It is usually a good idea to have real estate held by an limited liability company (LLC) and not individually. There are numerous estate planning and tax advantages from using an LLC. In addition and most importantly, an LLC provides insulation from personal liability for events that may occur on the real estate owned and operated by such LLC.
Here are some of the estate, gift and income tax advantages and legal liability protections to consider when contemplating the purchase of real estate:
Having real estate owned in the name of the LLC protects you from personal liability especially if something catastrophic happens on the real estate that is in excess of the insurance coverage on the premises.
It is not always clear whether you should keep adding additional real estate to an already existing LLC. Although it may be less expensive and easier administratively and there may be some estate tax advantages to having all real estate held in just one LLC, in certain cases in may be safer from a legal liability perspective to form a new LLC for each new real estate purchased. Forming separate LLCs would protect each property from liability that could occur on another parcel of real estate. This would especially be the case of ultra-hazardous real estate or if a catastrophic event were to occur on one piece of real estate.
By placing real estate into an LLC, the owner can gift membership interest to family members to reduce the size of his or her taxable estate. Each year the owner can utilize the annual donee exclusion by making gifts of this amount to as many family members deemed appropriate. This annual donee exclusion is currently $13,000 per year. If the owner is married his or her spouse can enter into a spousal joinder to allow for a second annual exclusion of $13,000. In addition, since the gift of such membership interest would not be a controlling or majority interest, the tax free gifts would be increased by the value of such discounts for lack of marketability and minority interest discounts. Finally, with these tax advantages along with the use of the lifetime gift tax exemption currently in the amount of $5,000,000, there are some real opportunities for reducing estate and gift taxes and perhaps overall family income taxes.
When young children are involved in this gift giving and overall family program, the use of trusts to own their membership interests should be explored and implemented with an experienced estate and tax attorney.
In certain states and cities, such as Pennsylvania and Philadelphia, a transfer tax is imposed on this change in title. If a person transfer title of real estate to a newly formed LLC, the result in a very large unforeseen tax cost. This is why it is better to form the LLC first and have it acquire the real estate. Essentially, purchasers of real estate need to plan the proper vehicle and ownership of membership units before actually acquiring such real estate to avoid unpleasant surprises or hidden costs and to maximize the tax position of their family from a global family perspective.
Whether you are subject to the passive loss limitation rules depends on many complicated factors (material participation, AGI less than $150,000, involvement as a real estate broker, etc.) that need to be explored to maximize income tax planning.
If you own the LLC 100% than it is treated as a disregarded entity for tax purposes. This allows you to report the LLC income or losses on your Form 1040, Schedule E while the LLC need not file separate returns, at least at the federal level. In any event, some states may require the LLC for file certain corporate tax returns.
Before making any real estate purchase it would be wise to meet with a tax and estates attorney to explore your options in structuring the purchase of the real estate, the choice of entity and how the LLC should be owned. Waiting until after you purchase the real estate could be a very costly mistake.
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