Whether you are currently an owner of rental property or planning to purchase one, you may want to opt for owning it in an LLC. Even though it is not always a cut-and-dry decision, we have compiled a guide to discuss all the pros and cons that come with an LLC for rental property.
What is a Property LLC?
Let’s first cover the fundamentals. LLC is a legal formation that incorporates corporation, sole ownership, and partnership components. LLC is usually a less complicated structure, and it comes with numerous benefits for business.
Property LLC is similar, and it is created to limit your liability on your property. Insulating you from personal responsibility is the most significant advantage of creating an LLC for your rental property.
Yes, you can have liability insurance, but if anyone is involved in an injury related to your property, you may be sued for health care and other damages that exceed the policy cap of liability insurance. If an LLC owns your property, your liability is covered in the event of such legal actions.
Advantages of LLC for Rental Property
One of the most significant advantages of establishing an LLC for investment property is pass-through taxation. In other words, the business doesn’t have to file for a separate tax return. Instead, the owner’s (or owners) personal income taxes will have profits and losses reported. The LLC is regarded as a sole proprietorship, and corporate taxes and regulations usually do not apply.
The same safeguard applies if you, as an owner, cannot pay your contractors for work done. Let’s assume that unforeseen renovations are required, and you have significantly underestimated the work’s financial burden. You chose to forgo the rental property growth and give up the project instead of continuing to lose out the money and drain your account. If an LLC owns your property, unpaid contractors can still sue the LLC for compensation, but your personal property and assets are protected.
If you want to buy the rental property with a business partner, setting up an LLC for real estate investment comes with even more benefits. Property LLCs allow foreign investment and ownership options that are not otherwise available to other corporate structures. Therefore, if you want to partner with another domestic and international investor in property, it is a wise option to consider establishing a property LLC and entering into an operating agreement.
LLC for a Property with a Mortgage
Using an LLC for a mortgage is a crucial way by which rental property investors protect their assets. Even though the name may suggest otherwise, an LLC mortgage isn’t any different type of loan. Instead, it only describes the process used to obtain financing for property registered under an LLC.
This also raises another critical question; can you refinance a property in an LLC? Well, yes, as long as the individual who is planning to refinance an LLC has a minimum of 25% documented ownership stake in the given LLC.
Disadvantages of LLC for rental property
Although it may seem very attractive to create a property LLC for your property based on what we have discussed up until now, there are several disadvantages to consider.
The development of an LLC involves setup costs (sometimes up to $500). On top of that, there are also annual compliance and regulatory fees to keep your LLC up and running. We recommend you check your state’s Secretary of the State to know the costs you will pay.
Moreover, if the LLC is a single-member (one owner), you would need to run the LLC as a separate entity to ensure a better role in any future legal challenges by maintaining a different bank account, an independent accounting system, leases, and contracts. The better the owner can show that the LLC acts as another party from the owner, the more reliable the liability limit would be. Maintaining all this setup adds up the cost of running your LLC.
As we have discussed above, one ideal situation to create a property LLC is when you’re planning to partner with other partners. In such shared property LLC, all co-owners of property LLC pay taxes on the LLC’s annual profits, whether or not they receive their share of annuals profits. This is not the case with corporations, where shareholders only pay taxes on their share of profits. It is one of the first disadvantages brought up when the pros and cons of LLC for a rental property are evaluated.
In America in DC, owning a property in a property LLC rather than owning it as an individual makes the rental property automatically subject to the USA’s Rental Housing Act of 1985 and its subsequent revisions. These regulations enforce rent control in residential housing and impose other restrictions on the housing provider.
One crucial factor that we can conclude here is that it can be complex and costlier to finance a property as an LLC than as an individual. Investing in a real estate purchase as an LLC also involves building up a development track record with a particular bank. This is further made worse by the higher interest rates of banks.
Furthermore, commercial loans will be provided with much larger down payments and other unfavorable conditions when the banks are involved. These combined factors could then result in higher mortgage payments for businesses.
Transfer Property to LLC and Other Considerations
You can create an LLC before you purchase a rental property, and it has its advantages, but it is not mandatory to avail of the benefit of an LLC. You can create the property LLC afterward and can still enjoy the benefits by simply transferring the deed to your designated LLC for rental property.
Transfer of property costs with an LLC is also variable depending upon the area of your business. Some jurisdictions like Virginia are simple, and the transfer of title can be completed with very minimal fees. In other areas, such as in DC, transferring property to LLC incur tax consequences which can add up significantly to the total cost.
Similarly, when buying a property with an LLC, if your real estate purchase was financed, the lender of the property may not allow ownership of the property by an LLC or any other person other than the actual borrower.
If you’re entirely relying on a property LLC to limit your liability, there could be scenarios where it may not be the way you want it to be. In cases where individual funds and business ones are not kept entirely and adequately separate or when you fail to maintain your LLCs registration, your liability protection could be at risk.
While it is imperative to set up the property LLC properly, running and maintaining it under the business laws is even more critical. Sometimes, a solid umbrella policy with various insurance providers proves to offer a better alternative to your liability protection, but its cons have already been discussed above.
Lastly, if you are the owner of or planning to be the owner of more than one rental property, it is advised to have a dedicated LLC for every property. One LLC structure for multiple rental properties is not advisable because the total assets of an LLC are at stake if there is a lawsuit on one property.
Therefore, if more than one property is held under one LLC, all the properties are at a grave stake, although the owner’s assets are still protected. If you have a separate LLC for each of your properties, only one property is at stake should a lawsuit involving that respective LLC be filed.
Frequently Asked Questions
- Can you buy property under an LLC?
A one-word answer would be Yes, you can buy property under an LLC. However, it is not as simple and there are things that ought to be considered. It is not always the right move for everyone to buy property under an LLC, to begin with, and then it is not practical in many scenarios.
- Should you create a separate LLC for each rental property?
As discussed earlier in the article, it is always a smart move to have a dedicated LLC for every property. It is due to the fact that if there is one LLC for multiple properties, the total assets of an LLC are at stake if there is a lawsuit on one property.
- Can I live in my LLC rental property?
A single-member property LLC is legally and technically you as the internal revenue services are concerned. You can live in your own property, but you can’t rent your property to yourself.
- Can I use my LLC to rent an apartment?
Theoretically, it is possible, as long as the landlord whose property you are planning to rent agrees to that. However, not all landlords are comfortable in renting their apartments to corporations without knowing that who will be residing in the property. So, the final decision lies on the owner of the apartment.