Trust vs. LLC for Rental Property: What Protects You More?

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When you purchase a rental property, there are two big risks you want to protect yourself from. First, if something goes wrong with your rental property, you don’t want to lose your assets. Second, you don’t want to lose your rental property if you get a judgment or lien because of something else. Here’s what you should know about whether using an LLC or trust is better to meet those goals.

What are the risks of owning real estate?

There are several risks that come with owning a rental property.

If your tenant, their guest, or a worker gets injured on your investment property, they may claim that it was due to your negligence and sue you.

If your tenant stops paying rent, you can’t find a tenant, or you have a repair that’s too expensive, your rental property could become cash-flow negative. You may be faced with liquidating personal assets to cover that shortfall or to pay any debts you incurred because of your rental property.

What is an LLC?

A Limited Liability Company is a type of business entity that allows you to operate your business as a separate legal entity from yourself. It’s the same thing as setting up a company to run an apartment complex, except your LLC will be much smaller.

What are the advantages of using an LLC to purchase a rental property?

The advantages of using a real estate LLC include the following:

  • The Limited Liability part of the name means that you generally aren’t personally liable for claims against your LLC. If your real estate LLC gets sued, the most you could lose is your business assets inside of the LLC. You can’t lose your personal assets if the claim is against your LLC.
  • You don’t have to file a separate tax return. An LLC is a pass-through company. You report its rental income and expenses on your personal tax return.
  • You can increase your privacy. Who owns an investment property is public record, so using an LLC can help keep your private personal information out of public view. LLCs owners are also generally public record, but you can often do things like using your property manager or attorney’s office instead of giving your home contact information.
  • LLCs are flexible. You can generally conduct any type of legal business in an LLC without having to adjust the LLC.

What are the disadvantages of using an LLC to purchase a rental property?

Using a real estate LLC also has some drawbacks including the following:

  • There is extra paperwork you have to do. You’ll need to set up a new corporation to buy a rental property. This usually involves filing articles of organization with your state’s secretary of state. In some states, you may have to run a newspaper ad saying that you formed an LLC.
  • Forming a real estate LLC can be expensive. The cost can vary depending on where you live. Some states charge nothing while others charge hundreds of dollars.
  • You need to maintain records. This includes documentation showing that ownership of your rental property and each lease you sign are within the LLC. You also need to keep track of your financial transactions for tax purposes.
  • You have to make sure you don’t commingle business and personal expenses.If you don’t actually treat your LLC as a separate business, you may lose your legal protections. This includes things like depositing rent checks into your personal bank account instead of a business account.
  • You must file an annual report. Most states require you to file an annual report. In some, you may need to do it less often. The annual report confirms your LLC’s ownership and contact information. Many states charge a fee with the annual report that could cost hundreds of dollars.

What is the difference between a corporation and an LLC?

From a legal standpoint, corporations and LLCs are virtually identical. The process to set them up is a little different, but you generally get the same protections.

The main difference is that corporations have a separate set of tax rules from LLCs. For real estate investors, this almost always results in paying more in taxes if you use a corporation instead of an LLC.

What is a trust?

A trust is a legal way to transfer property to someone else. A trust is a common alternative to a will because it allows you to automatically transfer the property in your trust upon your death instead of your heirs having to probate your will.

A living trust is a trust that you create while you’re alive and that lasts for your lifetime. When you die, the trust is dissolved with its assets automatically going to the listed beneficiaries. You can have either a revocable trust or irrevocable trust. A revocable trust is one that you can end at almost any time. An irrevocable trust can’t be changed after it’s formed except in extremely limited situations.

Real Estate Trust or LLC Comparison

 Real Estate LLCRevocable Living TrustIrrevocable Living Trust
Can you lose your personal assets because of a lawsuit against your rental property?Generally no.Generally yes. A revocable trust doesn’t give personal liability protection.Same as revocable trust, except some states allow you to create an asset protection trust that gives liability protection.
Can you lose your rental property because of a personal lawsuit against you?Generally yes. If your personal assets are on the line, your ownership share in your LLC is a personal asset.Generally yes. Since you can cancel a revocable trust at any time, you don’t get this type of protection.Generally no. Most states have estate planning protections that protect irrevocable trusts from creditors.
Do you have to file a separate tax return?No, real estate income goes on your personal tax return.Yes, you need to file IRS Form 1041.Yes, you need to file IRS Form 1041.

Can you keep your personal information private?

Generally yes.Usually yes, in the same way as an LLC.Usually yes, in the same way as an LLC.

Is it easy to make changes when you buy and sell a property?

You can usually create a broad LLC to avoid needing to modify it.You may need to modify a trust to buy or sell a property.You may need to modify a trust to buy or sell a property.

Do you need to file an annual report?

Usually, depending on the state.In some states.In some states.

Can you save on estate taxes?

Generally not.Generally not.Irrevocable trust assets are usually excluded from estate taxes.

Trusts are complex legal documents, so the advantages and disadvantages can vary based on how you set them up and your state’s laws. It’s usually a good idea to talk to a lawyer before creating a trust.

Can you just purchase a rental property in your own name?

You don’t have to use a real estate investment trust or LLC to hold a rental property if you think it’s too complicated, too expensive, or doesn’t provide enough benefits. Of course, you won’t get the advantages that come with a trust or LLC.

Can you use both an LLC and a trust to purchase a rental property?

Yes, you can use both a trust and an LLC if you think that’s the best option. You do this by making the trust the owner of the LLC instead of yourself. You then get the benefits of both.

Should you have multiple LLCs or trusts if you have multiple rental properties?

It’s pretty common for real estate investors to use separate LLC for each investment property. That way, if something goes wrong with one rental property, their other rental properties usually aren’t at risk.

For example, say you have four rental properties valued at $250,000 each. You get sued for $1 million because of a single rental property. If you have a single LLC, you may lose all four properties. If you have four separate LLCs, you may only lose the rental property you got sued for.

For this strategy to be valid, you generally have to run each property as a separate entity. This is the same as having to keep your LLC properties separate from your personal affairs.

How can using an LLC or trust impact your insurance coverage?

LLCs and trusts are separate legal entities. Insurance that’s in your name only often won’t cover LLC or trust assets. To protect your real estate LLC or trust, you may need to get liability insurance in the name of the LLC or trust.

Does using an LLC or trust prevent you from holding real estate in a self-directed IRA?

If you want to use a real estate IRA, there are a few things you need to know.

First, you have to contribute to an IRA in cash. You can’t move a property you already own into an IRA.

Second, you can own an LLC with a real estate or self-directed IRA, but it’s a complicated thing to get right that you should probably do with a lawyer.

Finally, you can’t move an IRA into a trust. It is possible to form an IRA trust which is a kind of IRA that is also a trust.

Conclusion

LLCs and trusts are both useful tools for holding real estate investments. LLCs are easier to use and provide the liability protection that is the main focus of most real estate investors. Trusts can be useful for more advanced tax planning or asset protection needs. Now that you have a basic understanding, you should talk to your tax and legal advisors to help you make your final decision.

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