What exactly is the purpose of an LLC? In simple terms, a Limited Liability Company is a type of business entity where members of the company are not personally liable for any legal or debt issues. The LLC owners or members may lose their capital contribution, but personal assets stay safe. Also, LLCs helps to establish that rental activity is a business for a tax purpose and not for investment activity.
Let’s focus on two things: liability protection and taxes.
1. Liability protection
When you own a rental property in your own name, you are personally liable for all the debts that arise from the property. Meaning, a creditor, who is a person or company to whom you owe money to, can go after your assets. LLCs use business entities to attempt to avoid personal liability for debts and lawsuits that could arise from rental property ownership. An LLC protects your personal assets and provides legal protection. How so? Well, as a member in an LLC, your business assets are separated from your personal assets as an owner. Nothing is more crippling and damaging than losing everything you have in a lawsuit. With an LLC, your name and your identity are not compromised.
LLCs, in theory, provide their owners with limited liability from debts and lawsuits. If you still don’t understand what limited liability entails, it simply means that you are not personally liable for debts and lawsuits that might be incurred. Your personal assets are not at risk. At most, you will lose your investment in the business. If there is a lawsuit, the company is being sued, not the owners or investors specifically. An important thing to note is that only the limited partners have limited liability. General partners are personally liable.
When it comes to taxes, there is a flexibility with how you are taxed. LLCs can choose how they are taxed meaning LLCs give owners pass-through treatment like a partnership or sole proprietorship. Allocated profits are only taxed once on each member’s individual income tax return. This is the most advantageous tax treatment for real property.
Furthermore, tying into pass-through treatment, the advantage is that there is no double taxation. An LLC is taxed more like a sole proprietorship versus a corporation where corporate owners pay tax on both corporate net income and dividend income that they collect from their business. In addition, the tax rate for an LLC depends on the total income of the owner. A huge benefit is that an LLC with a higher total income may pay taxes at a lower rate than a corporation.
In general, it’s easier to institute and maintain an LLC. Are you wondering how profits are shared in an LLC? Well, it’s quite flexible. The members in an LLC have this flexibility to decide how profits are allocated under terms of an operating agreement. Business entities usually distribute profits based on the owner’s capital contribution or their percentage of ownership interest. Members of an LLC are not limited within their proportion of ownership. To make this a little clearer, if a member puts in more work or effort, they can agree with the other members to receive more of the share than someone who is not as involved in the business. Hence, the flexibility in sharing profits. If you need help forming an LLC, contact your local CPA or Certified Public Accountant for more information.
In our experience, with the advantages that LLCs provide, it is recommended because of its simplicity, flexibility, and the ability to personally protect you as an owner.
Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. You should not rely upon the material or information on this Blog as a basis for making any business, legal or any other decisions. Seek professional advice from a CPA (Certified Public Accountant) before proceeding with any business ventures. The views reflected in the commentary are subject to change at any time without notice.