Limited Liability Companies or LLC for rental property can be a great way for you to hold it. There are multiple benefits and there is a fairly simple framework for setting up the LLC meaning nearly anyone could do it.
So why doesn’t everybody do it? There are of course some issues surrounding running an LLCs and these will need to be taken into account before deciding whether or not to run your property or properties as an LLC.
In this article we cover what an LLC is (if you are unsure) plus what the benefits are and what negatives you may come across. It is important to remember that LLCs are not the perfect idea for everyone, but when run correctly can bring you masses of benefits.
What is an LLC?
An LLC is a Limited Liability Company and it is a great way for you to isolate your business interests from your personal interests. LLCs provide their members with a certain level of protection when it comes to the legal aspects of owning a property (or any other business for that matter).
In legal terms any property held in an LLC would need to be sued accordingly, meaning that the LLC and not the members would be held liable. In short, if the LLC is taken to court only the LLC’s assets and not your own or any other members of the LLC are on the line.
A larger and larger number of properties are being held as LLCs as the benefits become more obvious. It always pays to keep your business and personal finances separate and an LLC allows you to do this. The LLC can be a single entity or can be a partnership or have multiple members. The benefits of financial separation remains the same for all of these scenarios.
Benefits of an LLC for rental property
LLCs offer numerous benefits from favourable tax situations, separation of finances and of course legal protection. In this section I aim to try to look through some of the more common benefits, how and why an LLC could help you and the tax implications (in brief) of running an LLC.
The Protection element of an LLC is something that is often talked about at length and I think the personal protection that it offers its members can be viewed as massively important.
As LLCs operate as business entities your funds or potentially your freedom (in a more serious cases) cannot be prosecuted. As the LLC is the framework that the property is held in any claims against the property would be deemed as claims against the LLC rather than the individual members of the LLC.
This is particularly important when viewing your property as a business as it means you are able to run the property as you would any other business; free from having to worry about the loss of your own funds should something go wrong.
Another great layer of protection that an LLC can provide is the ability to separate each property that you own. If you are fortunate enough to own multiple properties you are able to have each property set up as an LLC thus isolating it from all of your other assets.
This is again particularly important should something go wrong as none of your other properties would be at risk should an issue arise with another property. Put simply the layers of protection (from a legal and financial standpoint) are very attractive. If run correctly the only assets each LLC should encompass are the properties themselves meaning that no other assets are at risk when dealing with your property business.
Taxes are a tricky business at the best of times and this article is certainly not going to go into enough detail to discuss tax situations at length. Taking this into account discussing your personal tax situation with a qualified advisor is a must before you look to set up an LLC.
The most obvious tax benefit in relation to LLCs is what is know as “Pass-Through Tax”. This allows you to put the companies earnings through you own tax return and therefore the LLC is effectively not paying tax.
“Pass-Through Tax” can be explained thusly. When a company pays taxes it does so via Corporation Tax which is paid against the companies profits, the owners of the company then pay tax on their take home salary effectively meaning that owners are taxed again when taking income out of the business.
With an LLC the owner or owners of the company are able to pay taxes straight through their returns thus eliminating the need to pay Corporation Tax and therefore reducing the overall tax bill of the LLC.
By running your taxes this way you are able to reduce the amount of money paid in taxes from your own personal income; this is often seen as another very beneficial element of running an LLC.
The final point I would make is in relation to keeping your finances separate. An LLC is a great way to keep your money separate and is very simple to manage in that sense. You will have separate business accounts and the funds spent on the property would all need to flow back through those accounts.
Some people may see this as a slight negative as due to this enforced separation you are unable to borrow funds from the LLC for your own uses. Should you do this a legal case may be brought against you and it may be provable that the LLC is not an isolated business but rather something you are using to top up your everyday funds.
Losing the separation element of an LLC could cost you dearly as you may also lose the protection that this separation affords you and the LLC’s members.
Negatives of an LLC for rental property
As mentioned earlier in the article there are some negatives to be mindful of when considering whether or not to start an LLC, I have looked at a few here for you to help you make up your mind.
LLCs are not free to set up. They do cost money and some people may see this as a barrier to setting up an LLC for themselves. The fees for setting up an LLC yourself are minimal, but the time and legal knowledge required may make it difficult for you to take the budget route.
You can of course hire a lawyer to complete the process for you but you must be prepared to pay up to $2,000 for the pleasure. You will also find that in most states there are separate tax charges levied on LLCs along with annual subscription fees.
Do your homework before jumping into an LLC and find out the associated costs in your area as the benefits may not look so smart once the costs are factored into the equation.
LLCs tend to work best when set up in advance of the property purchase. In fact you may find it very costly and time consuming to try to transfer the deeds from your name into that of an LLC.
My advice would be to have the purchase in mind when thinking over the LLC process as invariably you will find it difficult to change the property into the name of an LLC.
Your mortgage company may view the deed change as a sale and therefore call in any loans held against the property. This could potentially be catastrophic and is certainly something you should be trying to avoid at all costs.
Speak with your financial advisor to get their views on whether any deed change would be advisable or even possible. As I said earlier in the piece, LLCs work best when you are purchasing a property to put into an LLC as you can set up all of the relevant documentation accordingly without having to pay transfer funds or run the risk of your lenders calling in any outstanding debt.
I touched on this in the positive section so you may be confused as to why it is mentioned in the negatives column, but it pays to look at this element of the LLC both ways.
Keeping your funds separate from a legal perspective is a very good idea and should be your target. Keeping funds separate will eliminate the danger of your own finances being used to pay off damages or claims held against your property.
It’s worth mentioning this as a negative at this stage as separating funds only works if you yourself are able to manage this. Having to keep the funds separate could be viewed negatively if you are simply not on a stable enough financial grounding to keep the two (business and personal) separate.
Remember even spending a small amount of the LLC’s money could be viewed as you breaking the isolation of the LLC and will then mean that all of the protections and tax breaks you fought hard to set up are undone by you not being able to manage your finances.
If you are not in a finance position to keep rent payments and LLC funds separate from your personal money an LLC may not be the ideal property set up for you.
Limited Liability Companies offer masses of legal protection, the ability to separate and isolate your other properties and keeps your own personal assets out of the reaches of those looking to claim against your property.
In my eyes an LLC is an absolutely must. Sure there are some issues with set up costs and yearly charges but I think the legal and financial protection offered by LLCs is too good a deal for a landlord to turn down. Particularly any landlords holding multiple properties.
Having said that an LLC isn’t for everyone and I would advise against trying to shoehorn yourself into an LLC set up because someone told you it was the right thing to do. Seek professional advice, talk to your financial advisor and do the numbers. As with any business decision if the numbers aren’t right keep doing what you are doing or look to hold your property in a different way.
For those that come away from this article thinking that LLCs are not the answer for them it is worth pointing out that good, solid Landlord specific insurance covering your rental properties against loss of rent, damages and legal costs will sometimes offer you some similar legal benefits to an LLC so looking into these types of insurance with your broker may be beneficial to you.