What does it mean to form a limited liability company (LLC) for your rental property? Is forming an LLC a good idea for small-time landlords? Let’s take a look!
What is an LLC?
LLC stands for Limited Liability Company; it’s a business structure that creates a separate legal entity for a landlord’s rental property. The landlord is the person who owns the LLC, although there can be multiple owners.
The main reason landlords form LLCs is to protect their personal assets from potential lawsuits.
What are the advantages of an LLC?
LLCs protect a landlord’s assets if they are being sued. If your property is in an LLC, someone filing a lawsuit against you can only go after assets owned by the business.
If your property is not in an LLC, a person suing you could go after your personal assets as well as your rental property. This means they could get your primary residence, car, or funds from your personal bank accounts as well as your rental property.
Essentially, an LLC moves you one step away from the property so that you have greater protection. You don’t own the property, but you own the company that owns it.
Landlords with multiple properties can use different LLCs to keep their properties financially separate from one another. This includes different bank accounts for each property. Setting up an LLC means your other properties won’t be affected in a lawsuit.
Another advantage is pass-through taxation, where company owners only get taxed once instead of twice. Unlike C corporations where owners need to pay tax in the name of the business and a separate tax on their earnings from that same business, LLCs have their taxes passed on directly to the owner.
What are the drawbacks of an LLC?
One drawback is the set up. There is a lot of paperwork and logistics that go into setting up an LLC, along with a setup fee ranging from $50-$200.
Some states like California charge annual taxes in addition to the setup fee. Landlords should research their state policies and decide if the protection an LLC provides is worth the annual tax.
Complications can arise with forming an LLC if you already have a mortgage on the property. Some lenders view transferring the property to an LLC as a sale. If there is a “due on sale” clause in your contract, you may be required to immediately repay the remaining amount you owe on your mortgage to your lender. Setting up the LLC before you buy the property eliminates this issue.
Is forming an LLC right for you?
It depends on how many properties you have and how much you need liability protection.
Some landlords opt for umbrella insurance instead of forming an LLC. This is a good option for landlords with fewer properties. The disadvantage is insurance usually has a maximum coverage amount.
For landlords with many properties, setting up LLCs can help protect you more effectively than an insurance policy could. Each property is insulated from potential lawsuits affecting the others. Each property’s finances are kept separate as well.
Landlords using Tellus to manage their rental properties can set up their LLCs in the app with separate bank accounts for each entity. See how it works by downloading the free app from the App Store or Play Store.
Whatever you decide, it’s always a good idea to consider your business needs and research state specific laws that would affect you forming an LLC.