Does a Real Estate Investor Need an LLC?

I get this question from my clients multiple times a month. And depending on what type of investor you are, and how much time and money you want to spend on the administration of an LLC, the answer may be different.

First, let’s start with an LLC, and why you would have one for your real estate investments.

An LLC operates to protect an individual from liability surrounding their ownership of real estate. In other words, an LLC protects the owners from from having to pay out of their personal funds in the event that they are sued by tenants for any situation for which they may be at fault. Having an LLC will cap the amount you as the owner will be held liable to the market value of the property and nothing beyond that. Simply, put it’s legal protection of your personal assets.

Having an LLC requires you to separate all of the real estate’s finances from your own personal finances. Not only do you have to set up the LLC itself, but you will need to file for a tax identification number, set up separate bank accounts, have separate books, and file a separate tax return for the LLC.

An LLC is not for all real estate investors. Unless you hold a large portfolio, it may not make sense to create an LLC to hold your real estate.

The first disadvantage is that lender will likely not be willing to finance, or refinance a property held in an LLC. And if you are able to, you may not receive the most favorable terms because of the LLC.

Secondly, the LLC alone is not enough protection. I always advise clients to carry a multitude of insurance coverages to protect them against events for which they may become liable. Without sufficient insurance, the protection of an LLC is simply not enough.

Let’s look at an example:

Say you have someone slip and fall, there is a fire, or someone otherwise gets injured on your investment property. If you are sued by this person, and you lose the lawsuit, you can still lose your property if your liability insurance is not sufficient. Given the choice between spending the time and money to set up an LLC, its associated bank accounts and structure needed, and to maintain the LLC every year, you may want to consider carrying more insurance coverage, which may be a better legal protection than your LLC.

Obviously, if you can afford to do both - the LLC and increased insurance coverage - that is preferred, but many smaller real estate investors need to watch their time expended and their budgets when it comes to expenditures.

Keep in mind this point as well: when you make repairs to a property yourself, you are opening up yourself to personal liability regarding that repair. When you hire a professional to do repairs, and those repairs cause injury, those professionals carry insurance which may be responsible, or at least help to contribute, to the liability.

Managing properties, no matter their size, requires thought, planning and good advice from professionals. Consider an umbrella policy for yourself also, which may help pick up some of the liability costs that would otherwise fall on you personally.