Why Use an LLC for Real Estate?

A limited liability company (LLC) is ideally suited for real estate applications.  LLCs provide their members (owners) the shield of limited liability like corporations yet have the flexibility and pass-through treatment of partnerships for income tax purposes.  A significant advantage of an LLC is the protection of limited liability it affords its members.  Generally, no LLC member (owner) will be personally liable for any debts or obligations of the LLC beyond the member’s investment in the LLC.  For the most part, the LLC’s debts must be satisfied out of the LLC’s assets.

Pass-through tax treatment is a must for most real estate ventures. This means that only one level of income tax is imposed on the profits and gains from the venture.  Since LLCs are pass-through entities for tax purposes, the LLC itself will not be subject to income tax.  Instead, the profits and gains from the LLC will be taxed to its members, based on percentage ownership.

There is another, more critical tax issue.  If planned correctly, land and other real estate can be pulled out of an LLC or a partnership without any income tax.  That is not the case with a corporation. Property distributed out of a corporation is a taxable event, causing income tax on the value of the property distributed over the cost basis in the shares of the corporation.  In many real estate deals, this flexibility is needed to be able to pull the property back out of the entity without any income tax.

Flexibility is a big advantage of LLCs over other business forms.  LLCs offer two basic structures: member-management or manager-management. Within those two structures, almost any desired structure can be put together.

Take a real estate development example. Suppose that a proposed real estate development involves 5 different players–the land owner, the money person (investor or lender), the construction company, the marketing company and the developer.  By using an LLC as the entity, the needs of each of the players could be recognized with each getting paid for his contribution plus a portion of the net profits:

  • landowner puts in land and will get $25,000 per acre plus 35% of net profits
  • money person puts in money and will get back his money with 8% interest plus 5% of net profits
  • construction company does the construction work and will get back its out-of-pocket construction costs plus 20% of net profits
  • marketing company sells the finished lots or units and will get 3% of sales plus 5% of net profits
  • developer designs the project, does the re-zoning and all entitlement work, and supervises the entire project to completion and will get back its out-of-pocket costs plus 35% of net profits

The LLC Operating Agreement could include these provisions and make the developer the manager of the LLC.  This same structure would be very difficult to achieve in a corporate structure.

Take an investment example. Suppose an investor and a landowner decide to team up. The investor pays the landowner a threshold price per acre up front–say, $15,000 per acre–and they agree to split the future profits from sale of the land 50/50 after the investor is first repaid his initial investment in the land.  An LLC could easily accommodate this deal.  It would be difficult in a corporate structure.

Or take a simpler example. Suppose a landowner builds an apartment house on his land and wants to hold the finished project indefinitely. He doesn’t want to pay any unnecessary income taxes.  An LLC would fit the bill here.  The LLC offers limited liability to the owner for accidents that could happen on the project yet provides a pass-through of all income, gains and deductions from the project for income tax purposes.

Thus, the LLC form is an ideal entity for real estate applications.

To obtain the full benefits of the LLC form, advice and assistance from a competent lawyer are essential.