Single-member LLCs (SMLLCs) are LLCs with only one member (owner). Thanks to the taxpayer-friendly “check-the-box” entity classification regulations, SMLLCs have become a popular entity choice for various business and investment activities.
Because of its unique attributes, SMLLCs are also ideal for real estate holdings. Why, Because they provide liability protection along with tax simplification, while also setting the table for tax-deferred transactions under both the Section 1031 like-kind exchange rules.
Under the check-the-box regulations, the existence of an SMLLC is generally ignored for federal tax purposes (the exception is when the member treats the SMLLC as a corporation, which is relatively unusual). This disregarded entity status means that the business or investment activity carried on by the SMLLC is considered to be conducted directly by the SMLLC’s member for federal tax purposes. When an individual uses an SMLLC to operate a business, the tax results are reported on the individual’s Schedule C, just as if the business were a sole proprietorship. No additional federal tax forms need be filed. When an individual’s SMLLC is used to own and operate rental real estate, the tax results show up on the member’s Schedule E. When a corporation owns an SMLLC; the SMLLC is considered to be an unincorporated branch or division. When an SMLLC is owned by an entity treated as a partnership, the SMLLC’s activities are directly reflected on the member’s Form 1065 with no additional federal tax forms required.
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 slip and fall on the sidewalk. Setting up an SMLLC to own real estate addresses the liability exposure problem without adding tax complexity since no additional federal tax forms are required. Of course, the SMLLC’s member will often be required to guarantee any mortgages against the SMLLC’s property personally, but that’s par for the course.
Here’s where it gets interesting. As explained earlier, the SMLLC’s member is considered to directly own, for federal tax purposes, any real estate that is owned by the SMLLC. Therefore, an exchange of property owned by the SMLLC will be treated as an exchange by the member for purposes of the Section 1031 like-kind exchange rules. Meanwhile, the relinquished property given up in the exchange and the replacement property received in the exchange can at all times be held within the liability-limiting confines of the SMLLC.
If the property to be relinquished in an upcoming Section 1031 exchange is currently owned directly by an individual, he or she can set up a new SMLLC to receive the replacement property. The exchange will still qualify for Section 1031 tax-deferred treatment because both the relinquished and replacement properties will be considered owned directly by the individual for federal tax purposes. However, under applicable state law, the SMLLC will protect the individual from liabilities associated with the replacement property because he or she will never appear in the chain of title.
Single member LLCs are excellent entities to own real estate.