Can You Start an LLC for Your Rental Property Business?

by Marisa Upson | Updated: Aug 11, 2023

Investing in real estate and managing properties (or having someone do it for you) can be a lucrative and rewarding venture. However, it also comes with some risks. One way to mitigate these risks is by forming a limited liability company, or LLC, for rental property.

Whether you rent out one home or a large apartment complex, your property may qualify as an LLC. Let's explore what this means as an owner and the advantages and disadvantages of setting up this business structure for your real estate investments.

What is an LLC?

Again, LLC stands for limited liability company. It's a popular legal business entity that's easy to set up and offers protection for property owners and landlords. These entities may consist of one or multiple members.

What are the advantages of an LLC for a rental property?

Let's discuss some reasons setting your rental business up as an LLC might prove advantageous to you.

1) Limits liability

Limiting liability is the most compelling reason to establish an LLC for a rental property. With an LLC in place, your personal assets are not in jeopardy. Rather, liabilities, such as debts and lawsuits, are restricted to the LLC.

For example, let's say someone falls down the stairs at your property and sustains major injuries. Should they claim the injuries occurred due to unsafe conditions, an LLC would prevent them from suing you as an individual and putting your personal assets at risk. Instead, they could only sue the LLC.

Additionally, if life throws a curve ball and you can't make payments on the property's loan, your personal assets will not be at stake.

For this reason, many property owners set up separate LLCs for every property they own. This tactic insulates each property from any liability claims. Banks may also prefer separate LLCs for the same reason.

Make sure to set up a bank account for the LLC and keep your personal finances separate. This separation ensures you retain liability protection. All transactions regarding your property go through the business bank account, including rent payments and any repairs or other debits.

2) Flow-through taxation

Flow-through, also known as pass-through taxation, means that profits and losses are passed on to LLC members who claim them on their personal income tax returns. This means you're only taxed once on the income. Corporations, on the other hand, are double-taxed. They pay taxes on profits, and stockholders pay taxes on the dividends.

Creating an LLC also separates your personal income from your rental income. This may help lower your income tax bracket and provide tax deductions for medical insurance and business expenses.

Additionally, you may qualify for the 20% qualified business income (QBI) deduction. This tax code allows business owners to deduct up to 20% of net rental income. To qualify, you need to keep detailed books and provide at least 250 hours of rental services each year.

3) Benefits partnerships

LLCs also benefit properties owned by multiple partners. For instance, you can bring in another partner by altering the operating agreement rather than going through time-consuming deed changes, which may need your lender's approval. It also benefits married partners, making it easier to transfer ownership and assets within the business structure.

The operating agreement also offers greater peace of mind by disclosing the management structure. This document includes the roles and responsibilities of each member, helping resolve any issues that may occur down the road. It also details the percentage of ownership and how members can leave the company or sell their share in it.

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What are the disadvantages of an LLC for a rental property?

There are drawbacks to making your property management into an official business, too. Read these before you act.

1) Costs

Each state regulates LLCs and mandates the set-up costs and annual fees, and these costs vary significantly from state to state. According to the World Population Review, LLC filing fees can range from $50-$500, and annual or biannual fees come in at $0-$800.

2) Setting up an LLC after purchasing the property

Setting up an LLC before purchasing your rental property may avoid several costs. For instance, transferring the title to an LLC requires changing the name and may result in the termination of the original financing agreement. This may trigger the due-on-sale clause, requiring payment of the remaining loan balance.

A new lending agreement in the LLC's name may translate to a higher interest rate. Additionally, title transfer taxes may also apply.

3) Additional paperwork

Depending on your location, you may need to file several documents. These include the articles of organization, which is, in essence, the blueprint of your business. Another document required in some states is the operating agreement.

Most states also require periodic reports known by various names, including business entity reports, annual reports and statements of information. Conversely, a sole proprietorship does not require any legal paperwork.

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How to set up an LLC

While each state has different rules for forming an LLC, most follow these general guidelines:

  • Check with your existing lender. If you have an existing loan on the property, contact the lender to find out the requirements or if they allow a title transfer to an LLC.
  • Select your business name. Make sure it's not already in use through your secretary of state office.
  • Identify the registered agent. A registered agent needs to live in the same state as the business. This agent ensures you receive essential and time-sensitive information about the LLC. You, a partner, an employee or a third-party business may act as the registered agent.
  • Create an article of organization and an operating agreement. While not all states require an operating agreement, it can help members avoid problems later.
  • Pay the required fees. Initial and ongoing fees vary by state.
  • Set up your rental company. After registering your LLC, you'll need to obtain a tax ID number, a bank account in the LLC's name, and a general business license.

Because every state's LLC laws differ, and lenders possess varying regulations, it may be in your best interest to go over your plans with an attorney, tax consultant, and your lender.

Categories: Landlords

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