The Magic Of LLCs In Real Estate Investing

January 16, 2023

If you’ve watched my online videos or read my books or blog, you’ve no doubt heard me talk about LLCs in real estate investing. The LLC, in my view, is a fundamental unit of privacy protection and asset protection. LLCs are not the perfect vehicle for every investor in every situation, but in most cases, if you hold rental property, you should know about LLCs and how to use them.

In my last blog post, I briefly explained a standard formula I recommend for using LLCs in real estate investing. I’ll provide more detail on that step-by-step formula in a future post. But for now, let’s talk about LLCs in general.

LLCs have a few advantages over straight corporations. First, they don’t create a taxable event when you move properties in and out of them (providing you make the proper tax elections). Second, they afford privacy protection, which I talked about in my last post. When people don’t know you own property, they can’t use that information against your interests. Period.

Third, and perhaps most importantly, they give you liability protection. LLCs are called “limited liability companies” for a reason—their purpose is to limit the amount of damage you can suffer in a lawsuit. LLCs offer two types of asset protection: inside and outside.

By “inside protection,” I mean they prevent damages that occur on properties owned by the LLC from becoming your personal liability. If someone slips and falls on an icy sidewalk in front of your rental property, the plaintiff’s attorneys can’t turn around and take everything you personally own. If the property were under your own name, however, they could do exactly that.

By “outside protection,” I mean that by using LLCs in real estate investing, you can prevent damages you incur outside the LLC from devouring all the real estate assets you own. In other words, if you do something that triggers a personal lawsuit—let’s say you injure someone with your automobile—the plaintiff’s attorneys can’t simply go after your real estate property as a means of collecting payment. You don’t own the real estate personally; it’s owned by the LLC.

LLCs cost money to set up and maintain, but it is money well spent. When I first started out as an attorney giving advice to real estate investors, I would often hear clients balk about the cost, which might be, say, $800 a year per LLC. And so, I would group all my clients’ properties under the banner of a single LLC to save them some of the filing costs.

I later realized this approach was wrong. What you really want to do is set up a “box” around each individual property. Why? So that damages that occur within one property stay contained to that property, rather than potentially spreading to all the other properties within the LLC. You want to protect your overall rental income, so that if something goes wrong with one of your properties, the most you’ll stand to lose is that single property and its income, not all of your properties and all of their income. That’s why I now recommend setting up one LLC for every property you own. (At least up to a point. When you get to a point in your business where you own dozens of properties, you can start bunching them within multiple LLCs.)

When it comes to property protection, don’t rely exclusively on your insurance coverage; there are many, many situations insurance doesn’t cover. And smart attorneys will try to seek damages beyond your policy’s limits. Think about using LLCs.

Remember this too: LLCs can’t be used universally. I’ve seen people create LLCs to try to protect their jewelry and motorboats. But an LLC must have a legitimate business purpose. When it comes to using LLCs in real estate investing, that business purpose is your rental income.

If you’re not currently using LLCs for your income properties, have a talk with your real estate attorney.