LIABILITY PROTECTION

Most real estate activity involves some risk taking. If you are buying and improving properties for resale, you will be using contractors and other parties to help with the improvements. There will be contracts signed and potential for accidents and disputes that arise out of the business activity. If you are a landlord, there is significant risk as you will have a tenant- someone living on your property.

When you take into account the fact that your business is also holding property that is of potentially significant value , there is a lot to lose if a dispute or accident occurs or a lawsuit is filed.

Because of the risk profile that comes with real estate investments, it is imperative that the real estate and the business be operated through an asset protection entity. There are two main choices- the limited liabilitycompany and the corporation.

Both the LLC and the corporation offer the same level of personal liability protection. However, the limited liability company is more simple to run and easier and cheaper to maintain.

TAXATION

What you pay in taxes makes a real difference to the bottom line of any business. Accordingly, you will want to minimize taxes and any potential for paying more to the government as much as possible.
The real estate LLC is the dominant winner versus the corporation when it comes to taxes. With the corporation, profits from any business are taxed twice. If you sell a piece of real property, the corporation must pay taxes on the gain. Then, in order for you to reap the benefits of the profits, the corporation will distribute cash as dividends and then you personally will need to pay taxes again on any dividends you receive. When you are selling real estate, this double tax can be significant.

Even if you are primarily renting and receiving rental income, the same double tax would apply to your profits.

There are also better tax rules that apply to a real estate LLC when property is traded in for other property or converted into other uses (like personal use). Trades or property conversions made by a corporation will generally trigger tax consequences. If done through an LLC, there is an opportunity to avoid or delay the tax obligation.

SUMMARY

Because of both the liability and tax consequences and the fact that business owners and investors can run and manage a limited liability company with very little formalities and paperwork, the real estate LLC is the best property and business vehicle for holding real property such as land, houses and buildings and for conducting rehabs, improvements, development and rental activity.

Many existing businesses expand by starting a joint venture or business arrangement with another business or person.  If the arrangement involves an ongoing activity, one of the best methods of creating a structured joint venture is by creating an LLC to house the venture and using the LLC governance processes to create the parameters and responsibilities of the joint venture parties.

Without an LLC, you need to rely on addressing all matters in a general contract.  A limited liability company provides an automatic mechanism for handling ongoing business interactions and activities among several parties.  Because an LLC is subjected to very little formalities and bureaucracy, you can tailor the governance and rules for your particular business transaction.

Also, because the taxes are pass through, you can accomplish the creation of a customized joint venture arrangement without having to worry about additional tax burden or complexity. You can form a limited liability company quickly and should do so prior to starting any joint venture activity.

Second, is it possible to not be personally liable for that debt after the transfer?

Question #1:  Yes, you can transfer any assets or debt to your LLC. You transfer assets with a document called a Bill of Sale and you assign debt with an assignment of the debt contract and obligation.  The LLC needs to agree to undertake the debt obligation by having its members formally approve this transaction.  The approval should be documented with a written resolution or consent.

Question #2: No.  Once you personally agree to an obligation, you cannot later get rid of that personal obligation by transferring he obligation to an LLC.  You remain liable.  The only way to change this is to get the other party (e.g., the lender or vendor) to agree to take you off as a liable party. In most cases, that party will never agree to this- it just does not make business sense.

The best approach is to create an LLC early and have your limited liability company be the contracting party or the borrowing entity from the beginning.  Please note that many banks will not lend money to a brand new LLC with no operating or credit history so you may end up being asked to personally guarantee the loan in any event.  Banks are conservative.  It is still worth your LLC being the borrowing entity (Even with the guarantee) as this is how you begin to establish credit for your LLC business.

Learn more about the limited liability company at The LLC Expert.