When buying an investment property, you have the option of purchasing it in your own name or purchasing it under the name of another entity, such as a limited liability company (LLC). The LLC then becomes the legal owner of record, not you as an individual. Purchasing commercial investment property under an LLC has significant benefits including protecting your personal home and other financial assets in the event of a lawsuit and experiencing favorable tax treatment by avoiding the double taxation that corporations experience. These benefits are enjoyed whether the LLC is a single member LLC or a multi-member LLC.
What is an LLC?
An LLC is a business entity that is separate from its owners, like a corporation. But unlike a corporation, which is double taxed and must pay its own corporate taxes, an LLC is a “pass-through” tax entity. This means that business profits and losses pass through to its owners, who report them on their personal tax returns. An LLC is often the best way for some investors to purchase property because of this unique benefit. This is true whether the LLC is a sole proprietorship or a multi-member with several members.
LLC Liability Protection
The key drawback to buying under your own name is liability; your personal home and other financial assets, whether owned jointly or individually, are exposed to lawsuit risk in the event you are sued or enter a foreclosure. However, properties managed under an LLC have limited liability for the owner, meaning that should the property be subject to a lawsuit, the owners of the LLC can be sued only within the limitations of what the LLC owns and not beyond that. This means that if you bought a commercial property under an LLC and someone files a claim against that property because they tripped and fell, the claimant cannot access or be rewarded out of your personal assets. However, if the building was purchased under your own name, you risk exposure as the claimant could access your personal assets since you as an individual will be held personally liable if an accident occurs on your property or you are unable to make payments.
For example, if someone is injured while a guest at a property you own, it is not uncommon for the guest to pursue a legal claim against the property owner for their injuries. Assuming you have homeowner’s insurance to cover such incidents, your insurance policy likely has limits and will only provide coverage up to a certain amount. If the amount of damages the injured party seeks exceeds the policy limit, your personal assets could be at risk. Even if you successfully defend the claim, your insurance premium could increase merely because your property was subject to a lawsuit. If, on the other hand, you placed the deed and title to the property in the name of an LLC, only the LLC’s assets would be obligated to pay an award of monetary damages if the injured party’s suit is successful and your personal assets are not exposed.
Other benefits of owning commercial property as an LLC is a more professional appearance to the public, especially when advertising the property for lease. Additionally, an LLC can be sold through a transfer of membership interests which allow new LLC members to take over while allowing the real estate to remain in the LLC’s name.
Whether you are the sole owner of the LLC or one of several members, you benefit from so-called pass-through taxation. For federal income tax purposes, pass-through taxation refers to the fact that any income earned by the LLC—including profits generated through real estate (such as rental income from leasing an LLC-owned property)—will pass through the LLC to its individual members. Any income earned by the LLC is not taxed at the corporate level (as would be the case with a traditional corporation) but only at the individual level. Each LLC member reports the income on their individual federal income tax returns—usually on Schedule C. These pass-through rules help members of an LLC avoid double taxation.
If your property will have more than one tenant, such as an apartment building, or will house commercial retail tenants, it is wise to purchase and operate the property under an LLC. Commercial properties are more risky compared to a single-family home as commercial properties have a continuous daily flow of individuals versus one person or one family accessing a single home. Accidents can happen anywhere and even the most careful owners are still subject to lawsuits of any kind. Owning your commercial property under an LLC will limit exposure to claims in the event an accident occurs. Having an LLC as a double layer of protection is a smart way to make sure no one can come after your home or other assets, should your insurance fail to cover you. You may be thinking, what about a partnership instead of an LLC? Partnerships, however, are actually worse than individual investors jointly participating in an LLC because each partner is responsible for his own debts and obligations as well as the other partners.
Creating an LLC
Setting up an LLC is relatively simply. To do so requires submitting an application to the state along with a fee. If approved, which most are, states charge an annual fee to maintain the LLC. In Oklahoma, the fee to create an LLC is $100 with an annual renewal fee of $25. Once your application is approved the LLC is created. You will then receive the Articles of Organization, the legal document that officially creates your Oklahoma Limited Liability Company. Once the LLC is created, the LLC becomes the legal owner of record rather than you as the individual. If you already own commercial investment property under your own name and would like to transfer it under an LLC to enjoy limited liability and avoid pass through taxation, that is an option as well. To do so requires deeding the property from your name individual to the LLC’s name and then filing that deed with the court.
You may need to obtain a waiver from the mortgage lender before transferring already owned real estate from your name as an individual into the LLC. This transfer could trigger the due on sale clause, a standard provision in the mortgage, that requires the borrower (named property owner) to pay the mortgage balance in full at the time of sale. A waiver from the mortgage property acknowledging the transfer to the LLC should eliminate this issue.
Contact Skillern Law Firm, PLLC
If you have commercial property or are considering purchasing commercial property as part of your investment portfolios, you should strongly consider creating an LLC. Contact Skillern Law Firm, PLLC today. The attorney at Skillern Law Firm can help evaluate what the best option is for you. For more information, reach out to us today at (918) 805-2511 or firstname.lastname@example.org.