Should Landlords Set Up an LLC for a Rental Property?

Written on August 10, 2015 by , updated on September 6, 2017

create an LLCIf you own rental property, you’ve probably wondered about forming an LLC, a limited liability company.

Although there isn’t one answer that applies to all landlords, there are some compelling reasons to form an LLC and some reasons not to. Once you understand the basics, it’s still a tough decision to make. But you’ll at least be more knowledgeable when consulting with your financial advisor.

LLCs Protect Your Assets

The main reason people set up LLCs is to protect their personal assets. An LLC shields you personally from being sued, though your company could still face litigation.

For example, your tenant’s drunken friend falls down the stairs and got hurt. You’re the big pocket in this scenario. When the friend sobers up, he figures he can sue you on some trumped-up reason. If that happens, you’d be named in the lawsuit and would have to defend your own personal assets.

If your property were under an LLC, however, only the LLC’s assets would be under attack.

Lots of Tax Stuff to Know

LLCs have “pass-through taxation,” which means that the LLC itself doesn’t pay any taxes. Any income made passes to the LLC’s owner or owners.

If you are the only owner of the LLC, you would report your taxes the same way you probably do now, assuming you’re a sole proprietor. That simply means you own rental property but are not a legal entity.

If your LLC has more than one owner, such as you and your spouse, the LLC files a separate tax return. And that could cost you extra money if you use a professional to do your taxes.

You can set up an LLC as an S corporation or as a C corporation, perhaps to reduce taxes if you pay self-employment taxes.

How you’d set up your LLC and whether you should set one up at all for tax purposes are matters to discuss with your tax advisor who can help you determine which setup, if any, would benefit you most.

LLCs Aren’t Free

A good reason to not set up an LLC is that is costs money to do so. You can set up an LLC with your local State Corporation Commission, and pay a small registration fee (usually $50-$150).

Or, you can hire a services company such as LegalZoom, which should cost you several hundred dollars when all’s said and done.

If you have an attorney set one up for you, you’ll probably pay between $1,000 and $2,000.

Also, some states charge either annual fees or taxes in addition to the setup costs, and that could be a deal breaker for you. For example, California has a relatively inexpensive filing fee, but then it charges some hefty taxes each year. You would need to check what the fees and taxes for your state are.

Insurance Also Protects Your Assets

If you have rental property, you should have landlord insurance, called a dwelling policy. This protects your rental property, and depending on your policy, it pays either cash value or replacement cost if catastrophe strikes.

You can also add loss of rental income to the policy. And you can get umbrella insurance on your dwelling policy to protect you from being sued.

The catch is that your insurance might not cover the total costs you incur. If that happens, your personal assets are at risk. Not so if your rental properties are protected under an LLC.

Moving an Existing Property with a Mortgage

If you already have a house you rent out, and you carry a mortgage on it, you might not be able to move that house to an LLC easily. This looks like a sale to the lender who might call in your mortgage, called a due-on-sale clause. You might lose out on your low-interest rate when you refinance, or you might not qualify for a mortgage anymore, depending on your circumstances, if that happens.

Keep Your Money Separate

If you do set up an LLC, be sure never to mingle your LLC money with your personal money.

If you head to the mall and use money from your LLC to buy a new outfit, or if you use your personal money to pay for a new garbage disposal for your rental property, a person suing you could claim that your LLC is not a separate entity. That could mean you lose your protection!

Related: 6 Ways to Avoid the Hidden Dangers of Co-Owning Property

Consult, Consult, Consult

As you can see, the issue of whether to form an LLC is complicated, and each landlord’s situation differs. Now that you know the basics, consult with your financial advisor, your CPA or your attorney to find out whether an LLC will benefit you.

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