Every perk you earn in a real estate or rental business entails certain risks. But did you know that forming a limited liability company can further protect your rental property and personal assets?
In this LLC for Rental Property review, our real estate experts will discuss all you need to know before incorporating your company into this popular business structure.
What is an LLC?
If you’re a seasoned business owner, you’ll know that a limited liability company or LLC is one of the best business structures you can consider for liability protection.
Given that it’s easy to form, it’s known to lessen business expenses for the registration and maintenance of your company. However, the overall cost still depends on the state regulations of where you’re creating an LLC. Additionally, this business structure includes specific tax benefits, which our team will discuss further below.
The Advantages of a Rental Property LLC
Personal Liability Protection
If you register an LLC for your rental business, creditors wouldn’t be able to go after your personal assets. As long as there’s no fraud involved, you have limited personal liability in any legal charges against your LLC.
This protection policy means that they can only go after rental properties owned by the company, not an LLC member’s personal assets or personal finances.
Besides the standard personal liability security, our property experts highly urge you to obtain general liability insurance for your business. Having liability insurance adds an extra layer of protection against injury and damage claims against your rental company.
As a property owner, it’s also wise to avail of homeowner’s insurance when creating an LLC, especially if the property you’re renting out is your primary residence.
There are many insurance types you can choose from when creating an LLC to safeguard personal assets. However, it’s important to note that these options don’t offer the same protection as the securities streamlined in the LLC regulations.
Pass-Through Tax
Admit it or not, pass-through taxation is one of the major reasons why our experts recommend forming an LLC. Because of this tax benefit, your company isn’t legally obligated to file corporate taxes.
Instead of that, tax obligations are passed through the LLC members. All your company’s rental income and losses must be reported in personal tax returns, so double taxation wouldn’t really be an issue when you form an LLC. And when an owner files a personal tax return, pass-through taxation also grants them a 20% deduction for every filing[1].
Pass-through taxation policy also applies for businesses operating under sole proprietorship but not for c-corporations.
Separate Personal and Business Expenses
LLC for rental property companies is only beneficial if you know how to manage your expenses. So if you don’t want further conflicts when your LLC is facing liability claims, you should open a separate bank account for business operations.
Opening a bank account for personal expenses will not only save you from legal conflicts and make tax filing easier for you. When creating an LLC, having separate bank accounts will also help avoid confusion in monetary expenses, especially if you’re a single-member LLC.
Member Flexibility
You don’t have to draft an LLC operating agreement for your company, but our trade experts highly recommend having one. Why? Because it’s the document that’ll allow management flexibility of one LLC throughout its operation.
It can be amended according to the needs of your structure. Besides that, it reduces liability risk by indicating specific guidelines in case of bankruptcy or other unforeseen events.
Company Shares
There are no shareholder restrictions when forming an LLC for your rental company. Unlike S-corps, limited liability companies can have over 100 shareholders or stockholders. A non-US resident can even own stocks in your LLC.
The Disadvantages of a Rental Property LLC
Additional Paperwork
Because you’re running a rental company, you have to register your properties into separate LLCs. Separating one property from another is a great way to avoid legal claims, but it implies additional paperwork. And every time you create an LLC, there’s a corresponding filing fee to pay for.
Setup Financing
As previously stated, there’s a filing fee to settle when forming an LLC. The best advice our team could give you is to check the requirements of the states you want to incorporate in to see if it fits your budget.
Franchise Tax
It depends on the state where you’ll create an LLC, but some places require paying franchise taxes. It’s basically a mandatory expense you must pay to keep operating within the state. But then again, it depends where you’ll register and where your property purchase is.
Long-Term Financing
When forming an LLC for an existing property, the transfer of the property title could put a dent in the owner’s personal money or financing. There are also annual fees you must settle, which could vary depending on the state of your incorporation.
Increased Interest Rates
If you’re buying a property as an LLC or transferring an existing loan, expect higher interest rates. Our real estate experts would also like to note that transferring property could lead to due on sale clause. This policy means that you have to pay the remainder of the mortgage as the new owner.
How to Form an LLC for Rental Properties
If you have an ongoing mortgage, asking the lender permission for property transfer is the first thing to do before you create an LLC. You should pick out an appropriate business name and file your articles of organization.
Obtain all the necessary documents like licenses and permits for registration before preparing to transfer titles to your LLC.
Transferring Titles to Your LLC
When you create an LLC for your property, there’s a high chance that you’ll incur additional tax consequences. This taxation policy is called the title transfer tax, and the expenses will depend on the property’s value.
The good news is you don’t have to worry about title transfer tax if you buy the property before you create an LLC.
Formation and Annual Costs
As we previously discussed, the overall expenses you’ll have to prepare for incorporating and maintaining an LLC vary in each state. The registration could cost you as low as 50 dollars to 600 dollars.
You could incur additional costs for annual filings as well. While some states don’t require these submissions, there are a few mandating this every two years.
Umbrella Insurance vs. LLC
If you’re a real estate newbie, you probably haven’t heard of the umbrella insurance policy. These are among the many insurances lenders offer to land buyers with the promise of the same liability security as LLCs.
However, that’s not always the case. There are certain instances where the value of your insurance cannot cover the overall damages or lawsuits. If that happens and you’re not protected as an LLC entity, creditors could easily go after your physical and monetary assets. If you ask our experts, this business structure remains the best protection for your properties.
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Conclusion
Incorporating an LLC for rental property companies is among the best business move you can make in the landholdings industry.
With reduced liability risks and flexible taxation, our team is certain that forming this type of legal structure won’t bring much confusion and hassle to new business owners. LLCs could be a fruitful journey as long as you follow the necessary steps and requirements.
