By Greg Herlean
No investment you ever make will be without risk, and real estate investing is no exception. If you do your homework and make sure you stick with your budget, you can almost always make a great profit flipping houses, but even this steady and lucrative market has its risks. At our Property Bank workshops, I’ve heard a lot of questions about these risks, how to avoid them, and how to recover from them. One option that a lot of people ask about is incorporating and/or creating an LLC for their real estate investing businesses.
What Is an LLC?
LLC stands for limited liability company, and it’s basically a legal business structure that protects all owners of the company from personal liability for any debts or claims accrued by the business. Basically, if your house flipping business gets in trouble, your loan holders, the IRS, and anyone else you owe money to can only come after assets that are owned by your LLC.
What’s the Difference Between an LLC and a Corporation?
A lot of people get confused when it comes to creating a corporation versus creating an LLC. A corporation is legally a separate entity from you and is considered to be a “person” in terms of tax laws and contracts. As a result, your corporation will be taxed separately from you. With an LLC, you’ll have a “pass-through” tax entity, so you’ll be taxed based on your LLC but you won’t be personally liable for your business’ debts and liabilities.
If you’re expecting to have multiple partners and investors in your business, creating a corporation is the way to go, but this really isn’t the case for most house flippers. While you’ll be working with others, they won’t be owners, and so if you’re incorporating in any way, it’s best to do it through an LLC (an S-corp) instead of creating a C-corporation.
Are You Worried About Personal Exposure?
In a perfect world, all of your house flipping deals would go through without a hitch, and you’d never find major problems like structural damage halfway through rehab. You’d also never have issues with a house sitting on the market for much longer than you’d imagined possible. Without these kinds of stumbling blocks, you would never need to worry about incorporating your business.
If you’re just getting started and you’re concerned about paying off hard money loans or paying back investors in the case of a disaster during a flip, you might want to consider creating an LLC for your house flipping business. Forming an LLC requires only one owner, so you can do this before you invest in your first flip if you want. It may be the insurance you need to feel comfortable making your first investment and starting to grow your business in earnest.
It Does Take Work and Maintenance, and Has Expenses
With all that in mind, a lot of real estate investors find that it’s just not worth it to spend the time, effort, and money to form and maintain an LLC. In fact, some house flippers invest in liability insurance instead to cover them in cases when they would otherwise have to pay out a great deal or risk their personal assets. However, insurance does have its limits, and it won’t cover everything.
In all honesty, it’s almost never a bad idea to protect your personal assets by creating an LLC for your real estate investing business. It does take some maintenance, but your accountant should be able to handle most if not all of this for you. And you’ll be able to rest assured that you’re protected in case of a disaster for your business.