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Real Estate Investing - Step One - Start a Limited Liability Company
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While real estate investing can pay huge dividends it can come with huge financial liability. Savvy real estate investors often protect themselves and their assets with setting up a Limited Liability Company, or LLC to own their properties. LLC’s are a great way to protect personal assets of the owners, but they can be expensive to legally setup, especially as the number of members increase.
In setting up an LLC, it is advisable to have an attorney prepare an operating agreement which stipulates how the company operates, makes decisions, and reacts to a death or member withdrawal etc. In some states, if a member withdraws or dies, the LLC is dissolved. Your operating agreement can be written to make provisions for these cases. Make sure you check with your attorney for your individual state law regarding what happens in these cases.
Consider this, for example, that you have 5 investment properties all attached to you personally without any type of lawsuit protection for your personal assets. Something goes terribly wrong at one of your properties like a structural defect in your property that paralyzes a tenant for life. Or there are claims brought forth against you related to fire damage or personal injury, or even environmental contamination. Your insurance policy might have a cap on how much you will receive to pay on a claim against it. What happens or better yet, who is responsible to pay for additional expenses associated with that particular claim? Well, you guessed it – you are. A situation like this could cost you everything you own. What do you to protect yourself?
How you protect yourself is to start an LLC and have that LLC own the investment property. If you own more than one property, have more than one LLC. In fact you might want to have an LLC for each investment property that you own. This way, if something catastrophic happens in one property you probably will not lose everything. All that you are likely to lose are the assets contributed by each member of the LLC.
LLC’s are started when at least two entities “invest” or put in startup capital into a common pool and become members of the LLC. Each member gets ownership or membership based on a percentage of the total amount invested by each and all investors combined.
From a tax standpoint, LLC’s are considered “pass-through” entities when it comes to income distribution. What this means is that profits are distributed to members base on their percent ownership. The profits are taxed at the individual member level not at the LLC level. In other words, the LLC is not taxed, only the members on their individual tax returns are taxed for the LLC’s profits for the year. Make sure you contact your consult your tax advisor for exact clarity on the tax implications on you regarding an LLC.
Starting an LLC can take a little bit of time especially if you have to register the name of the LLC with your State’s “Corporation Commission” or equivalent for your State. Make sure you find out how long it takes to set up your LLC to give yourself the lead time you need before you start to purchase a property.
Filing the paperwork for an LLC is not that difficult and can be handled by you with a little footwork. However, talk to your attorney for guidance on setting up the operating agreement. You will want their input and guidance to make sure all parties in the LLC are covered for how the LLC does business into the future.
If you do your research about the best entity to hold real estate, you will find that the LLC is commonly used by real estate investors. Check it out for yourself; you will be the only one to tell if it is right for you and your investments.
Article written by GetPreQualified.com's editorial staff.
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