Real Estate Trust vs LLC: Which Is the Best Option for Investors?
Are you considering buying an investment property? If so, you are making a wise financial decision. Historically, real property has been one of the best wealth builders in the United States. It's not uncommon for home prices to appreciate 10% or more in any given year, and that's on top of the rents you can collect! With a vibrant economy and still (comparatively) inexpensive housing, Charleston has emerged as one of the top spots for investors. Investors looking to protect their assets (and we recommend you do) frequently debate using a real estate trust vs LLC for their investments.
Here's what you need to know about the topic, including which of these legal structures would work best for you!
Real Estate Trust vs LLC: What Are These Entities?
Before getting into the pros and cons of using each type of entity to buy your investment property, there's some critical background information that all investors should know.
First, real estate investing can incur legal liability. Something could happen with the property and injure your tenant, for example. In that case, the renter may sue for damages. Your assets (including your home) could be up for grabs if you, and not a company, own the property. Plus, if you buy a property in your name, anyone can look you up and know you own it. Therefore, most people want a legal entity to give them some level of privacy and shield them from some legal risk.
There are two commonly used entities to hold real estate: a real estate trust and an LLC.
A real estate trust is a simple legal entity that any lawyer can set up. Usually, it is a legal vehicle for people to pass assets to heirs, but people needn't necessarily use it for estate planning purposes. Technically, at its core, it's merely a way for some people to hold something for the benefit of others.
An LLC (short for limited liability company) is a formal legal structure recognized by all states, including South Carolina, that is a stand-alone business entity. It acts much like a corporation but is easier to set up and has less onerous reporting requirements. LLCs, as the name implies, shield owners from liability. It's possible to "pierce the corporate veil," but it's not easy with LLCs.
The question then remains, between these two legal vehicles, real estate trust vs LLC, which should you use?
Real Estate Trust Benefits and Drawbacks
To start, let's consider a real estate trust first. Real estate trusts are incredibly easy to set up. Any estate lawyer can set one up on behalf of their client. Some jurisdictions, like Charleston, don't even require people to register them with the county! They sit at a law office and are legal entities authorized to make real estate purchases.
Due to their nature, there are three main benefits that investors get when they buy using a real estate trust:
- Estate planning: If you want to ensure that your property avoids death taxes when you pass away, the real estate trust is fantastic for that - after all, that's its primary purpose!
- Easy to have multiple owners: A trust makes it easy to document all the owners and their relationships (including who gets what if one or more owners pass) in a single document.
- Anonymous (for multiple owners): If you are buying the property alone, you'll probably be the principal trustee, so people can know you own it pretty quickly; however, if you have multiple owners, the trustees are often obscured.
There are two primary downsides to using this method to buy a property:
- No liability limitations! If your tenants sue, your personal assets would be on the line. This downside is significant for using a real estate trust.
- Frequently changing rules: Unfortunately, the regulations around trusts can change. They are not as straightforward and iron-clad as corporate law.
All in all, real estate trusts are a fantastic option if you want to pass your investments to your heirs tax-free. They are not a good choice if you would like liability protection!
Limited Liability Company Pros and Cons
A limited liability company requires a little bit more paperwork and some money to set up. In South Carolina, an LLC costs somewhere between $100 and $400, depending on whether you have a lawyer do it or elect to fill out all the paperwork yourself. However, if you are investing from another state, you'll want to form the LLC in your home jurisdiction. In some states, like Nevada, Washington, and Texas, it can cost hundreds of dollars to form an LLC. When considered, though, with the hundreds of thousands you'll spend on the property, though, it's a relatively minor expense!
There are two main pros of LLCs for prospective South Carolina investors:
- Liability protection! Unless they can pierce the corporate veil (which is rare if you set it up correctly), your assets won't be fair game in a lawsuit or bankruptcy.
- More flexibility in property ownership: With an LLC, you could potentially even own a commercial property or multi-family unit. While it's possible to have those without a corporate entity, they're also higher risk (people coming in and out more frequently). The LLC gives you more freedom to buy any property in Charleston that you want, knowing that you have that liability protection.
There are two cons for LLC ownership:
- You're still not anonymous: looking up the owners of an LLC is as easy as going to your secretary of state's website and searching for the company. Structured right (and with enough people) a trust can provide some anonymity, whereas there is no way for an LLC to provide any.
- Not as significant inheritance tax benefits: While you can get a 40% discount transferring an interest in an LLC to your descendants, it's not as straightforward or intuitive as a trust is. It requires a lot more work and planning to avoid taxation.
All in all, an LLC is a wise decision when looking to own real estate! The liability benefits are significant, and the flexibility of property types is excellent if you're looking to expand your rental units!
Real Estate Trust vs LLC: Which You Pick Depends on Your Situation
Ultimately, the type of vehicle you use to own your Charleston property depends mainly on its purpose. When considering a real estate trust vs LLC, neither is unequivocally "the best." Choose a trust if you want to pass these homes to your children and lower their tax burden. However, if you are younger and are looking to build out your portfolio of rental properties, minimizing liability is substantial. That alone likely makes the LLC the more favorable legal entity.
Consult with a lawyer and a real estate agent. They can both help you find the right legal structure for your investments!
Charleston is one of the best areas to buy an investment property. It has a vibrant economy, sunny weather, and a picturesque lifestyle! If you are interested in purchasing an investment home, please get in touch with us! We'd love to help find you the perfect property!