Should You Invest in Real Estate Syndicates & Funds as an Individual or Through an LLC?
From time to time we get asked about the advantages and disadvantages of investing in real estate syndicates and funds as an individual vs. an LLC.
In this article, we’ll discuss the advantages and disadvantages of investing in each primarily from a tax perspective, and we’ll touch on other aspects from a more general perspective.
Investing as an Individual
Investing as an individual, or in your personal name, is the most common way for individual investors to invest in syndicates and funds.
From a tax perspective, it’s generally the simplest as well. As an individual investor, you will generally invest in a partnership as a limited partner and receive a K-1 that reports your share of the partnership’s income, deductions, credits, etc.
This K-1 will then get reported on Schedule E Page 2 of your individual tax return, Form 1040, and you will be subject to tax according to your individual circumstances.
While I’m not an attorney, generally as a limited partner you will not be liable for any of the debts or obligations of the partnership. In addition, you should also be protected from potential lawsuits that may arise from the operations of the partnership.
Investing via a Revocable Living Trust
If you have a revocable living trust, you may wish to invest in the name of the trust so the investment will bypass probate upon your death.
These trusts are generally disregarded for tax purposes and will be taxed in the same manner as if you invested in your personal name as described above.
That being said, investing as an individual or via a revocable living trust is generally the appropriate way to invest for most investors.
Investing Through an LLC
Single-Member LLC (SMLLC)
If you use a single-member LLC (SMLLC) to invest in syndicates and funds, the LLC will generally be treated as a disregarded entity and taxed the same way as if you invested in your personal name.
Thus, there are generally no tax benefits of investing through an SMLLC. Also, generally the LLC wouldn’t add any additional protection from the liabilities of the partnership as the investor is already a limited partner with no management responsibilities.
However, we’ve worked with some clients that use SMLLCs, at the direction of their attorney, to help protect their investment from potential liabilities from their other business activities. That’s something you would have to consult an attorney on to see if it makes sense for you.
As for the disadvantages of investing via an SMLLC, there aren’t many outside of some administrative costs to maintain the LLC. These costs vary state to state and are generally low, however, there can be additional tax considerations for investors who live in states like California and Tennessee.
Multi-Member LLC (MMLLC) Taxed as a Partnership
Multi-Member LLCs (MMLLCs) are LLCs that have more than one member (i.e. owner) and are often taxed as partnerships when they invest in syndicates and funds.
One advantage of an MMLLC is that, in some cases, it can allow individual investors to pool money together to meet the minimum investment requirements of a particular syndicate or fund when they don’t have the capital to make the minimum investment individually.
In this case, the LLC will receive a K-1 from the private investment partnership and then report the K-1 on the LLC’s partnership tax return, Form 1065. Then the LLC’s members will receive a K-1 from the LLC and report their share of the investment’s income, deductions, credits, etc., on their individual returns.
The disadvantage of this is more administrative costs because the MMLLC has to also file a partnership tax return, adding another layer of cost and complexity to what many want to be a simple passive investment.
The Bottom Line
Generally, investing in syndicates and funds as an individual or via revocable trust will be just fine for the needs of most individual investors – even though investing through an LLC sounds sexy.
However, there are special circumstances where investing through an entity may make sense. Before doing so, it is important that you seek the advice of your tax advisor in order to avoid unintended tax consequences.
