Real Estate LLCs, Real Estate Trusts, and Other Real Estate Purchasing Options
The pros and cons of various ways to purchase real estate investment property.
When buying an investment property, you have the option of purchasing it in your own name or under another entity name, such as a real estate trust or a limited liability company (LLC). The reasons to do the latter mainly revolve around your desire for anonymity or liability protection. The type of property you are buying, the number of tenants you will have at that property, and the amount of investing you plan to do in the future, should all be considered when selecting your purchasing approach.
Reasons to Purchase Investment Property Under Your Own Name
Here are factors to consider when deciding whether or not to purchase investment property under your own name.
- Legal fees. Drafting the paperwork for either a realty trust or an LLC will require an attorney and other costs, which means more closing expenses. You can avoid the extra cost by putting the property in your own name.
- Insurance. Liability insurance is cheaper if the property is under your name, rather than an LLC. If you buy a single-family home under an LLC, your insurance premium might be twice the amount it would have been under a realty trust or your own name.
- Mortgages. It may be easier to obtain a mortgage under your own name because banks will want to have some recourse to pursue your personal assets, should you default on your loan payments.
The key drawback to buying under your name is liability: If you buy an investment property under your own name, then your personal home and other financial assets are exposed to lawsuit risk. Be sure to obtain an appropriate insurance policy to limit your level of risk in case someone is injured on the property.
Reasons to Purchase Investment Property Under a Real Estate Trust
A real estate trust is widely used as a tool to disguise owner names, help with estate planning or allow a group of people to invest in a property without getting taxed differently. Here's why a real estate trust may be a good option for some investors:
- Anonymity. Not too long ago, real estate trusts were a great way for an investor to remain anonymous, especially if they were investing in properties that were in, or near, the same town they lived. But as counties increasingly go online with recorded deeds, and town assessors go online as well, it is more difficult for anonymity to be maintained. If an individual is looking to buy an investment property alone, they will be the principal trustee of that trust by default, and their name will often appear on tax records, assessment records, and any other recorded documents that can be found online, including the deed as well as the declaration of the trust. To benefit from some level of anonymity while receiving the same tax treatment of an individual, it makes more sense to do a realty trust when a number of people have interest in the property being obtained.
- Multiple owners. If there will be several owners of an investment property then a trust is very useful to document the relationships and ownership interests of all the owners, in a consolidated way.
- Estate planning. For those looking to ensure that their investment property can avoid death taxes, many will transfer the investment property to their heirs by way of a real estate trust.
The downside to a trust is that the rules around how much can be put into a realty trust for estate planning purposes continue to change, and partners of a realty trusts will also have modifications they need to make in the future. These possibilities will require additional legal fees to manage down the road, on top of the original fees.
Reasons to Purchase Investment Property Under an LLC
For some investors, an LLC is the best way to purchase property. Here's why.
- Liability protection. Properties managed under an LLC have limited liability for the owner, meaning that should the property be subject to a lawsuit, the owners of the LLC can only be sued within the constraints of what the LLC owns, and not beyond that. This means that if you bought a commercial property under an LLC and someone files a claim against that property because they fell on some ice in the parking lot during the winter, the claimant cannot be rewarded reimbursement out of your personal assets. If the building was purchased under your own name, however, you risk exposure.
- Anonymity. Although you can look up corporations online in many states, and find out who the owners are, it’s a step most people still don’t take. At a community level, LLCs tend to offer more anonymity than realty trusts, unless you advertise the LLC.
- Commercial properties. If the target property will have more than one tenant, such as a multifamily apartment building, or will house commercial retail tenants, it is wise to purchase it under an LLC. A property like this is subject to a considerable amount of risk compared to a single-family home where only one person or one family comes home to it every day. Commercial buildings of any nature have a continuous daily flow of visitors and are often located in areas of high traffic. Accidents can happen anywhere and even the most conscientious of owners are still subject to lawsuits of any kind. Insurance companies tend to settle claims, even when the owner is at no fault, which can make insurance premiums sky rocket and limit the owner’s ability to get a policy. Having an LLC as a double layer of protection is a smart way to make sure no one can come after your home or other assets, should your insurance fail to cover you.
The key drawback to an LLC is financial: States charge an annual fee to file an LLC, typically in the $100 range, though some states can charge upwards of $500 or more.
For details on LLCs, including how members are taxed, state rules on LLC protection for members' personal debt and asset protection, and more, see Nolo's LLCs section. Nolo also offers a comprehensive online LLC package to form an LLC.