Standing back to back, each member will take three paces (six steps) away from the other, turn, and fire all three rounds. Impact on the face mask is worth two points, impact on the body is worth one point; total points after all three rounds have been fired is deemed the winner.” 

Minutes of Meetings

This is not required in order to form the entity, but you should strive to keep notes of any/all meetings your LLC has to both document decisions that are made and prove the LLC is conducting ongoing business meetings. 

This is a good practice to show that your company is still operational and functional in the event of a lawsuit.

Filing With Your Secretary of State

Straight up, you can file to form an LLC online—I did it last week. In order to file for an LLC, you simply need to contact your Secretary of State and talk to them about the process…or hire an attorney!

Do You Need To Start an LLC For Real Estate Investing?

TL;DR: Do You Need An LLC?

An LLC is a good idea for asset protection and to start treating your investments as a business. It is not, however, something you should get hung up on. You can form an LLC at any time, and forming an entity doesn’t need to be another roadblock to justify your analysis paralysis

Ultimately, the answer to “do you need to start an LLC for real estate investing?” is … maybe?

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David Pere

David Pere

David is an active duty Marine, who devotes his free time to teaching personal finance and real estate investing for service members, and the working class!

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