Rental Property LLCs: The Good, the Bad and the Bad

Nevertheless, that being said, there are also certain downsides to consider before resolving that your rental properties should be under LLC.

What Is an LLC?

LLP is a type of business that is designed in such a way that it shares the protection of liability of a corporation and tax flexibility of a partnership. The earnings of an LLC generally flow through to the members which implies that the company is not taxed. This is because members report their personal tax returns as profits and losses. Moreover, the management of LLCs is very flexible and it does not need much of formalities as a corporation does.

Dangers of having Rental Properties

There are natural risks involved in owning rental properties. These are tenant injuries, rent or security deposit disagreements, disagreements about the condition of property, and possible problems that arise regarding property purchase or lease involving legal matters. When there is no LLC, you will be a sole proprietor, i.e. you and the business will be regarded as one. In this case, your assets, on a personal level, are considered as at risk in case someone files a claim or a lawsuit. An LLC is capable of securing you by separating business debts and your personal wealth.

The benefits of the LLC in use in Rental Properties

1. Personal Liability Protection

The first advantage is insurance over liability. When a person provides a lawsuit regarding the event that took place in your rental house, the assets that belong to the LLC are usually at stake. Your personal assets are not at a risk, and it has peace of mind.

2. Ease in Administrativeness

LLCs are less cumbersome compared to corporations. You do not have to have a board of directors and hold annual meetings, but most states mandate annual reports. This renders LLCs easier and less expensive to the real estate investor.

3. Control and Flexibility

Being part of LLC, you are in full control of management decisions. The members of LLC can tailor management and decision-making unlike corporations that have structured roles and duties assigned to directors and officers.

4. Tax Flexibility

LLCs are pass-through entities by default, which are taxed as either sole proprietorships or partnerships based on the number of members. Nevertheless, LLCs have the option to be taxed as either C-Corporation or S-Corporation to benefit. C-Corp taxation permits taxation of profits at corporate rate and this may reduce taxes on the net of dividends. The S-Corp organization is capable of lowering the self-employment taxes of the members but can add more payroll and accounting responsibilities.

5. Profit-Sharing Flexibility

In contrast to corporations that do not pay dividends on the basis of ownership only, in LLCs, members are in control to decide on how to split profits as provided by the operating agreement. Such flexibility comes in especially handy when there are a few members who spend more time or work on property management.

6. Credibility

Being a LLC gives your business a separate legal name with which you can lend legitimacy to your rental business over and above you being a separate individual with a separate name.

Possible Disadvantages of LLC on Rentals

1. Formation Costs and Maintenance Costs

It can turn out to be costly to form an LLC in each of the rental properties, which includes filing fees, attorney fees, and annual state report fees. Although the additional security is worth it, an investor has to evaluate the cost of such security particularly when dealing with numerous properties.

2. Insurance Considerations

In certain homeowners insurance plans, particularly those ones that have umbrella coverage, liability protection may be substantial without the creation of an LLC. You might discover that insurance is sufficient in terms of cover at a reduced price.

3. Implication of Mortgage and Sale

Any transfer of property into an LLC can create a due-on-sale clause in a mortgage, forcing the lender to wipe out the balance of the loan within a short time unless the lender issues a waiver. Legal and financial advice should be taken in order not to breach loan contracts.

Conveyance of Property to LLC

In case you have a mortgage on your property, it is necessary to seek the approval of your lender. It is as though the new deed is a sale and a new deed is frequently necessary. In the event that there is no mortgage, a warranty deed can be used to transfer, and a warranty deed is a title guarantee. Another tool is the quitclaim deeds, which do not provide any assurance regarding the title claims, whereas warranty deed can be an advantage.

Considerations of Operating Agreement

An LLC operating agreement is expected to describe rental property peculiarities. This deals with the buying and selling of properties, profit and division of responsibilities among members. The single-member LLCs can also enjoy the benefits of an explicit operating agreement that will record the structure and processes of the business.

Lease and Tenant Bearing

Upon conversion of property to LLC, the leases have to be changed to show the LLC as the legal holder and lessee. The failure to do so might undermine the protection against liability of the LLC exposing members personally.

Frequently Asked Questions