Individuals or groups looking to diversify their investment portfolio with commercial real estate might consider using a Limited Liability Corporation (LLC) designed for this kind of investing. In determining whether an investment LLC is the right fit, the individual or group needs to assess their long-term strategy, how many properties they plan to buy, and whether LLC’s tax structure is beneficial.
LLCs spell it all out
Those considering forming a new entity often appreciate an LLC’s straightforward arrangement that can offer stability, certainty, and peace of mind. LLCs utilize an operating agreement (sometimes also called an LLC Agreement) to provide for governance, ownership and other organizational matters. The details frequently include:
- Roles and responsibilities within the ownership group
- Management structure
- How the capital will be invested
- Other financial arrangements specific to the LLC’s objectives
- How and when members may or must sell eqiuty or leave
Common benefits of LLC
There are pros and cons to any business structure. The benefits to an LLC often include:
- Limited impact on personal assets: LLCs generally protect the investor if an unexpected setback impacts the company or its property. For example, someone who falls and injures themselves on company property may file a lawsuit against the LLC for damages, but typically does not have recourse to the investor. There is also the benefit of holding assets in the name of an LLC named rather than the investor, thus providing some anonymity. (However some laws require disclosure of the LLC owners.) Finally, personal assets are generally not exposed solely because someone invests in an LLC.
- Pass-through taxation: Depending on how the LLC elects to be taxed for federal income tax purposes, profits earned by the LLC can be passed through to its owners. Each LLC member then reports the income and pays federal taxes. This is in contrast to subchapter C corporations which have earnings taxed before distribution to the owners, who are then also taxed on the distributions they receive (this is referred to as double taxation and can result in higher overall taxes).
Look for “due on sale” clauses
If an individual owns real property and wants to transfer it to an LLC, the mortgage lender may claim that the transfer violates the “due on sale” clause. This is true even though there is not a true sale occurring. The mortgage lender may have a right to accelerate the full mortgage and require the borrower to pay the balance at the time of the transfer. For that reason it is important to seek a waiver before transferring mortgaged property to an LLC.
There are always risks involved with investing, even with the relatively stable commercial real estate market. So it is best to think strategically about long-term goals to determine the best approach to avoid unnecessary risk. A properly structured LLC can help achieve those goals if it reflects the needs of those who create the LLC. Investors with concerns can discuss legal and financial issues with an attorney who thoroughly understands these matters.