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A Guide to Forming a Real Estate LLC

A real estate LLC can offer certain protections and tax benefits when investing in real estate.

[Updated: Feb 04, 2021 ] Jun 01, 2020 by Liz Brumer
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Creating a real estate LLC is often one of the first steps an investor takes when deciding to invest in real estate. After all, a real estate LLC offers the real estate investor certain protections and tax benefits for a real estate business and is relatively cheap to establish. If you're considering forming a real estate LLC, learn what it is, the pros and cons of investing with a business entity, the cost to start one, and how to create your own real estate investment LLC.

What is a real estate LLC?

A real estate LLC is a limited liability company (LLC), which is a legal entity separate from the individual investor that's capable of purchasing, owning, and managing real estate. Since LLCs are their own entity, they have their own bank account, file their own taxes using an Employer Identification Number (EIN), and provide certain personal liability protection and tax benefits to the LLC owner by acting as an independent real estate holding company. LLCs can be established for a particular real estate transaction or asset, or an LLC can hold multiple real estate investment properties.

Pros of a real estate LLC

Real estate owners often choose to create a real estate LLC because it offers:

  • Asset protection.
  • Liability protection.
  • Tax benefits.

Asset and liability protection

When an investor owns property in their personal name, they're exposing themselves to unnecessary risk and liability in the event they're sued by a tenant or third party. If the property owner is found at fault in a litigation case, their personal assets, like their primary residence, could be seized.

If real estate is owned in an LLC, it offers a layer of protection and separation from personal assets and personal property. In the event an LLC is sued or files bankruptcy, only assets belonging to that particular LLC can be used in the case.

For this reason, many investors choose to create a separate LLC for each investment property they own. This creates additional separation and protection from having other assets seized in the event of a lawsuit or bankruptcy.

Tax benefits

LLCs in particular offer major tax benefits for investors, especially those investing in rental real estate, such as qualified business income (QBI) deductions and general business deductions that allow you to write off certain expenses relating to operating your real estate investing business.

Cons of a real estate LLC

The biggest drawback of creating a real estate LLC:

  • The cost of establishing and maintaining the LLC over time.
  • Financing challenges.

Upfront cost

While the cost for establishing an LLC in many states is nominal -- currently the average cost for creating an LLC is $132 -- it can be expensive in certain states, costing $500 or more. Additionally, if you choose to hire a third-party company or attorney to file for you, it can cost you around $1,000 to $2,000, depending on the state. Some states will also require you to publish a statement of formation in addition to paying the state filing fee for the articles of organization, announcing your newly created limited liability company, which can increase total filing costs as well.

Financing challenges

Owning real estate in an LLC can also make financing difficult. Many traditional lenders will not finance or mortgage a property that's owned by a business entity, forcing investors to look elsewhere for alternative financing. Most of the financing alternatives charge higher interest rates, typically for shorter terms.

How to start an LLC

If you want to start an LLC, you can file the paperwork yourself or you can hire a third-party company or real estate attorney to do it for a fee. Make sure you consult with a qualified real estate accountant or attorney to determine the proper structure for your investing business. There are additional elections you can make when filing, including S-corp designation. Start by visiting your state's Division of Corporations, which will explain the cost to file in your particular state and the process of filing. After choosing an available business name in your state, you begin the filing process, which can include:

  • Filing the articles of organization of your business, stating:
    • the LLC structure (member managed or manager managed, sole proprietorship).
    • the LLC member or LLC managers name(s) and address(s).
    • Registered agent information.
  • Publishing statement of formation (Arizona, Nebraska, New York, and Pennsylvania).
  • Creating your operating agreement for the business.
  • Paying any local fees for operating a business in your county or city.

Some states will require you to determine a registered agent, which can be either your business or a third-party company that receives any government or legal correspondence on behalf of the LLC. Some choose to have a third party as the registered agent because it can provide autonomy and privacy, although some states may not require this.

An LLC operating agreement defines the business structure, including ownership percentages, contributions, and processes for buying, selling, or transferring ownership rights of the LLC or property owned by the LLC. While not every state requires an operating agreement, it's a good idea to create one. Banks, especially commercial lenders, will require a copy of the operating agreement as a part of their underwriting process.

Once your business is established, check with your local county and city to see what fees there are for operating a business. Most municipalities charge an annual license fee, which can be $50 to $250+. You'll also want to maintain your LLC over time, refiling your articles of organization each year -- typically before the first of May to avoid penalty or dissolution of your business.

The Millionacres take on starting a real estate LLC

An LLC is not the only business entity structure available to real estate investors. The property owner can opt to create a corporation instead -- although this is not a popular structure because it can be subject to double taxation -- or choose to purchase liability insurance to gain some of the liability protection an LLC would typically offer.

Whether you're investing in commercial real estate or residential rental property, having an LLC is typically a good idea because of the liability protection it offers and the tax savings it can bring. Regardless of which path you take, it's a good idea to consult with an experienced attorney and accountant to find out which holding structure is best for your investing business and needs.

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