Tag: LLC

Deeper Dive into Single Member Limited Liability Companies

Posted by Simon Filip on

Deeper Dive into Single Member Limited Liability CompaniesEntity classification

LLCs with two or more members can be treated as a partnership or corporation for tax purposes. An LLC with one owner or single member limited liability company (SMLLC) can choose to be treated as a corporation or a “disregarded entity.”

The member of a SMLLC who wishes to be treated as corporation for tax purposes must file either Form 8832 to be treated as a ‘C’ Corporation or Form 2553 to elect classification as an ‘S’ Corporation. Where an individual does not file Forms 8832 or 2553 to elect to be treated as a corporation, the IRS will treat the LLC as a disregarded entity and it will be taxed as a sole proprietorship.

Tax treatment

By default, the IRS treats a SMLLC as a “disregarded entity.” This means the IRS will not look at a SMLLC as an entity separate from its sole member for the purpose of filing tax returns. Instead, similar to a sole proprietorship, the IRS will disregard the SMLLC and the member will report income and expenses and pay taxes for the business as part of his or her own personal tax return. Taxable income or loss generated by an operating business will be reported on Schedule C, while rental income will be reported on Schedule E. Since the ultimate responsibility for paying taxes on income generated by a SMLLC is passed through to the member, this way of taxing profits is called pass-through taxation.

Profits earned

As a disregarded entity, if the SMLLC has taxable profits for a given year, the sole member is required to pay taxes on that profit, regardless of whether the profits are actually distributed to the member. It is not relevant whether a member of a SMLLC leaves the profits in the business bank account or withdraws the money. Regardless, all income or loss are reported by the SMLLC owner for income taxation.

Example

Steve’s SMLLC, which owns rental real estate, earned $25,000 this year after expenses and depreciation. Steve decides that he doesn’t need the money and will leave the entire $25,000 in his business checking account to use next year. Steve will have to report and pay tax on the full $25,000.

SMLLC to partnership

There are instances when a SMLLC ceases to be a disregarded entity. One instance this is accomplished is through the addition of one or more new members to the limited liability company. The LLC’s tax reporting after an additional member is admitted no longer is reflected on Schedules C or E of the former sole member. The entity has become a multi-member limited liability company and must obtain an Employer Identification Number and file a partnership return.

We’ve got your back

With Simon Filip, the Real Estate Tax Guy, on your side, you can focus on your real estate investments while he and his team take care of your accounting and taxes. Contact him at sfilip@krscpas.com or 201.655.7411 today.

Should I Acquire and Hold Rental Real Estate in an LLC?

Posted by Simon Filip on

At KRS, we get this question often from both new and seasoned investors acquiring new properties. Here’s what investors need to consider.

Should you buy and hold rental real estate as an LLC?Limited Liability Company

A limited liability company (LLC) is a legal structure that provides the limited liability features of a corporation and the tax efficiencies and operating flexibilities of a partnership.

The owners of an LLC are referred to as “members.” The members can consist of two or more individuals, corporations, trusts or other LLCs. Unlike a corporation, an LLC is not taxed as a separate business entity. Instead, all profits and losses are “passed through” to each member of the LLC.

A central motivation behind investors forming LLCs is to protect the LLC’s members (owners) from personal liability for debts and claims. At its very root, an LLC is utilized to keep creditors – such as suppliers, lenders or tenants – from legally pursuing the assets of a member. There are exceptions to the limited liability, such as in cases of illegal or fraudulent activity.

Disregarded Entity

LLCs are typically taxed as partnerships, which file separate tax returns. However, a single-member LLC, owned by one individual, does not file a separate tax return, but reports the activity on the tax return of its sole owner (Schedule C for business operations or Schedule E for rental activities). LLCs with one owner are commonly referred to as a “disregarded entity.”

Do I need an LLC?

Many real estate investors and landlords often ask whether they should purchase their rental property in an LLC. I have read numerous articles by attorneys, tax advisors, real estate professionals, and insurance agents with opinions on this matter. I believe there is no “one size fits all” answer. Just as in selecting which property to acquire, where investors consider multiple factors including cash flow, appreciation, capital expenditures, interest rates, proximity to transportation and etc., there are multiple considerations in choosing whether or not to acquire a property in an LLC.

Here are factors investors and landlords should consider when making their decision:

  1. Cost – I have seen clients utilize websites that charge fees as low as $100 to form an LLC (plus state filing fees). It is not uncommon to find an attorney’s fees to form a single-member LLC (including state fees) range from $1,000 to $3,000 depending on the state of formation.
  2. Filing fees – most states have an annual filing fee to keep the LLC in good status. That fee is currently a flat $50 in my home state of New Jersey. However, in New York, the fee can range from $25 to $4,500 depending on gross revenues (disregarded LLCs in New York are subject to a $25 flat fee).
  3. Type of property – the type of property to be purchased impacts risk. For example, a single family rental in a good neighborhood is less risky than a multi-unit property or commercial property.
  4. Financing – it is typically easier to obtain financing as an individual than as a commercial entity (i.e., an LLC).
  5. Interest rates – an individual borrowing to acquire an investment property may pay a higher rate than an LLC borrowing for the same property.
  6. Insurance – an umbrella policy provides coverage beyond the basic property insurance and covers additional risks. Umbrella policies may also pay for attorneys appointed by the insurance company and paid to defend you. Depending on an investor’s risk tolerance, an umbrella policy should be considered whether the acquisition is made with or without an LLC.
  7. Net worth – without an umbrella policy, an individual with a high net worth may be exposing his or her other assets to claims of creditors of his or her rental investment.

Transferring to an LLC

Frequently an investor has already closed on a property and the question arises regarding subsequently transferring the property to an LLC. After the property has been deeded there are concerns that should be reviewed including:

  1. Mortgage – if there is a mortgage on the property, contact the lender. Many mortgages have a “due on sale” clause, which means that if you transfer ownership of the property, the lender could require you to pay the full mortgage amount.
  2. Transfer tax – transfer of real property, depending on state law, may be subject to a transfer tax. Some states may exempt the transfer to a wholly owned LLC.
  3. Title insurance – a review of the title insurance policy should be undertaken to determine if the policy continues after transfer.
  4. Leases – tenant leases should be updated to reflect the LLC, and not the individual, as the owner of the property.

Acquiring real estate in an LLC should be included in an investor’s thought process or deal checklist before an acquisition. As the projects grow in size, value and risk protection afforded by an LLC will likely make their use instinctive.

We’ve got your back

If you have additional questions about rental properties and LLCs, we’re here to help. Contact me at SFilip@krscpas.com or 201.655.7411.