Creating a limited liability company ( LLC) for your rental property business can provide you with many benefits, including saving some money during tax time.
Here, we will cover what an LLC is, why you might need one, how to set it up, what the tax benefits are, and some of the pros and cons of creating an LLC for your rental property. Read on to get informed about LLCs for rental properties so you can decide if creating one is right for you.
What is an LLC?
A limited liability company (LLC) is a way to structure your business that allows you to have limited personal liability for the debts of the company. This means if your company accumulates a lot of debt or other liability, you cannot usually be held personally responsible for it.
An LLC can have one owner or multiple owners, all of whom are considered members of the LLC. The basic function of the LLC is to allow members to shield their personal assets from the assets and liability of the business.
The specific state you live and work in regulates LLCs. This means the process of creating one and the rules regulating their functionality might differ from state to state. Be sure to research what an LLC is in your specific area.
Do I Need an LLC for a Rental Property? What Are The Benefits?
You don’t need one, but in most cases it is a good idea. Whether you are the sole owner of a single rental property, or you own a rental property or multiple properties with other people, setting up an LLC has many benefits.
Some of the benefits associated with creating an LLC for your rental property include limiting your personal liability, separating your various rental properties if you own more than one, separating your personal expenses from your business expenses, and taking advantage of pass-through taxation.
Limiting Your Personal Liability
If you don’t set up an LLC for your rental property business and simply own the property as an individual, you can be sued individually. This means your personal assets can be in jeopardy if you lose a lawsuit.
Your personal residence, car, and other personal assets can be taken. If you own your rental property as an LLC, only the business assets are vulnerable to a lawsuit. You may lose your rental property, but your personal assets are safe from litigation and other liabilities related to the business.
Separating Rental Properties
If you own multiple rental properties, you should consider a separate LLC for each one. Much like limiting your personal liability, this limits the liability of each property. If one of the LLCs gets sued, only that property can be taken if you lose the lawsuit.
If all of the rental properties you own are part of the same LLC, they all are at stake even if a lawsuit is only taken against one of them. This strategy is all about mitigating the damage that can be caused by litigation or other liabilities against a specific rental property.
Keeping track of all of your rental property expenses like maintenance costs, property management costs, supplies, and more can be daunting. Keeping track of those costs in addition to your personal expenses can be even more of a challenge.
With an LLC, separating your personal expenses from your rental property expenses makes becomes simpler. Creating a checking account and taking out credit cards under the LLC will make sure money is going in and out of the right entities. This will make it easier to separate all your expenses and profits at tax time as well.
Speaking of tax time, one of the biggest benefits of creating an LLC for your rental property is pass-through taxation. Corporations are taxed each year on their profits and their owners are taxed again on the personal income they generate from their business.
With an LLC, the income from your rental property is passed through to you as the owner. This means you get taxed on your personal income statement but not on the LLC statement. This is to avoid double taxation.
How to set up an LLC for a rental property?
Step One: Your Loan
First, you need to change the loan you got to purchase your rental property so that it won’t be under your name, but under the LLC. Talk to your lender to understand how to do it and how it will affect the loan terms.
It’s important to note that the terms of your loan may change when you transfer ownership to your LLC. It could be a different interest rate or a one-time fee to make the change.
Step Two: Name Your LLC
Now, it’s time to choose a name for your LLC. You can select any name you want as long as it is not already taken by another LLC and it’s relevant to your business. Most rental property owners use the property address of their rental property as the name of their new LLC. Indeed, it clearly states what the LLC is for, and the address is usually not already registered as an LLC.
Step Three: Articles of Organization
Use your local municipality’s website to fill out the articles of organization for your new LLC. This will include basic information about the LLC, including the name you have selected.
Step Four: Operating Agreement
The operating agreement of an LLC outlines the rights of each member of the LLC as well as what they are responsible for. This needs to be done even if you are the only member of your LLC.
Step Five: Notice of Intent
In some states (though not most) you may be required to fill out a notice of intent form for your LLC. This is a statement that outlines what the intention of your new LLC is. The statement must be published in an official local newspaper.
Step Six: Permits and Licenses
Depending on what state you are creating your LLC in, there may be specific permits and licenses that you need to apply for.
Step Seven: Register The LLC
Once you have all the LLc documents completed, you need to turn them into the state you are working in so they can officially register your LLC. Usually this can be done online and there is often a registration fee.
Step Eight: Title Transfer
This is the official step that transfers the ownership of your rental property from you to your LLC. This is done through a quit claim deed, which will identify you as the grantor and your LLC as the grantee. This can also be done online.
Step Nine: Banking
Separate the funds of your LLC and your personal funds by creating a business checking account at your bank. This will facilitate better monthly bookkeeping for your business and ease the pain of determining your deductions when tax time rolls around each year.
Step Ten: Rental Leases
The rental leases you have with your tenants list you as the owner of the property. These should all be changed to list the LLC as the owner of the property instead. In addition, rental payments should be deposited into your new business checking account instead of your personal checking.
Pros and Cons of LLC for rental property
Still not sure you should set up an LLC for your rental property business? Let’s take a quick look at the pros and cons to help you make the best decision.
Pros of LLC for Rental Property
- If your business gets sued or experiences some other form of liability, you are much less likely to be held personally liable.
- Each of your rental properties is separate from and not liable for the others.
- Separating personal and business expenses is easier
- Pass-through taxation ensures your income is not taxed twice.
Cons of LLC for Rental Property
- Some additional paperwork is required
- In some cases, you will have a harder time qualifying for a mortgage as an LLC as opposed to an individual.
- You must file annual taxes for an LLC, which can cost you some money during tax time.
Weigh the pros and cons carefully to make the best decision for your specific rental property business. In most cases, you will find that creating an LLC for your rental property is a good idea. You save money, decrease your personal liability, and help the financial operations of your business run smoothly.