The pros and cons of various ways to purchase real estate investment property.
Real estate is often used as a vehicle for investment. The hope is that property purchased now will be worth more when sold in the future, particularly if the owner makes improvements to it. When buying an investment property, you have the option of purchasing it in your own name or purchasing it under the name of another entity, such as a real estate trust (also called a realty trust) or a limited liability company (LLC).
Each of these options has benefits and drawbacks, largely related to the scope of the owners anonymity and liability protection. In making this choice, you might also wish to consider the type of property you are buying, the number of tenants you will have at that property, and your time horizon for holding onto the investment property before reselling it.
Reasons to Purchase Property as a Real Estate Trust
A trust is a legal vehicle used to pass assets, in which trustees hold title to the property for the benefit of one or more beneficiaries. This arrangement is widely used as a tool to disguise owner names, to help with estate planning, or to allow a group of people to invest in a property without getting taxed differently.
Heres why a real estate trust can be a good option for some investors:
- Multiple owners. If there will be several owners of an investment property, a trust is useful for documenting the relationships and ownership interests of all the owners in a consolidated fashion.
- Estate planning. For people looking to ensure that their investment property avoids death taxes, transferring it to heirs by way of a real estate trust can be a workable option.
- Some level of anonymity. At one time, real estate trusts were a great way for investors to remain anonymous. But as counties and town assessors increasingly go online with recorded deeds and tax information, it is more difficult for anonymity to be maintained. Someone looking to buy an investment property solo will be the principal trustee of that trust by default, and his or her name will likely 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 tax treatment as an individual, it makes more sense to do a realty trust when a number of people have interest in the property being obtained.
The downside to a trust is that the rules around how much can be put into a realty trust for estate planning purposes change frequently, 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 Property as a Real Estate LLC
An LLC is a business entity that is separate from its owners, like a corporation. But unlike a corporation, which must pay its own corporate taxes, an LLC is a pass-through tax entity, which means that business profits and losses pass through to its owners, who report them on their personal tax returns (just as they would if they owned a partnership or sole proprietorship). Because of an LLCs unique benefits, an LLC is often the best way for some investors to purchase property. Heres 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 be sued only 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, its a step most people dont 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 owners 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, anywhere between $75 and $250.
For details on LLCs, including how members are taxed, state rules on LLC protection for members personal debt and asset protection, and more, see Nolos LLCs section. Nolo also offers a comprehensive online LLC package to form an LLC.
Reasons to Purchase Investment Property Under Your Own Name
Of course, the most obvious way to purchase real estate (like any other form of property) is simply in your own name, without any other legal vehicle. Here are factors to consider:
- 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 being owned by 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 in your own name.
- Mortgages. It can be easier to obtain a mortgage under your own name, because banks will want to be able to pursue your personal assets should you default on your loan payments.
The key drawback to buying under your own name is liability; 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.
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