Should you form an LLC to co-buy a home?
Forming an LLC to co-buy and co-own property has implications for financing, accounting, taxes, and legal. We break it down and talk to the experts.
💡 At a Glance
• An LLC is a business structure
• Co-ownership doesn't require an LLC
• Practical and affordable alternatives exist
At CoBuy, we’ve worked with all kinds of co-owner groups. You name it—friends, family, unmarried couples, multiple couples—we’ve seen it. Over the years, we’ve often been asked: "Should we use an LLC to co-buy a home?".
With so much information out there on LLCs in real estate, it's crucial to separate fact from fiction. Co-ownership is a personal decision, and having quality information empowers decision-making.
In this post, we'll explore:
- Co-buying and co-ownership basics
- LLCs in real estate
- When LLCs make sense
- Challenges with LLCs
- Tenants in Common as an alternative
Spoiler alert: You don't need an LLC to co-own a home with friends, family, or your partner. In many cases, the costs of creating and managing an LLC outweigh the benefits.
Co-buying and Co-ownership Basics
Co-buying is when two or more people who aren't married join forces to purchase a home. Traditional real estate practices don't address co-buying and co-ownership well since they're built around the concept of a nuclear household.
It’s helpful to think of co-ownership in three stages:
- Co-ownership period
- Exit (by sale or transfer)
You also want to consider equity and debt.
Every situation is different, and the right structure for your co-ownership arrangement depends on your circumstances and goals.
➡️ Who is involved?
➡️ How will you or did you finance the purchase?
➡️ What are your goals?
Answering these questions is a great starting point.
The Lowdown on LLCs
A Limited Liability Company (LLC) is a business structure that can combine the pass-through taxation of a partnership or sole proprietorship with the limited liability of a corporation. In real estate, investors sometimes use LLCs to buy and hold property investments for financial or legal protection, tax minimization, and flexible membership. While LLCs have their place, they may not be suitable for everyone.
The IRS says:
“A Limited Liability Company (LLC) is a business structure allowed by state statute. Each state may use different regulations, you should check with your state if you are interested in starting a Limited Liability Company.
Owners of an LLC are called members. Most states do not restrict ownership, so members may include individuals, corporations, other LLCs and foreign entities. There is no maximum number of members. Most states also permit “single-member” LLCs, those having only one owner.”
When do LLCs make sense?
There are no hard and fast rules here, friends. Generally, using an LLC to buy and own property makes sense for:
- Real estate investors who own/operate multiple cash-flowing properties
- Co-owners who own property with people they don’t know, where all parties are comfortable paying substantial recurring fees to a management company
Remember: forming a limited liability company entails costs and responsibilities. Consider the periodic tax and accounting reporting requirements. Failure to comply can undermine the intended benefits, incur financial costs and penalties, and carry legal implications.
Challenges with LLCs
Setting up an LLC to co-own a home with your partner, family members, or friends might not be your best bet. Here are a few reasons why:
Getting a mortgage: Most mortgage lenders won't lend to a newly-formed LLC created solely to buy and own a primary residence. They view this as a risk since an LLC limits individual liability. Attempting to transfer ownership to an LLC after closing can trigger the due-on-sale clause, which allows a lender to demand immediate repayment of the mortgage in full if there's a sale or transfer of ownership.
Costs: Forming an LLC involves time, cost, and complications. Shane Yelish, a real estate attorney, says: "There are costs to form the LLC and annual fees to maintain the LLC." Requirements include filing Articles of Organization, securing a Registered Agent, and creating an Operating Agreement. LLCs are also subject to tax and regulatory reporting requirements at the state and federal levels. Luke Frye,CPA, points out:
"Generally, an LLC is meant for a profit-seeking business entity. Using an LLC to co-own real estate generally makes it a partnership for federal income tax purposes. That means you’d have to file a Form 1065, due March 15th.
The LLC is a flow-through entity for federal income tax purposes, which means it doesn’t pay federal income tax, but you do on your personal return. This would then be reported on a K-1 and carried to schedule E on your personal return due in April.
You may have other state and local tax obligations as well."
Risks and implications: If you're buying a primary residence, using an LLC can eliminate tax benefits such as mortgage interest tax deductions, capital gains exclusion, and 1031 exchange eligibility.
ℹ️ Due-on-sale clause
A provision in a mortgage contract that allows the lender to demand immediate repayment of the loan in full if the property is sold or its ownership is transferred.
💡Capital Gains Exclusion Example
The IRS provides a tax break for homeowners who sell their primary residence and make a profit. A single homeowner can exclude up to $250,000 in capital gains, and a married couple can exclude up to $500,000. However, if you own the property through an LLC, you might not be eligible for this tax benefit.
Alternative: Tenants in Common (TIC)
Many co-buyers opt for a Tenants in Common (TIC) structure. It's flexible, cost-effective, and compatible with residential mortgage lending standards. Best of all, TICs don’t require you to create and manage a business entity. That said, folks who choose the TIC route should create a co-ownership agreement to define the terms of co-ownership and address various risk scenarios. TIC arrangements allow each co-buyer to own a distinct, undivided interest in the property, making it easier to manage ownership shares, occupancy rights, and exit strategies.
Should you form an LLC? There’s no one-size-fits-all answer. That said, you don’t need an LLC to co-own your home—particularly if it’s a primary residence for one or more co-owners.The costs and complications of forming and maintaining an LLC often outweigh the benefits for co-owners.
⚡ Key Takeaways
• LLCs have their place in real estate
• You don’t need a business entity for your primary residence
• TICs can be a more practical, affordable alternative for co-owners
If you just want exposure to real estate as an asset class, check out our friends Lofty. They let you invest as little as $50, and they'll handle the LLC.