The liability exposure problem without adding tax complexity.
Single-member limited liability companies (SMLLCs) are limited liability companies (LLCs) with only one member (owner). As with a corporation, operating a business or investment activity as an LLC generally protects your personal assets from exposure to liabilities related to the activity — under applicable state law. However, SMLLCs offer some unique tax attributes that make them ideal real estate ownership vehicles. Here’s the story on their advantages.
Advantage: Disregarded SMLLCs are ignored for federal income tax purposes
Under IRS regulations, the existence of an SMLLC is generally ignored for federal income tax purposes. In other words, the SMLLC is a so-called disregarded entity. The federal income tax treatment of a disregarded SMLLC is super-simple: its activities are considered to be conducted directly by the SMLLC’s sole member (owner). For instance:
* When a disregarded SMLLC owned by an individual is used to own rental real estate, the federal income tax results are reported on the individual member’s Form 1040. You need not file a separate federal income tax return for the SMLLC.
* When a disregarded SMLLC is owned by a partnership, the SMLLC’s federal income tax results are reported on the partnership’s federal income tax return (Form 1065). No separate federal income return is required for the SMLLC.
You get the idea. This is easy!
Advantage: Disregarded SMLLCs are separate legal entities under state law
Here’s where it starts to get interesting.
Although disregarded SMLLCs are ignored for federal income tax purposes, they are not ignored for general state-law purposes.
* A disregarded SMLLC will deliver to its member (owner) the liability protection benefits specified by the applicable state LLC statute. These liability protection benefits are usually similar to those provided by a corporation.
The preceding happy set of tax and legal circumstances for disregarded SMLLCs open up some nice planning opportunities in the real estate arena. Please keep reading.
Strategy for real estate owners
Real-estate investors are rightly concerned about exposure to all the various and sundry liabilities that property ownership can entail. These can range from environmental liabilities to personal injury claims when tenants or visitors slip and fall on icy sidewalks.
Setting up a disregarded SMLLC to own real estate addresses the liability exposure problem without adding tax complexity. The SMLLC’s member (this could be you) will probably have to personally guarantee any mortgages against the SMLLC’s property, but that’s par for the course in the real-estate world.
Here’s where it gets even more interesting. The disregarded SMLLC’s member (this could be you) is considered to directly own for federal income tax purposes any real estate that is actually owned by the disregarded SMLLC. Therefore, an exchange of property owned by your SMLLC will be treated as an exchange by you personally for purposes of the Section 1031 like-kind exchange rules. Under these rules, you can potentially swap appreciated real estate for a replacement property (or properties) while owing little or nothing to Uncle Sam. Meanwhile, the relinquished property that you give up in the exchange and the replacement property (or properties) received in the exchange can at all times be held within the liability-limiting confines of the SMLLC. Wonderful! If you are the skeptical type, please be assured that the IRS has repeated confirmed this taxpayer-friendly conclusion.
If property that you will relinquish in an upcoming like-kind exchange is currently owned directly by you as an individual, you can set up a new disregarded SMLLC to receive the replacement property. The exchange will still qualify for tax-deferred treatment under the like-kind exchange rules, because both the relinquished and replacement properties are considered owned directly by you as an individual for federal income tax purposes. However under applicable state law, the SMLLC will protect you from liabilities associated with the replacement property, because you personally will never appear in the chain of title.
Disregarded SMLLCs owned by partnerships and other LLCs can deliver the same legal and tax benefits. For an IRS primer on like-kind exchanges, see Like-Kind Exchanges Under IRC Code Section 1031.
Don’t overlook state and local tax implications...
While disregarded SMLLCs work great as real estate ownership vehicles under the federal income tax rules, there might be adverse state and local tax considerations. For example, Texas SMLLCs with incomes above certain levels must pay the state’s franchise tax (similar to a corporate income tax). Fortunately, the tax will not be a big number in most cases. Even if a disregarded SMLLC isn’t required to pay any state tax, it may still have to pay an annual registration fees and file some paperwork.
The bottom line
You now understand the liability protection and federal income tax advantages of using a disregarded SMLLC as a real estate ownership vehicle. Even so, please consult a tax pro before taking action. I want you to understand exactly what you are getting into.
Plus: Disregarded SMLLCs must pay certain federal taxes in their own names
While disregarded SMLLCs are ignored for federal income tax purposes, they are treated as separate taxpayers for federal employment tax purposes and for certain federal excise tax purposes. Specifically:
* Disregarded SMLLCs are treated as separate corporations for federal employment tax purposes. As such they must withhold Social Security and Medicare taxes (FICA taxes) from employee paychecks, pay the employer’s half of Social Security and Medicare taxes, pay federal unemployment tax, and withhold federal income tax from employee paychecks — just like any other corporate employer. The must also file federal payroll tax returns just like any other employer. However none of this matters if the SMLLC has no employees.
* Disregarded SMLLCs must also pay certain federal excise taxes and file Form 720 (Quarterly Federal Excise Tax Return) just like any other taxpayer. However these excise taxes are unlikely to apply to an SMLLC used just to own real estate.
To inquire about about Investment opportunities in Real Estate, contact: 314-500-1515 or email: info@STAgencyRE.com