As a landlord, you might be wondering whether you should create an LLC for your rental property. In many cases, it can be a good idea, but that does not mean that it’s right for every situation. Below, you’ll learn more about what an LLC is and the benefits that it can offer, as well as when you should and shouldn’t use an LLC.
What Is an LLC?
An LLC is a limited liability company, which is a type of business that combines features of a corporation, partnership, and sole proprietorship. People tend to like this type of business because it is not as complicated as a corporation. The owners tend to have a range of benefits that they would not receive with other types of companies, as well.
Benefits of an LLC for Rental Property Owners
Why would you want to bother starting up an LLC? If you don’t need to have one as a real estate investor with rental properties, is it worth going through the hassle? Although you do not need to have an LLC for this type of business, you may find that it is advantageous to create one.
Personal Liability Protection
What happens if you own a rental property and are sued by someone who slips and falls because of a loose stair railing? If the property is in your name, it means that your personal assets would be in jeopardy. You could end up losing a substantial amount of money, which would damage your finances for years to come.
However, when you instead opt to create an LLC, only the LLC’s assets are at stake. It will keep your rental property separate from your assets. For this reason alone, many people have chosen to create an LLC. Although you may not believe that you are at risk of getting sued, it can and does happen. It’s better to be safe rather than sorry.
You Can Keep Rental Properties Separate
Here’s one of the benefits that many people do not realize about LLCs. You don’t need to keep all of your properties in an LLC, although you could if you wanted to. However, it might be a better idea to separate those properties from each other by creating a separate LLC for each of them.
Let’s go back to the previous example of someone suing because of an injury on your property. If you have all of your properties in the same LLC, all of them would be affected by the lawsuit. However, if you have your properties separate from one another, only the property where the injury occurred would be affected.
Although this would require taking the time to set up multiple LLCs, it is one of the best options to ensure that you have that added protection.
Separation of Business and Personal Expenses
When you create an LLC, you should also create a new bank account specifically for that LLC. This will ensure that you can keep your personal and property expenses separate from one another. This will make all of your bookkeeping much easier. You and your accountant will appreciate it when tax time rolls around.
Pass-Through Taxation
One of the other benefits of creating an LLC is called pass-through taxation. Typically, a corporation would be taxed directly because it is a business. The owners would also be taxed when they make income from the property. When you have an LLC, you can avoid this problem, as the company’s income passes to you, the owner, and will then be taxed just once. It can help to reduce the amount of money that you have to pay in taxes, which is always nice.
When Should You Use an LLC?
You will find that most landlords will benefit from creating an LLC. This is true whether you have just a single property or you have several. The benefits discussed above are often substantial enough that they will outweigh some of the drawbacks, but it ultimately depends on how you want to invest.
If you are going to be investing with more than one person and there will be multiple owners, it is a good idea to use an LLC. This is because the LLC will allow you to create an operating agreement. This agreement will guide those involved on the responsibilities and rights of each of the owners who are members of the LLC. It makes it easier to manage the property and to reduce potential conflicts. It also protects all of the members in the event of a legal problem.
Those who are only dabbling in real estate and who have just one or two properties might not need to create an LLC if they are doing it on their own. However, if you want to run your real estate properties like a proper business, going with an LLC is likely the option you will want to choose. It will be very helpful when you build your investment portfolio.
Starting the LLC now, before you grow your portfolio of investment properties, will be easier than trying to transfer those properties to an LLC later with a title transfer. If your goals are to have a large portfolio with multiple investment properties, you are better off starting the LLC right now. This will also eliminate the title transfer tax that you would have to pay for transferring your title from your name to the LLC.
When Not to Use an LLC
As touched on earlier, if you are only dabbling in the field of real estate rental properties, and you have just one or two properties, you might not need to have an LLC. However, it is still something that you might want to consider given the benefits it can offer. There are some caveats, though.
In some cases, using an LLC could make it impossible for you to get the financing that you want. If you are going to be looking for mortgages that are FHA-backed, from Fannie Mae, or that are low-money down, you will not be able to hold them under an LLC. Certain types of loans can’t be used to buy properties that will be held in this way, so consider how you are going to buy the properties and the types that you are going to buy. Make sure that it will be possible to buy under the LLC.
Additionally, you might find that some banks could be willing to let you put down a small down payment on the property if you are buying it on your own. If you are going through an LLC, the bank might charge as much as 20% down, which might not be feasible for all investors.
When you have an LLC, you might not qualify for the same tax breaks that you would when buying without an LLC. However, you will likely be able to claim other tax write-offs if you have a limited liability company, as mentioned above. Consider the way you are going to be investing before you choose to create an LLC.
What’s Right For You?
All investors are different and will have different goals and ways of investing. Before you decide to create or forego an LLC, think about how you want to invest. How many properties do you want? What types of rental properties will you choose? How will you be funding the properties? Consider the pros and cons, talk with an expert, and choose the path that’s right for you.
