Setting up an LLC for Investing Purposes
Whether done to reduce liability, reap tax benefits, or a combination of the two, many investors opt to isolate specific property investments from their other assets through the use of a holding company — most commonly found in the form of a limited liability company or LLC.
Regardless of the reasoning behind it, setting up an LLC for apartment investing purposes can be beneficial for investors. That said, starting an LLC can be a complex process depending on many factors, from the state of origin to the experience of the investor. In this short guide, we’ll run through some of the important steps and considerations for setting up an LLC as a holding company.
What Is a Limited Liability Company?
A limited liability company can best be described as a business structure or entity created under state statute. Each state has its own rules, regulations, and restrictions when it comes to LLCs, but, in general, they have anywhere from one to an unlimited number of owners, referred to as members. Within applicable state rules, limited liability company members can be any combination of individuals, corporations, other LLCs, and even foreign entities.
In some states, a limited liability company can be formed with only one member. These single member LLCs are not taxed directly, but instead taxation passes through to the sole member — filed on the owner’s personal federal tax forms. LLCs that have two or more investors are known as partnerships. Partnerships are the most common form of LLC, and in most cases, each member is taxed as a partner. Limited liability companies can also be created as corporations and would then subsequently be taxed as such.
Forming an LLC
The difficulty that surrounds forming an LLC wholly depends on the state it’s based in. Each state has its own process and eligibility requirements when it comes to the formation of an LLC. Even so, the formation of an LLC in almost every state uniformly requires that the investor do the following:
1. Decide on a name
When it comes to choosing a name for the LLC, most states offer substantial flexibility with only a few ironclad rules. In most states, a name already in use cannot be used. In many cases there are also certain words like “bank” and “insurance” that are prohibited. In any case, investors should take great care in learning the relevant statutes in the state the LLC will be registered in. This information is typically accessible via the appropriate Secretary of State’s office — and can often be found by searching a state’s online database along with the availability of possible names.
2. Designate a registered agent
In every state, it is required that an LLC has a registered agent. The role of the registered agent is to receive formal official or legal documents on behalf of the entity. Much of the time, the creator of the LLC elects to name themselves as the registered agent, but this is not a requirement. Most states also have incredibly flexible rules regarding eligibility criteria for a registered agent, leaving the role open to virtually anyone — sometimes even non members of the LLC — so long as the person resides in the state where the entity is registered and is at least 18 years old. In apartment investing, it is common for companies to be named as the registered agent of an LLC.
3. Create and file articles of organization
The preparation of the paperwork required for forming an LLC is arguably the most critical step. Investors must utilize a state-specific organization form and in most cases provide basic information such as the LLC’s name, address, and the purpose of the entity. More detailed information is also usually necessary, but each state’s requirements can vary greatly. Questions regarding the entity’s management structure, details pertaining to the registered agent, or the length of time the holding company is expected to exist are a few popular examples. It is also of the utmost importance to assess the required documentation required by the state the entity is registering in.
Important Considerations
Limited liability companies are formed and utilized for all sorts of purposes and benefits, but they are not a one-size-fits-all business solution. Additionally, these companies are not meant to protect owners participating in unsavory business practices, so they are not to be thought of as impervious to government laws, policies, or procedures. Strict adherence to state policy is crucial, and it can be extremely beneficial to draft an operating agreement for the LLC. A good operating agreement outlines the entity’s rules for members, profit distribution, how losses will be addressed, and the percentage of ownership that each member has. It should also include each member’s role, rights, and responsibilities.
For apartment investors, depending on the type of financing chosen for an acquisition, the lender may require that the LLC be structured as a special purpose entity, or SPE. A special purpose entity is a legal entity created to fulfill specific or temporary business needs. SPEs are only allowed to have ownership over a single asset. This defining attribute is often considered to be more advantageous for investors, as the singular focus only further mitigates risk for the LLC members by greatly limiting potential liability.
As a final consideration, many states require payment of an annual fee as well as regularly submitted business filings that update the state on the business activities of the entity. Maintenance fees for LLCs are not required in every state, and some states don’t charge a fee to keep a legal entity active at all. Once again, the best course of action would be to research the state requirements before making any decisions.
Related Questions
What are the benefits of setting up an LLC for investing in commercial real estate?
Setting up an LLC for investing in commercial real estate can provide several benefits, including asset protection, ease of setup, and tax advantages. An LLC is a type of corporate structure that insulates its shareholders from personal liability, meaning that if someone sues the LLC for business-related activities, they are less likely to be able to sue the owner individually. LLCs are also generally easy to set up and can have an unlimited number of shareholders. Additionally, LLCs can be taxed as if they were S-corporations, which can sometimes be beneficial.
It's essential to have an ironclad operating agreement before signing the papers on your new real estate holding company. The operating agreement should detail specific management expectations, and may also want to mention how and under what circumstances management responsibilities should be transferred to different members. It should also include percentage ownership interests for each member, members rights and responsibilities, and delegation of management responsibilities.
Commercial real estate is known for the variety of tax benefits it can offer investors. From accelerated depreciation to mortgage interest deductions and tax advantages for an investor’s heirs, these benefits can lead to a massive difference in returns, especially over an extended period of time.
What are the steps to setting up an LLC for investing in commercial real estate?
The steps to setting up an LLC for investing in commercial real estate include:
- Creating and filing articles of organization. This requires utilizing a state-specific organization form and providing basic information such as the LLC’s name, address, and the purpose of the entity. More detailed information is also usually necessary, but each state’s requirements can vary greatly. Source
- Designating a registered agent. The role of the registered agent is to receive formal official or legal documents on behalf of the entity. Most states have flexible rules regarding eligibility criteria for a registered agent, leaving the role open to virtually anyone — sometimes even non members of the LLC — so long as the person resides in the state where the entity is registered and is at least 18 years old. Source
- Creating an ironclad operating agreement. Whether you choose an LLC, a C corporation, an S corporation, or something else entirely, it’s essential to have an ironclad operating agreement before signing the papers on your new real estate holding company. The operating agreement should detail specific management expectations, and may also want to mention how and under what circumstances management responsibilities should be transferred to different members. It should also detail exactly how the voting process will work. Source
What are the tax implications of setting up an LLC for investing in commercial real estate?
Setting up an LLC for investing in commercial real estate can have a variety of tax implications. Depending on the type of LLC you set up, you may be able to take advantage of pass-through taxation, which means that the LLC itself does not pay taxes, but instead the profits and losses are passed through to the owners of the LLC. This can help to reduce the amount of taxes you have to pay on your commercial real estate investments. Additionally, LLCs can help to protect your personal assets from any liabilities associated with the commercial real estate investments.
It is important to note that LLCs are not a one-size-fits-all solution, and you should consult with a tax professional to determine the best structure for your investments. Additionally, you should be aware of any changes to the tax laws that may affect your LLC, such as the capital gains changes for 2022.
What are the legal requirements for setting up an LLC for investing in commercial real estate?
The legal requirements for setting up an LLC for investing in commercial real estate vary by state. Generally, you will need to:
- Designate a registered agent, who must be at least 18 years old and reside in the state where the entity is registered.
- Create and file articles of organization, which will require basic information such as the LLC’s name, address, and the purpose of the entity.
- Have an ironclad operating agreement before signing the papers on your new real estate holding company. This should include percentage ownership interests for each member, members rights and responsibilities, delegation of management responsibilities, and voting.
What are the best practices for setting up an LLC for investing in commercial real estate?
The best practices for setting up an LLC for investing in commercial real estate include:
- Creating and filing articles of organization with the state, providing basic information such as the LLC’s name, address, and purpose of the entity. (Source)
- Assessing the required documentation required by the state the entity is registering in. (Source)
- Having an ironclad operating agreement before signing the papers on the new real estate holding company. (Source)
- Defining percentage ownership interests for each member. (Source)
- Defining members rights and responsibilities. (Source)
- Delegating management responsibilities. (Source)
- Defining voting processes. (Source)