Owning property in Texas puts you in a decent financial position – especially if you’re renting the property and making a profit on it. But if you want to make your profits consistently, and mitigate potential risk, you need to strategically plan to protect yourself.
One way to protect yourself – and your entire real estate operation – is to form an LLC for your investing needs. But how exactly does this work and is it worth the money and effort to protect your rental property in Katy, Houston, or another Texas city?
What Is an LLC?
A limited liability company (LLC) is a type of organization meant to provide liability protection to the owners of the organization (plus some other benefits). Like a corporation, it’s treated as a separate legal entity, meaning it can take on debt, hold assets, and be targeted in a lawsuit just like an individual person. It’s also treated as a “pass through” entity for tax purposes, meaning the LLC won’t owe taxes on the money it makes; instead, you’ll pay taxes on the money you withdraw or receive from the LLC as an individual.
The rules and requirements for LLCs differ by state. Each state has a slightly different process for how to form LLCs, how LLCs are treated and taxed, and how to actively maintain an LLC. But for the most part, starting an LLC is relatively straightforward and inexpensive.
In Texas, LLCs aren’t required to file annual reports with the Secretary of State, but you will need to file annual franchise tax reports.
Why Form an LLC?
Why would you form an LLC for your real estate interests?
- Liability protection. Real estate investing does carry some risk. You could lose money on a property if there’s a real estate crash in your area. You could end up spending too much on repairs and upgrades, compromising your profitability. You could even end up with a string of unreliable tenants who don’t pay rent.
But one of the biggest risks you’ll face is legal action. If a tenant hurts themselves at your property, or if you treat the tenant unfairly in some way, they can hypothetically sue you. A liability insurance policy can provide you with some protection, but you’ll still be named as an individual in these matters, meaning you’ll be held personally liable for the damages. If you create an LLC for your property, you’ll enjoy a layer of extra protection for yourself; the LLC can be held liable instead of you.
- Tax benefits. Forming an LLC can also confer tax advantages under the right conditions. Because LLCs are pass through entities, you’ll have more direct control over how your assets are managed, how you make money, and how your income is taxed. You can even use an LLC to reinvest your profits, reducing your tax bills while helping you secure new opportunities. Note that forming an LLC isn’t always a strict tax advantage; consult with your tax professional for further guidance on this point.
- Partnership management. LLCs can make it easier to manage a property (or several properties) with another person or entity. There’s nothing stopping you from forming a conventional partnership and navigating the joint management world that way – but having an LLC adds protection for stakeholders and streamlines some aspects of management. Just make sure you have a solid operating agreement in place to explain the roles, responsibilities, and entitlements of each party involved.
- Succession planning. An LLC can also make succession planning easier. If you have many different properties, it could be a hassle to manage deed transfers and other legal transactions when it’s time to transfer assets. But if all those assets are unified under the umbrella of an LLC, all you have to do is transfer the LLC to ensure a successful transition.
- Scalability. If you plan on purchasing and managing many properties in the future, the benefits of an LLC increase further. Having a stable organizational framework for your endeavor makes it much more easily scalable. That said, you may want to start separate LLCs for separate real estate endeavors.
Are There Downsides to Creating an LLC?
There are some downsides you’ll need to consider as well.
- Initial time. While starting an LLC isn’t necessarily complex or hard, it does require some time from you upfront. Depending on your existing level of familiarity, it could take you a few hours or a few days to get started.
- Mortgages and financing limitations. Getting a mortgage as an LLC is often more difficult than getting a mortgage as an individual. This can make it challenging to secure the financing you need to secure more purchases.
- Costs. In Texas, you can start an LLC for a mere $300 filing fee (plus a handful of other incidental expenses). That’s not prohibitively expensive, but it’s still a cost worth considering. For most LLCs, there are no annual fees to worry about.
- Limited forms of protection. As the name suggests, limited liability companies can only provide you with limited forms of protection. You may be held personally liable for certain issues and under some circumstances.
The Role of a Property Management Company
If you have a property management company working on your behalf, you may benefit from some liability protection without the need for an LLC. Your property manager will likely be liable for a variety of possible issues related to your property and your tenants; this is highly dependent on the initial contract you sign, so make sure to investigate the details and understand what you’re signing.
The Bottom Line
In some situations, it pays to create an LLC for your real estate investment interests. If you’re managing properties alone, if you’re building a business with a partner, or if you plan on scaling up your operations significantly in the future, this is especially true. But there are also situations where creating an LLC is unnecessary – and may add some complexity to your property management approach.
Navigating the worlds of real estate investing and property management are tough, but it’s even tougher when you’re making every decision without professional guidance and advice. Green Residential exists to make your Texas real estate investing decision easier – so contact us today for your free consultation!