Just like any investment, you have to consider a lot of things when flipping houses. Among these considerations, the decision of whether or not to form a Limited Liability Company (LLC) can be quite critical.
The answer to this question depends on a multitude of factors, including your financial situation, risk tolerance, and long-term investment goals.
To help you decide, this blog focuses on the intricacies of house flipping under an LLC, unraveling the complexities that often surround this decision-making process and providing you with expert insights to guide your real estate investment journey.
An LLC, or Limited Liability Company, is a type of business structure that combines the operational flexibility of a partnership or sole proprietorship with the legal protections of a corporation. In other words, it is an unincorporated business.
When applied to real estate, an LLC allows investors to buy and sell properties under the umbrella of a company rather than as individual investors.
A Sole Proprietorship, on the other hand, is a business that has a sole owner. In other words, this business is run by one individual who is responsible for all of the company's debts. In sole proprietorships, there's no legal distinction between the owner and the business. This means that the owner is personally liable for all the business' debts, losses, and liabilities.
If a sole proprietor uses their personal name for their real estate business and a lawsuit arises, their personal assets can be at risk.
An LLC isn't a requirement to start investing in real estate or flipping houses. Plenty of successful real estate investors operate as individual sole proprietors, especially when starting out.
The decision to establish an LLC should be primarily influenced by your personal risk tolerance and business goals. House flipping involves a significant amount of risk, and these risks can potentially lead to legal action.
An LLC provides a layer of separation between personal and business assets, which can be especially important when facing a potential lawsuit.
Many investors encourage using an LLC to flip houses because of its tax advantages. But apart from this, this strategy actually has a lot of other benefits and they’re all detailed below.
One of the most notable benefits of using an LLC for flipping houses is the potential for significant tax flexibility. An LLC, by default, is a "pass-through" entity for local tax purposes. This means the LLC's income is not taxed at the company level.
Instead, the income taxes or losses are passed through to the individual members and reported on their personal tax returns. This can help avoid the issue of double taxation faced by some other types of corporations as the tax is separate from your personal taxes..
Moreover, LLC members can also take advantage of tax deductions available to businesses, such as deducting the expenses related to running the house flipping business, including office space, travel, equipment, and more without the need for any tax attorney. In the long run, this can help you keep your business running without financial issues even after you pay taxes.
Aside from benefits on personal tax returns, another key advantage of an LLC is it can help you protect your personal assets as a house flipper. This is known as limited liability protection.
If the LLC incurs debt or if the business is sued after starting a house flipping business, the members' personal assets, such as their homes, cars, or personal bank accounts, business credit card, are generally not at risk because it is an unincorporated business. Only the assets owned by the LLC can be used to pay off the debts or the business liability.
This is a crucial advantage if a house flip goes wrong or a legal issue arises related to a property you're flipping. LLC is a great way to protect your business from liability.
Compared to investors without an LLC, house flipping LLCs tend to require less paperwork and administrative upkeep. For instance, corporations are typically required to hold annual meetings, maintain meeting minutes, and issue stock, among other formalities.
On the other hand, an LLC has fewer state-imposed annual requirements and ongoing formalities so it is ideal for starting a house flipping business. However, it's important to remember that while there may be less paperwork compared to a corporation, there's still an obligation to maintain proper business records and necessary licenses.
LLCs offer flexibility in terms of ownership and management. If you decide to include additional partners or different types of business entities even after starting your house flipping venture, it's relatively easy to do so. LLCs don't have restrictions on the number of members they can have.
New members can be added to the LLC by simply amending the LLC operating agreement after setting up your business. This flexibility can be particularly beneficial if you want to pool resources with others to invest in more expensive properties or diversify your investments.
By operating under an LLC, you can enhance your earning potential with each successful transaction. This comes down to the professionalism and credibility an LLC can provide. If you're dealing with sellers, contractors, or financial institutions, operating as an LLC can show them you're serious about your legitimate business.
This professional appearance can often lead to better deals, terms, or opportunities, all of which can contribute to enhancing the earning potential of each successful house flip.
One often overlooked benefit of operating under an LLC is that it is possible to transfer or sell the enterprise for financial gain. If you decide to exit even if your business is doing well, having an established LLC with a track record of successful transactions can be an attractive acquisition for other investors. Of course, all the owners of the company should consent.
The value of your LLC is not just in its physical assets (i.e., properties) but also in its brand, relationships, and operational systems unlike . Therefore, an LLC provides you with the flexibility to eventually sell the business for financial gain if you choose to withdraw from house flipping. You can easily sell your LLC without any issues.
As is with any investment, creating an LLC to flip houses has its own risks and advantages. It’s crucial that you know about all of these before taking the LLC route.
Creating a business entity for your house flipping business is an important choice since it comes with an increase in operational costs. While these costs vary by state, they often include the fees to file the necessary paperwork to establish the LLC, ongoing annual report fees, and potential franchise taxes.
Furthermore, you may need to employ the services of an attorney or accountant to ensure your paperwork is filed correctly, and your business remains in compliance with all relevant laws. It can be difficult to flip houses without spending a dime especially in the current market.
Opening a bank account for an LLC can be more challenging than opening a personal account. Banks will typically require copies of all your LLC's founding documents, including your Articles of Organization and Operating Agreement, and your Employer Identification Number (EIN) from the IRS.
Some banks may have additional requirements or paperwork, leading to a process that can be time-consuming. Moreover, some banks may have higher minimum balance requirements or charge higher fees for business accounts compared to personal accounts.
While an LLC is designed to offer protection for personal assets, these protections may not always be foolproof. This concept is often referred to as "piercing the corporate veil."
If you fail to maintain a clear separation between your personal finances and your LLC's finances, a court may rule that your LLC is merely an alter ego of your personal finances. In this case, your personal assets may be at risk.
Establishing an LLC can be a complicated process, particularly for those unfamiliar with business law and state regulations.
Each state has different rules for setting up an LLC, which can include drafting Articles of Organization and an Operating Agreement, obtaining an EIN from the IRS, and paying the necessary filing fees.
Mistakes during this process can lead to delays, potential legal issues, and additional costs. This complexity can be particularly challenging if you're trying to focus on finding and flipping houses.
If you are a business owner who have already decided to use an LLC to flip houses, you should be aware of the process of registering an LLC. Lucky for you, we’ve detailed all the steps below.
The first step in registering an LLC for flipping houses is to decide on your business structure. This involves considering whether an LLC is indeed the best structure for your needs, or if sole proprietorships, partnership, or corporation might be better suited to your situation.
The choice of structure will influence your personal liability, taxation, and administrative responsibilities.
Next, you need to choose the state where you want to register your LLC or new business. Most people choose to form an LLC in the state where they are planning to do most of their business.
However, some might choose to register in a state known for its business-friendly laws and regulations. It's important to research the specific LLC laws, costs, and ongoing requirements in your chosen state. After which, you need to file an LLC with the secretary of state through online application.
Choosing the right name for your LLC is an important step. The name should be unique and not currently in use by another company in your chosen state. Most states have an online database where you can check the availability of a business name.
Your LLC's name typically must end with an indicator of its limited liability status, such as "LLC" or "Limited Liability Company."
Every LLC is required to have a registered agent - a person or business entity authorized to receive legal documents on behalf of your LLC. The registered agent must have a physical address in the state where your LLC is registered.
Some states allow an individual within the company, including yourself, to serve as the registered agent, while others may require you to hire a professional registered agent service.
The Articles of Organization, sometimes known as the Certificate of Formation or Certificate of Organization, is the document you file with your chosen state to officially form your LLC.
This document usually includes information such as your LLC's name, its purpose, information about the registered agent, and the names of the owners (members). There is typically a filing fee associated with this document.
An Operating Agreement is a legal document that outlines the ownership structure or how your business will be run and member roles within the LLC. While not all states require an operating agreement, it is strongly recommended to have one.
This agreement details the responsibilities, rights, and obligations of each member and outlines how profits and losses will be distributed.
An Employer Identification Number (EIN), also known as a Federal Tax Identification Number, is used by the IRS to identify your business for tax purposes.
Even if you do not plan to have employees, most LLCs are required to obtain an EIN from the IRS. This can usually be done quickly and for free on the IRS website.
After forming your LLC, there are some additional steps to follow:
Each state has its own legal requirements for maintaining an LLC. This could include filing an annual report, paying an annual fee, or franchise taxes. Be sure to understand and keep up with these requirements to maintain your LLC's good standing.
Before you start business operations, you'll need to set up an accounting system. This involves setting up separate business bank accounts for your LLC to maintain a clear separation between your personal and business finances.
You'll also need to decide on an accounting method (cash or accrual), set up a bookkeeping system, prepare for your annual taxes, and manage other entities for house flipping.
With the LLC for a house flipping business officially formed and your accounting system in place, you can begin your business operations. This includes things like finding and purchasing properties to flip, hiring contractors, and marketing and selling your finished properties.
Finally, it's important to procure appropriate business insurance. This can protect your business and other entities for house flipping from financial losses due to things like lawsuits, property damage, or injuries.
The exact insurance you'll need can depend on various factors, including the state where your LLC is registered, the number of employees you have, and the nature of the properties you're flipping. It's advisable to work with a knowledgeable insurance agent to ensure you have adequate coverage.
The cost of forming and running a house flipping business using an LLC typically falls into the same range as forming any other LLC, with fees varying depending on the state. Generally, you can expect to pay between $50 and $500 for the initial filing fee to set up an LLC. This cost is associated with the processing of the Articles of Organization.
In addition, most states require an annual report that typically includes a fee ranging from $20 to $200. Some states also charge a yearly franchise tax or LLC fee.
The taxation of an LLC compared to a sole proprietorship in flipping houses can vary and depends on several factors. An LLC offers more flexibility and can choose to be taxed as a corporation if it is beneficial. For example, if an LLC generates a significant amount of income, it might choose to be taxed as a corporation to potentially lower its overall tax liability.
In contrast, a sole proprietorship cannot choose to be taxed as a corporation and might face higher self-employment taxes. This cannot be also used to protect their personal assets.
As you may have deducted from this blog, whether you need an LLC for a house flipping business depends largely on your individual circumstances and risk tolerance.
Registering your house flipping business as an LLC can provide a shield against personal liability, potential tax advantages, and the ease of adding additional partners. However, it also introduces higher operational costs, potential administrative complexities, and some unique challenges.
If you have already successfully registered an LLC for your flipping business, your next task would be to find the best deals. To do this, you can connect with us at Property Leads. We offer highly motivated seller leads generated from SEO and we sell them exclusively!
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