What is an LLC (Limited Liability Corporation)?
A limited liability company, or LLC, is a form of business organization that allows for limited liability for an unlimited number of shareholders that they might not have otherwise enjoyed had they formed as a simple partnership, but all the while maintaining most of the taxation benefits afforded by a partnership.
Because of these dual benefits, the shareholders, or “Members” as they are known if part of an LLC, basically enjoy the same types of limited liability protection that a corporation offers, with very few exceptions, and at the same time, also enjoy certain tax advantages, including, but not limited to, pass-through taxation and partnership treatment by the IRS. These advantages make LLC’s very desirable for certain business dealings and ventures.
After limiting individual member liability and thus providing for the protection of member assets, the advantage of “pass through taxation” can be one of the key benefits offered by an LLC. The profits or losses of the business, whether or not there is an actual distribution, pass directly through to the Member’s personal income tax return (IRS Form 1040) and by-pass the typical “business profit” tax at the company level. The LLC files a Form 1065, then lists each member’s taxable profit on IRS Form K-1. This pass through taxation is one of the hallmarks of the tax advantages available to an LLC. Because of this tax treatment, the LLC is not subject to the double taxation pitfall that befalls standard corporations (where income is taxed at the corporate or company level as profit, then again at the individual shareholder
level as earned income). The net profit of the LLC is not considered to be income earned by the Members, though portions distributed to the Managing Member (if the LLC is thusly structured) can be treated as such via the “fringe benefit” treatment called for by the IRS.
LLC’s can provide a professionally managed, institutionally funded “turn-key” real estate solution with many benefits to the individual investor such as:
- Achieve cash flow with less liability (non-recourse debt)
- Creates access to a larger pool of potentially higher-quality, institutional-grade investment properties
- Allows investors with limited funds to enjoy geographic diversification
- Enables investors to trade time and labor intensive properties for more passive forms of real estate ownership.
- Passive Income generated by property can be used to offset Passive Losses with no phase out based on any income level.
- Triple-net lease structure provides stable returns
- Interest can be transferred the same as sole ownership property
- Eliminate management obligations
- Generate renewed tax deductions that permit greater tax savings
- Benefit from the extensive due diligence performed
- Loan default could result in loss of entire investment
- Available to Accredited Investors only
- LLC’s are subject to the usual risks of real estate
- Cash flows and returns are not guaranteed
- LLC interests involve fees that may offset tax savings
- LLC interests are generally illiquid. There is currently no market to sell interests.
- LLC interests require a high level of due diligence
- LLC interest risks include failure to meet required completion deadlines as well as the potential lack of cash flow
- Value of property could decline
- LLC interests’ values can be negatively affected by fees and costs
- Co-owners of LLC properties do not directly participate in the day-to-day management of the properties
- LLC interests may be subject to unfavorable tax rulings which could result in immediate tax liabilities
- No 1031 exchange available for LLC interests
Investment Property Types
*Accredited Investors – from: http://www.sec.gov/answers/accred.htm
Under the Securities Act of 1933, a company that offers or sells its securities must register the securities with the SEC or find an exemption from the registration requirements. The Act provides companies with a number of exemptions. For some of the exemptions, such as rules 505 and 506 of Regulation D, a company may sell its securities to what are known as “accredited investors.”
The federal securities laws define the term accredited investor in Rule 501 of Regulation D as:
- A bank, insurance company, registered investment company, business development company, or small business investment company;
- An employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;
- A charitable organization, corporation, or partnership with assets exceeding $5 million;
- A director, executive officer, or general partner of the company selling the securities;
- A business in which all the equity owners are accredited investors;
- A natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person;
- A natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or
- A trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.
For more information about the SEC’s registration requirements and common exemptions, read the brochure Q&A Small Business & the SEC.