Depending on what you know about LLCs, you might not realize the benefits they give, or you might think they do a lot more than they actually do. Here are some of the things to think about when deciding if you want to use a rent LLC.
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Pro: Personal Liability Protection
One of the major benefits of a Limited Liability Company is personal liability protection. This means your personal assets generally aren’t at risk if something goes wrong with your rental property.
For example, say someone gets hurt on your rental property, sues you, and wins more than your rental property is worth. If you have an LLC, you’ll probably have to sell the rental property and any other assets inside of your LLC, but you won’t have to put your personal assets towards paying the lawsuit.
There are limits to personal liability, though.
For example, if you violate housing laws, the fines will often apply to you personally as the landlord not just to the LLC. If you take out a loan to buy more rental properties, banks will often ask you to personally guarantee the loan instead of having it solely under your LLC.
Pro: Separate Your Rental Properties
Many people use an LLC to show they’re separating personal and business expenses for tax reasons, but you don’t always need a Limited Liability Company to do that. Getting a separate bank account and using QuickBooks is often enough for tax purposes.
What LLCs can do is help you separate your rental properties into different businesses. This is similar to personal liability protection.
If something goes wrong with a rental property in one LLC, your rental property in a different LLC often won’t be at risk the same way your personal assets won’t be at risk.
There are limits to this, though. Just like you need to keep business and personal assets separate, you also need to make sure you’re running the rental properties in separate LLCs separately.
The technicalities can vary depending on where you live, so you may want to talk to a local real estate lawyer.
Pro: Tax Choices
Many people avoid corporations because of double taxation, but a Limited Liability Company gives you a choice. An LLC is what’s known as a pass-through entity.
Pass-through taxation means the LLC doesn’t exist for tax purposes. The profit and loss from your LLC goes on your personal tax return, just like rental property income that isn’t in an LLC.
You can still operate your rental properties as a passive investment, active investment, or rental business, depending on your goals.
Pro: Protecting Your Identity
When you buy real estate, it’s public record. In fact, almost every county has a website where you can go online and look up the owner of every property.
As a rental property owner, you may be worried about a disgruntled tenant trying to harm you or becoming a target for scams.
When you buy through an LLC, the LLC will appear in public real estate records. While LLC owners are also public records, you have more options to use a business address or to display a registered agent instead of your own contact information.
Con: Creating an LLC for an Existing Rental Property
If you already own a rental property, moving it into an LLC can be complicated. When you move rental properties into an LLC, you have to legally transfer the title from your personal name to the LLC.
This might mean more than just paperwork since transferring rental property to an LLC is legally similar to selling it. You could have to pay title transfer tax like the Florida documentary stamp tax.
If you have a mortgage, the mortgage holder may not want you to transfer the property title the same way they wouldn’t want you selling the rental property to someone else without paying off the loan at closing.
If they do allow you to transfer the property title, you’ll usually have to personally guarantee the mortgage. You may also face an increased interest rate, other changes in terms, or having to pay closing costs or other fees to modify the mortgage.
Con: Legal Costs
There are costs to create an LLC and maintain it.
Initial filing fees are usually $100 to $500. You may also have to pay to run a public notice that you’re creating an LLC. Finally, you may also want to hire a lawyer to give you legal advice or to prepare your documents.
Once you have an LLC, some states charge you an annual fee to renew your LLC. You may also have to pay an annual franchise tax which is a flat tax that can be an additional several hundred dollars per year.
Con: Liability Insurance May be a Viable Alternative
Some landlords use liability insurance in place of creating an LLC. This can be a viable option in many situations.
You can get insurance for nearly every potential lawsuit except to repay a debt. As a small real estate investor, you’re usually going to have to personally guarantee any loans anyway.
Just like with creating an LLC, there are certain situations where your insurance may not cover you.
An additional risk is if you face a lawsuit for more than your insurance limits. In that situation, your personal assets could be at risk.
Con: Making a Mistake Can Make Your LLC Useless
In order to receive the protections of an LLC, you have to do everything by the book. If you don’t, courts could decide to ignore your LLC and allow a lawsuit for your personal assets.
While accidentally swiping the wrong credit card usually isn’t enough, there are many mistakes that are easy to make and could have a big impact. These can include forgetting to pay your annual filing fee, not having an operating agreement (even if you’re the only member), or not keeping detailed enough bookkeeping records.
The biggest problem is that no one audits you to make sure you’re running your LLC properly unless you hire your own lawyer and/or CPA. If you try to manage an LLC on your own, you could find out years later that you did something wrong and all of the extra expense gave you no extra protection.