Pros and Cons of Forming an LLC
Over the last decade, limited liability companies (LLCs) have become one of the most preferred forms of business entities through which to hold title to investment real estate properties. Prior to LLCs, real estate investors seeking limited liability protection were largely limited to using corporations to acquire title—a form of entity that has potential drawbacks.
The insulation from personal risk exposure for real estate investors provided by LLCs, coupled with the relative ease of administration and potential tax benefits, make ownership of investment property through an LLC a very desirable option in most instances.
LLC vs. Liability Insurance
Although there are many benefits to holding real property assets through an LLC, a limited liability company may not be the best holding vehicle for every property owner. For many real estate investors, the trouble of forming and maintaining a company isn’t worth protection from the theoretical threat of a lawsuit, particularly when affordable liability insurance is available.
That said, real estate investors that rely solely on insurance as a means of protection from personal liability take a significant risk. Liability policies typically have limits, exceptions and carve-outs. While the chance of a loss that exceeds policy limits may be remote, if it happens, the consequences can be devastating.
Under current laws and market trends, the popularity of real estate holding LLCs is very likely to continue to increase as more and more property owners seek to take advantage of the benefits offered by this form of entity.
Minimize Risks with The Right Strategy
There is simply no way to eliminate all the risks associated with starting a real estate investment business, but you can easily improve your chances of success by complying with the corporate formalities required by applicable laws, even though these steps may seem tedious and somewhat confusing.
If you are in the market for investment real estate, you should at least consider whether or not the acquisition through an LLC is the right choice for you. If so, it is much easier to purchase the property through the LLC to begin with, as opposed to trying to transfer the real estate to an entity at a later date where a lender might have to consent to the transaction.
An LLC may not offer any more or less protection from outside lawsuits than a properly formed and operated corporation or limited liability partnership, but it does offer many other advantages that make it the most desirable form of entity in many cases, particularly with respect to real estate holding companies.
Explore Your Options
Many business owners choose to form an LLC because they are unfamiliar with the many legal nuances between different entity choices, and they simply assume that an LLC offers the most protection from risk because it has “limited liability” in its name.
In reality, a properly formed and operated LLC does indeed limit the personal liability of the owners, as much as U.S. law allows, by affording the owners no personal risk above and beyond their investment in the company—but, in many instances, so do corporations and certain partnerships.
Of course if a small business owner of any entity form fails to respect the separate and distinct identity of the business or observe statutorily required corporate formalities (such as co-mingling personal and business funds, paying owners instead of creditors, or failing to maintain a registered agent), the integrity of the corporate shield provided by law will be compromised and potentially expose the owners to personal liability. Generally speaking, though, the basic requirements to operate an LLC within the confines of the corporate statutes are not particularly onerous.