5 Benefits of a Real Estate LLC Business Structure
Investing in real estate can be a lucrative path to financial security if you know how to navigate the tax system. How you structure your ownership can impact your bottom line; that's why understanding real estate LLC tax benefits is crucial for professional investors.
The limited liability company (LLC) has become popular among real estate investors with good reason. LLCs offer a compelling blend of liability protection and tax advantages which make them an obvious choice for real estate professionals.
1. Shields Personal Assets
Perhaps the most significant advantage of an LLC is the separation of your personal and business assets. In the unfortunate event of a lawsuit, liability is limited to the LLC's assets, not your own. In the same way, if a business encounters financial hardship, the owner's personal assets are protected. This means your personal savings, car, or home are typically safeguarded from creditors or any claims against the business.
Example: Imagine a tenant suffers an injury as a result of a faulty appliance in one of your homes and files a lawsuit against your company. The tenant is unlikely to get their hands on any of your personal property or savings regardless of the outcome of the lawsuit.
Important: Setting up an LLC is a great way to protect your personal assets as a real estate investor. However, asset protection is never absolute. Certain circumstances like personal misconduct could still put your assets at risk.
2. Pass-Through Taxation
Unlike some corporations that pay taxes on their profits and then again when dividends are distributed to shareholders, LLCs benefit from pass-through taxation. The profits or losses of the LLC "pass through" to the individual members and are reported on their personal tax returns. This avoids double taxation for members and translates to significant savings.
Filing "pass-through" taxes as an LLC involves presenting the business's profits and losses for the tax year and the percentage corresponding to each owner. The owners then pay taxes on their share of the business profits on an individual basis. Pass-through taxation allows LLCs to pay less federal income tax on their profits than a C corporation.
How LLCs Are Taxed
Tax flexibility is one of the biggest reasons why so many new businesses choose to set up their companies as LLCs. Of the 689,971 business entity filings in Florida in 2023, 562,716 were domestic LLCs. You can elect to pay taxes in your LLC as a sole proprietor, partnership, or S corporation. The default classification will depend on the number of members in the LLC.
Sole proprietorships, partnerships, and S corporations have benefits and disadvantages that partly depend on the income you make from your real estate investments. It's wise to ask an expert in real estate accounting services before deciding on a real estate business structure.
3. Qualified Business Income (QBI) Deduction
Since 2017, many self-employed individuals and business owners of “pass-through” entities like LLCs have been able to deduct up to 20% of their qualified business income. QBI is the sum of income, gains or losses, and deductions (your LLC’s net profit).
The QBI deduction can significantly reduce your tax burden. Indeed, a 2022 report by Stanford University noted that deducting QBI effectively allows “pass-through” entities to reduce the top individual income tax rate from 37% to 29.6%.
There are some limits to this. For example, total taxable income for the 2023 year must be under or equal to $182,100 for single filers. This figure rises to $191,950 for the 2024 tax year.
4. Anonymity
Your personal name isn’t attached to property on public records if you buy real estate as an LLC. This can be helpful for high-profile and high-income investors who wish to keep their identity private.
5. Flexible Ownership and Management
Investing in real estate as an LLC allows you to add or change owners (“members”), increase or reduce your percentage of ownership in the LLC’s properties over time, and share property management responsibilities with the other members of the LLC. Some LLCs register a different LLC for each property they own to limit the potential consequences of a lawsuit.
Other Important Tax Benefits for Rental Property Investors
Owning a rental property business opens the door to additional tax benefits that can reduce your tax burden.
Capital Gains Deferral
Capital gains deferral via like-kind property exchanges (Section 1031 of the Internal Revenue Code) isn't a benefit exclusive to LLCs, but it's of vital importance to rental property investors. The Section 1031 exchange is a tax break that can help you avoid paying tax on profits you make from selling a rental property.
Section 1031 stipulates that when you sell a property held for business or investment purposes, you have 45 days to identify a replacement property and 180 days to close the sale. If these conditions are met, you can defer paying capital gains taxes.
Real Estate Tax Deductions
Professional investors can deduct mortgage interest, qualifying rental expenses, and depreciation on the buildings and structures on the residential rental properties they own. The depreciation deduction is calculated over a period of 27.5 years using the General Depreciation System or 30 years under the Alternative Depreciation System (page 14 of the linked PDF).
LLCs: A Powerful Tool for Real Estate Investors
The tax benefits of an LLC structure can be a game-changer for real estate investors. By avoiding double taxation and deducting legitimate business expenses, you can keep more of your hard-earned profits.
The liability protection and operational flexibility of an LLC are additional benefits of this business structure for real estate investors. Couple all of these benefits with advice from a tax professional to navigate the exciting world of real estate investing with greater financial security and peace of mind.
