Over the years I’ve been asked a number of times about how to set up and operate an LLC. This is typically in regard to “running a business” and coming from someone that is buying an investment property or in a similar situation. This post is a quick guide to getting an LLC set up (and as the disclaimer at bottom notes, not legal, business, or tax advice).
After completing a renovation, consider protecting your investment with an entity like an LLC.
First – why create an LLC? Primarily for liability protection. You do not need an LLC to conduct business. You can operate a business as a sole proprietor without any legal form or as a partnership (formal or informal) or any other entity structure. An LLC provides liability protection if a suit or claim impacts the assets that the LLC holds. In the case of real estate this would typically mean the LLC holds the title to the property, and any debts, and if the property had a loss or claim the LLC entity would help to protect the other assets of the LLC owner(s). The loss or claim could be a discrimination suit, property damage that exceeds insurance coverage, or a personal injury on the property. In addition to creating an LLC there are a variety of other tools you can use to reduce liability exposure, which I call the “The Protection Pyramid“.
If you do want to create an LLC the steps to do so are pretty straight-forward, but can be a bit intimidating if you aren’t already familiar with the registration and creation processes. An attorney can be a great help if you don’t want to do the paperwork yourself and will typically run in the range of $500 – $2,000 in my experience.
If you want to create an LLC yourself the basic steps are:
- State registration – An LLC is created at the state level, by filing the formation documents with the Secretary of State. You’ll need to complete an LLC Operating Agreement and/or Articles of Organization to create the LLC, which are then provided to the state. You can hire an attorney to create these documents, use an online provider like LegalZoom, or download a free template like this one. I would generally opt for the attorney option, at least for your first LLC to ensure it’s done properly. The state will then provide you with a state ID number and the LLC is officially created. There will typically be a small fee to register, and an annual form and filing fee for future years. (For an example, here is the Nevada website to register a new LLC.)
- Federal registration – After creating the LLC at the state level you will want to register with the IRS to get a Federal Employer Identification Number (FEIN). You can do this online on the IRS website. This process is free.
- Bank account – For any business entity like an LLC make sure to keep business transactions separate from personal transactions. This goes for any income and any expenses. It will also make it easier to report the business activity at tax time. You can set up this account at any bank but should consider monthly fees, ATM access, and other banking offerings you may want. I also highly recommend a business credit card so you can conveniently make purchases in addition to the checking account. I personally like the Capital One Spark Business Card which offers 2% cash back on all purchases. Credit cards also offer better fraud protection than bank accounts, and reward programs like cash or travel miles.
- Financial software – This is not a required step, but one I highly recommend. Financial software organizes all the transactions for the business more easily and can create an income statement, balance sheet, or other reports. I use Quickbooks but you can also use NetSuite, Freshbooks, or a variety of other options. Whichever you pick, having online access and bank account syncing are critical tools to consider.
If you are the sole owner of the LLC you will include the business activity directly on your personal tax return each year and not likely have additional income tax filings required. If you have more than one owner you will likely need to file an annual income tax return on Form 1065 for Federal purposes and a state specific LLC return as well. The LLC does not pay income taxes, but will provide a Schedule K-1 to each LLC owner with their share of the business activity, which is incorporated into their individual tax return (Form 1040).
I hope this quick summary of the process to create an LLC is helpful to you. An LLC can be a great tool to give yourself additional liability protection at fairly low annual cost.
An LLC can help avoid the prick of claims on your assets. Ouch!
Note: The content of this post is for informational and discussion purposes and is not financial or tax advice. Consult with an advisor before relying on this or any information.