Renting out properties can be exciting. Not only can you get an additional revenue stream, but you can also build up a solid rental portfolio, just like in the good old game of monopoly.
While there are many aspects to becoming a successful landlord, today I’d like to focus on legal protection and why you should consider setting up your rental properties as a Limited Liability Company (LLC) if you operate in the United States.
Your rental property is a business and should be treated as such. It has customers (your tenants), revenue (monthly rents) and expenses (insurance, taxes, utilities, etc). You, the landlord, are the CEO of your business.
Let’s do a brief overview of terminology. There are four main ways to set up a business: sole proprietorship, partnership, corporation, and Limited Liability Company (LLC). For the first two, you are your business. It is in your name and any liability falls on you and your personal assets (your house, your car, etc). The latter two separate you from your business, and set it up as a separate entity.
The reason why you should consider the LLC structure is because it’s a hybrid between a corporation and a sole proprietorship. It gives you the best of both worlds, so to say.
When it comes to managing your rentals, using an LLC is better than a corporation because it limits the amount of paperwork and hassle. With corporation, you must have a board of directors, hold shareholder meetings, and file minute meetings. With an LLC, you can have just one owner but still receive the limited liability benefit of a corporation.
With an LLC, you get to choose whether you want to be taxed as a proprietorship or a corporation. This gives you the benefit of pass-through taxation. A corporation gets taxed on two levels. It has to pay taxes on its revenues, and then when it pays dividends to its shareholders, those dividends are taxed at the personal level as well. With an LLC, you can avoid this double-taxation.
A Limited Liability Company is better than a sole proprietorship because it limits clams to assets owned by the LLC in case of litigation. This protects your personal assets in the case you are sued in relation to your property. This protection is not perfect, though. Heatherman Law mentions, “If you were personally responsible for doing something, such as snow removal, and you didn’t do it, and that omission lead to an injury, you would still potentially be on the hook as the person responsible for that job, and not merely as the land owner.” So in some cases, your own assets may be at stake. However, having LLC protection is certainly better than having nothing at all.
Some things to consider:
- When you set up an LLC, it can own one or several properties, which is up to you. You may want to put each rental property under its own LLC. Then, in case of litigation, any damages will be limited to that property alone.
- Another important point brought up by Heatherman Law: most mortgages have a “due on sale” provision, which requires the mortgage to be paid off in full when the property is sold. You transferring ownership of your rental from yourself to the LLC is considered a sale. In this case, your mortgage holder has the right to ask you to pay off whatever was owed on the mortgage or you lose the property. It’s best to renegotiate with your mortgage broker if moving your property to an LLC structure to avoid any issues later on.
- Treat each of your LLCs as its own entity. Set up a separate bank account for each.
- If you’re the sole owner of the LLC, you don’t have to file separate tax returns for the LLC. It can be done via Schedule C on your personal tax returns.
- You may wish to have additional owners for each LLC which may further diversify any potential liability.
As you see, setting up your rental properties under a Limited Liability Company is a great way to go despite its flaws. The setup process is fairly quick and easy. It’s also relatively inexpensive. According to CostHelper, fees can range anywhere from $60-800. LegalZoom.com has some basic LLC packages for as low as $169.
When dealing with legal structures like an LLC, it is advisable to consult a lawyer who is knowledgeable in real estate. You want to make sure that you structure your LLC properly to ensure there are no problems which could come back to bite you later on.