What are the Benefits of LLC for Rental Property?
Are you interested in joining the millions of real estate investors making money off rental assets? You are in the right place. Real estate is a significant investment that provides a stable passive income but comes with potential risks.
However, you can mitigate these risks by setting up a business to own the property instead of buying them in your name. So, how do you reduce the risks? Forming an LLC for your rental property will help manage your income taxes and protect you from liability in your rental business.
An LLC will protect you from unexpected events that can hinder your investment success, like inevitable lawsuits and legal trouble. Legal troubles can affect your business if you join the real estate industry without the proper protection.
But how do you benefit from creating a limited liability company (LLC) for your rentals? An LLC is a smart choice for your rental property as it comes with more gains while limiting overall liability. So, let’s answer the following question: What are the benefits of an LLC for a rental property? We’ll break down the rental tax advantages and how you benefit from best practices to help you invest with the correct information.
What is an LLC?
A Limited Liability Company (LLC) is a business structure that offers some protection for the owner. It separates personal assets and the business to ensure no business liability boils over to the owner.
If a business experiences financial issues, the owner’s assets and finances are safe from any legal claims against it. , the LLC and the owner are two different entities before the law. The requirements of an LLC are regulated at the state level, meaning they vary from state to state.
Hence, it would help if you researched the guidelines in your state and the fees charged. The protection an LLC offers in financial security is why many landlords consider creating an LLC for rental property.
What is an LLC for Rental Property?
Real estate investors use an LLC business structure to hold property on their behalf. The shareholders of an LLC are known as members and can have a single member or multiple members, which depends on an investor’s goals.
The Internal Revenue Service (IRS), the US federal tax regulatory body, considers an LLC a pass-through entity for tax purposes. The profits or losses from an LLC are passed through each member and reported on their tax returns. As a pass-through entity, an LLC doesn’t pay corporate tax. However, in some states, LLCs must pay an annual renewal fee.
Profits and losses are allocated to members depending on how many shares they hold in the LLC. For instance, if Jordan and Myrra own an LLC whereby Jordan owns 55% of a company shares, and Myrra holds 45%, Jordan receives 55% of the profits and losses while Myrra gets the rest. However, LLC members can have a provision for a special allocation that allows any benefits or losses to be shared or passed through without considering the ownership percentage.
The Benefits of LLC for Rental Property
Owning rental properties through an LLC is much better for investors than owning them directly under their names. Although the structure is a good business vehicle for the investor, it also has some drawbacks every investor must know about. For this reason, investors need to talk to a real estate attorney before creating an LLC to hold their rental property. But for now, let’s look at the pros of LLC for rental property.
1. Protection and Separation of Personal Property
Any functional business faces the uncertainty of legal threats and other issues daily. However, owning a rental property under an LLC may help protect an investor’s assets in case of a lawsuit. Generally speaking, if a tenant sues the landlord whose property is held by an LLC, they’ll deal with the business, not the landlord and only the business assets are at risk.
A lawsuit is a costly process, no matter how small it is. You must pay an attorney even when your rental property is under an LLC. However, your finances are protected since the LLC acts as the landlord.
Under an LLC, you protect your properties from each other by separating them by registering them under different LLCs. Creating individual LLCs for each property means you have nothing to worry about when faced with liability suits for unrelated properties.
The party suing the LLC can only go after the assets under the LLC. Hence, if you have different rental properties, create separate LLCs for each property for more asset protection. Separating the properties limits vulnerable assets if a lawsuit is brought upon your properties. The same liability protection applies when creditors seek to resolve debts.
2. Single or Multiple Ownership
An LLC can have one or multiple members, which allows investors to benefit from all the advantages and protections an LLC offers. However, treating an LLC as an S-Corporation for tax purposes, there’s a limit of 100 members.
3. Separation of Rental Properties
Besides separating personal assets from rental assets, an LLC will separate your rental properties from each other if you own multiple of them. If you own multiple properties, create separate LLCs for each property to keep them separate in case trouble arises for any of them. Having all your properties under a single LLC means a lawsuit against one property can affect the rest. Hence, separating them is an effective measure to protect your properties.
4. An LLC can Have Foreign Members
Depending on the state in which an LLC is formed, non-US citizens can become members, which makes it easy for investors to raise capital. LLC laws vary in different states, and if the state is established to allow non-US citizens to be shareholders, investors can invest in the US real estate industry.
5. Pass-Through Taxation
In an LLC, pass-through taxation means the property earnings pass directly to the owner, and the LLC isn’t taxed through the rental property. Businesses owned by a single person benefit from pass-through taxation. As for corporations, typically, a corporation pays the corporate tax directly from its profits to the IRS, and then the owners are taxed again for any income they make from the business.
As the business owner of an LLC, the company’s income passes through, a benefit a property owner can take advantage of.
You report your rental property’s income through your income tax return. As a result, the money deducted from your income to pay taxes is minimized.
6. Estate Transfer is Simple
An LLC simplifies property transfer if something happens to the owner by preventing complex legal measures and large tax bills. The structure allows you to gradually give some of our property to family members or heirs. The annual gift tax exclusions lower tax liability for your family. Depending on the operating agreement, LLC shares can be sold or transferred. The LLC-owned real estate properties remain under the LLC even when new members are in control.
The Cons of LLC for Rental Property
In the same way, an LLC for rental property comes with a handful of benefits, but there are also some downsides an investor needs to know about. Although they might not affect everyone in the same measure, it may depend on which state the LLC is located. LLC laws vary from state to state, and you must research your state’s provisions for LLCs. Here are some of the disadvantages of an LLC for rental property.
1. Additional Paperwork
Although every business has to deal with paperwork, there’s more in an LLC, especially if they’re several. There will be different papers to file every year, and the registered agent must ensure the information is correct and up to date to avoid fines or penalties.
2. Not Lawsuit Proof
Real estate investors use LLCs to save on taxes and get more protection from liability. However, the property under an LLC isn’t guaranteed protection. If a tenant is disgruntled, they’ll still sue the landlord, who is the LLC. Suppose the lawsuit is ruled in their favor, and the LLC suffers the losses, meaning the members are liable.
3. You Have to Pay for Setup and Maintenance
Most US states charge a fee to register an LLC, and the charges can vary from state to state. Hence, you should check with your state to know how much you need to register an LLC. Plus, LLC owners pay an annual maintenance fee in some states. The cost is low and easy to manage.
4. You may End Up Paying More Taxes
Remember the pass-through taxation that comes with an LLC? Pass-through taxation only benefits your tax bill, keeping it almost the same as for a sole proprietor. That’s a boon. However, on the flip side, an LLC can result in extra taxes in some states where you must pay a title transfer fee when the property is changing hands.
Similarly, other states require you to pay franchise tax, which can be a flat rate or a percentage of the LLC’s net worth. Neither of these situations is applicable in all states, but in the end, it depends on your location and situation.
How to Set Up an LLC for a Rental Property
Setting up an LLC for rental property is a straightforward process that only takes a few steps. Follow these steps to create your LLC for rental property:
1. Get an EIN
An Employer Identification Number (EIN) or Tax Identification Number (TIN) for submitting taxes to the IRS. The EIN or TIN is like a form of identification for your business in an official capacity.
2. Use the LLC’s Name to Open a Bank Account
Operating a separate bank account for your business is essential to separate personal and business finances. A business account is where all the company money goes, and you can make decisions depending on the cash flow and expenses without mingling finances.
3. File the Deed to Transfer Property Ownership to the LLC
This process will vary depending on your state, situation, and the type of deed at hand. In most cases, it’s a quit claim deed. Consult with your lender to find the best way to go about it. For instance, you can refinance the property by changing the property name to the LLC. Your LLC is ready for business, and you can start enjoying its benefits.
When to Create an LLC
Whether you set up your LLC before or after acquiring a rental property isn’t an issue. The process is simple, as detailed above, so it’s wise to set up the LLC before acquiring property.
Suppose you plan to get funding to finance the property purchase rather than paying cash; setting up the LLC before the purchase is prudent. Alternatively, you can transfer a mortgaged property to an LLC and deal with the following issues:
- Notify the mortgage holder about the transfer
- The mortgage holder can close the loan and start a new one, meaning there will be closing costs and interest rates that can be higher
- Inform the tenants about the property’s new owner (LLC)
- Ensure the rental agreements are up to date
- The transfer can lead to new taxes, like a title transfer tax
Creating the LLC before acquiring a property means the property deed is in the company’s name from the start, and you’ll not be dealing with transfer issues.
How to Manage Your LLC for Rental Property
Once you have an LLC for your rental property, here’s a list of the best practices for managing the property:
1. Keep Strict Financial Records
Ensure you separate personal and LLC bank accounts plus credit cards. Keeping the two apart differentiates private transactions from those related to the business. This practice keeps finances transparent, increases the business’s credibility, and makes tax preparation easier. Mingling personal and business expenses can lead to tax complications and, even worse, jeopardize liability protection from the LLC.
2. Evaluate the Operating Agreement Regularly
Regularly reviewing the operating agreement ensures it aligns with your state’s current laws. You can hold the review every other year to ensure the LLC complies with relevant regulations, and if there are any changes, you can include them. Neglecting your operating agreement can cause disputes or legal issues within the LLC over time.
3. Get Adequate Insurance
Although your LLC will provide liability protection, you need landlord insurance tailored to cover rental properties. Insurance provides an additional layer of financial protection against future uncertainties. Liability protection from an LLC doesn’t cover emergency repairs, natural disasters, or any other costly measures that may arise. However, getting adequate insurance coverage will shield you from these issues.
4. Remain Compliant
Regularly checking local codes, landlord-tenant laws, and licensing requirements helps you comply with state regulations. Being on top of things allows you to avoid penalties and legal challenges arising from noncompliance with specific regulations locally or at the state level.
5. Consult Tax Professionals Where Necessary
Always have a Certified Personal Accountant (CPA) or tax advisor familiar with real estate at arm’s length for consultation. They’ll advise you on the best approach when dealing with real estate LLC business taxes. As a result, you can maximize tax benefits and not overlook or break any IRS regulations. Working with an advisor ensures you don’t miss out on tax deductions.
6. Implement Time-Saving Practices
As a landlord, you must manage various processes like rent collection, tenant screening, and track maintenance. These tasks can be overwhelming for a single person, but you can get a landlord software tool to help you streamline property management. Software enables you to manage your properties, saves time, and gives you peace of mind.
Does an Umbrella Insurance Policy Offer the Same Protection as an LLC?
Landlords use umbrella insurance policies to cover numerous properties. Typically, umbrella liability offers liability protection when a tenant gets injured on the property and files a lawsuit.
So, it’s natural to wonder if setting up an umbrella insurance policy is better than an LLC. For landlords, umbrella insurance works with liability protection, which doesn’t cover everything, and neither does an LLC.
For landlords to have absolute property protection in LLCs, it’s wise to use liability protection plus an umbrella insurance policy. However, whether you choose to use an LLC and the insurance policy may depend on your situation and state. Before committing to an insurance policy, check with your insurance rep to identify a cover that works to provide maximum protection.
If you’re forming an LLC from outside where the LLC is registered, you need additional property protection from charging orders.
But what are the charging orders? Charging orders allow most states to claim against payments you pay yourself from the LLC in a lawsuit. Not everyone needs additional protection, but you need to check with an attorney in the state where your LLC is located to determine if you should or shouldn’t take this route.
Form Your LLC with Foundeck Today
Foundeck offers a range of fast and efficient online company formation services, allowing you to register a business structure of your choice quickly. To get started, kindly contact us here.
Frequently Asked Questions
What do I need to know about LLCs in America?
An American Limited Liability Company (LLC) is a business structure where the owners are limited by their shares. The business is allowed by state statute, but each state may have different regulations regarding the structure. Therefore, check with your state to know their provisions for owning an LLC.
Why should I consider buying property under an LLC?
An LLC can buy property in America and be listed as the owner, withholding the true identity of the actual owner. Buying property as an LLC is highly advantageous to the owner as it offers asset protection from liability and tax benefits.
Can two people own an LLC?
Two or more people can own an LLC in America and benefit from the many advantages of the structure. Commonly known as a multi-member LLC, its ownership is divided among the members (shareholders) who own shares. Shareholders are liable to the business to the extent of their shares.
Must I be an American Citizen to own an LLC?
You don’t need to be an American citizen to own an LLC. You can own and run an LLC without setting foot in the country. With an internet connection, you can start your LLC in America from anywhere in the world.
Can I own an LLC alone in America?
You can form a single-member LLC online or in person, spending on where you are and enjoying its benefits. A single-member LLC is the same entity as the owner, taxed as one.
In summary
What are the benefits of LLC for rental property? The benefits of an LLC for rental property include separation and liability protection of assets, as well as tax benefits.
Forming an LLC for your rental property protects you from any claims against you or your property. It’s a sound move to shield your assets and separate your finances from your business. You have a choice to form the LLC before acquiring the property or after, spending on your needs.
If you have numerous properties, creating a different LLC for each property keeps them safe from each other in case one is sued. Any legal issues that arise against the LLC only affect that specific business. Moreover, related debts only extend to the protection offered by an LLC. Do you have any questions on the benefits of LLC for rental properties? If yes, kindly contact one of our experts here for help.
