Single-member LLCs are limited liability companies with only one member (owner). They have become popular for business and investment activities.
Should you use a single member LLC as a real estate ownership vehicle?
That might be a very good idea. This blog post explains why.
Ignore the Disregarded Single-Member LLC for Federal Income Tax Purposes
Under the so-called check-the-box regulations put out years ago by the IRS, you can generally ignore the existence of a single-member LLC for federal tax purposes.
The exceptions are:
- when you elect to treat a single-member LLC as a corporation for federal income tax purposes (relatively unusual), and
- for purposes of most federal employment taxes and certain excise taxes (see Sidebar 1 below).
When you choose not to treat a single-member LLC as a corporation for federal income tax purposes, the single-member LLC has disregarded entity status for those purposes, and we will call it a “disregarded single- member LLC.”
The federal income tax treatment of a disregarded single-member LLC is super-simple, because its activities are considered to be conducted directly by the single-member LLC’s sole member (owner).
For instance:
- When an individual (like you) uses a disregarded single-member LLC to own rental real estate, you simply report the federal income tax results on Schedule E of Form 1040. You need not file
a separate federal income tax return for the single-member LLC.
- When your corporation owns a disregarded single-member LLC, it’s considered an unincorporated branch or division of the corporation. So, you simply report the single-member LLC’s federal income tax results on the corporation’s Form 1120 (for a C corporation) or Form 1120S (for an S corporation). You need not file a separate federal income tax return for the single-member LLC.
- When a partnership owns a disregarded single-member LLC, you simply report the single- member LLC’s federal income tax results on the partnership’s Form 1065. You need not file a separate federal income tax return for the single-member LLC. Ditto when a single-member LLC is owned by a multimember LLC that’s treated as a partnership for federal income tax purposes.
You get the idea.
Take Advantage of Single-Member LLC Liability Protection
Although you ignore a disregarded single-member LLC for federal income tax purposes, it is not ignored for general state-law purposes.
Therefore, a disregarded single-member LLC will deliver to its sole member (owner) the liability protection benefits specified by the applicable state LLC statute. The liability protection benefits are usually similar to those offered by a corporation.
The bottom line. With a disregarded single-member LLC, you get super-simple tax treatment combined with corporation-like liability protection. This happy set of circumstances opens up some real planning opportunities in the real estate arena.
As a real estate investor, you 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.
Strategy: Use a Disregarded Single-Member LLC to Own Real Estate
Setting up one or several disregarded single-member LLCs to own your real estate assets addresses your liability-exposure problem without adding tax complexity, since no separate federal income tax returns are required for your single-member LLC(s).
More Tax Advantages
As the sole member (owner) of a disregarded single-member LLC, you are considered to directly own, for federal income tax purposes, any real estate that is actually owned by the disregarded single-member LLC.
Therefore, when you exchange property owned by the single-member LLC, it is treated as an exchange by you for purposes of the taxpayer-friendly Section 1031 like-kind exchange rules.
Meanwhile, the property you relinquish in the Section 1031 exchange and the replacement property you receive in the exchange can be held within the liability-limiting confines of the single-member LLC.
If you are the skeptical type, please note that the IRS has more than once confirmed this taxpayer-friendly conclusion.
Strategy. If you directly own property that will be relinquished in an upcoming Section 1031 exchange, set up a disregarded single-member LLC to receive the replacement property.
The exchange will still qualify for Section 1031 treatment, because both the relinquished and the replacement properties are considered owned directly by you for federal income tax purposes.
But under applicable state law, the single-member LLC will protect you from liabilities associated with the replacement property, because you personally may never appear in the chain of title for that property.
Takeaways
The beauty of the single-member LLC for your rental real estate is tax simplicity with corporate-style liability protection.
You obtain the tax code disregarded entity status with single-member LLCs owned by corporations, partnerships, and other LLCs, and they also deliver the same legal and tax benefits.
See Sidebar 1 below to understand how tax law treats disregarded single-member LLCs as separate taxpaying entities for most federal employment taxes and certain federal excise taxes.
See Sidebar 2 to understand why you may need to consider state and local tax issues that could affect the
attractiveness of using a single-member LLC as a real estate ownership vehicle.
Sidebar 1: Disregarded Single-Member LLCs Must Pay Certain Federal Taxes in Their Own Name
Although disregarded single-member LLCs are ignored for federal income tax purposes, they are treated as separate taxpayers for most federal employment tax purposes and for certain federal excise tax purposes. Specifically:
- Disregarded single-member LLCs are treated as separate corporations for federal employment tax purposes. As such, they must withhold Social Security and Medicare taxes (FICA taxes) from employees’ paychecks, cough up the employer’s half of FICA taxes, pay the FUTA tax, withhold federal income taxes from employees’ paychecks, and file Forms W-2 and 941 just like any other corporate employer.
- Disregarded single-member LLCs must also pay certain federal excise taxes and file Form 720 (Quarterly Federal Excise Tax Return) just like any other taxpayer.
Exception. You have proprietorship treatment (not corporate treatment) for family employment, as explained the IRS Now Says No Payroll Taxes on Family Employment in a Single-Member LLC.
Sidebar 2: Beware of State and Local Tax Issues
Although a disregarded single-member LLC can work great as a real estate ownership vehicle under the federal income tax rules, watch out for adverse state and local tax considerations.
For example, Texas single-member LLCs generally must pay the state’s corporate franchise tax, whereas individuals and partnerships are exempt.
Even if a disregarded single-member LLC is not required to pay any entity-level state taxes, most states impose annual registration fees and some may require the filing of separate returns.
On the other hand, using a disregarded single-member LLC can sometimes be beneficial under local tax rules.
In one real-life case, the taxpayer acquired a disregarded single-member LLC that owned the replacement property for a Section 1031 exchange. This indirect acquisition of the replacement property allowed the taxpayer to avoid local real estate transfer taxes that would have otherwise been due.
Meanwhile, the transaction was treated as a direct acquisition of the replacement property under the taxpayer-friendly Section 1031 exchange rules, because the single-member LLC’s existence was disregarded.
Bottom line. Always consider state and local tax implications before using a disregarded single- member LLC