December 26, 2022

You have likely heard of an LLC. You may even know that it protects your assets. But I would be willing to bet that in this week’s podcast of the LearnLikeaCPA show there is something new for you.

Misconceptions

The first, and by far biggest misconception about an LLC is that you have to have one to deduct expenses. This is flat out not true. Business and rental property expenses can be deducted on an individual basis as well as an LLC, Partnership, or S Corp. Single member LLCs are “Disregarded entities” in the eyes of the IRS. This means that the federal government sees no difference between you and your company for tax purposes. You are one and the same. 

For this reason, LLCs are the most simple company structure when it comes to filing taxes. If you have a multi-member LLC, you will need to file a partnership tax return. This return is due March 15 instead of April 15 and will incur an additional fee to file.

LLC Advantages

So what does an LLC do for you? Well, as the name implies, an LLC gives the owner limited liability. This limited liability is protection and It comes in three ways. It protects you from your business, your business from you, and your businesses from each other. Secondly, an LLC shows vendors, customers, and creditors legitimacy. Businesses tend to be taken seriously. Third, it is important to separate business and personal funds. Comingling of funds should be avoided and an LLC is a good way to make a separation. Four, having an LLC allows you to operate out of the business’s name. This is again another way to separate yourself, while also providing legitimacy. Lastly, If you are running a normal trade or business you can have your LLC elect to use S Corporation status in order to save on self employment taxes.

LLC Limitations

Well it sounds like an LLC is a magic bullet. Nothing can go wrong, sign me up! Right? Well no. While an LLC can be great it is a tool that has advantages as well as limitations. Let's look at three. First, not everything can be deducted. You can't buy your niece a doll for Christmas and write it off as a real estate expense. Deductions must be business related and tie to your LLC. Second, an LLC does not make you untouchable by the IRS. If there are expenses being deducted by the business that seem personal in nature, the IRS will want an explanation of why these were necessary business expenses. Thirdly, LLCs will not make you bulletproof against creditors, potential lawsuits etc. They do not guarantee 100% coverage. In fact, a lot of states will disregard LLCs because they are also disregarded on a federal level.

Set Up Time

After reading the advantages and limitations, maybe you think an LLC is right for you. Great! What now? Now it is time to set up your LLC. This week’s podcast shows a simple six step plan to form an LLC.

1. Register Paperwork with your Secretary of State. States filing fees may differ

2. Go to the IRS website and register for an EIN. Be sure to select Single Member and use your business name 

3. Go to your local bank with your articles of organization and EIN to open up a business bank account 

4. Keep the loan and title or deed of your rental property in the LLC bank account. This is what gives the limited liability protection.

5. Keep separate books and records for each LLC

6. Beware of state filing fees and potential tax returns

How many LLCs?

The next logical question is, do you need an LLC for each property/entity? That depends. There are a number of factors to consider to make an educated decision. Consider the amount of equity in each rental property and your personal net worth. A lot of people will choose to transfer a property into an LLC when they reach a particular threshold of equity to take advantage of the protection. It is important to consider State filing fees. If the filing fee is high, you might want to consider fewer LLCs. Lastly, keep in mind book keeping. Remember, the more companies, the more difficult it is to keep good records.

The Golden Rule

I want to leave you with the golden rule. Rental real estate should be held in your personal name, single member LLCs, or multi-member LLCs taxed as a partnership. You do not want to hold rental real estate in S or C Corporations due to adverse tax consequences. However, if you have an ordinary business activity you may want to look into setting up an LLC taxed as an S Corporation to save on self employment taxes as mentioned above.

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