If you’re considering becoming a landlord and investing in real estate property, you may be wondering: Do I need an LLC for my business?
Depending on your circumstances, the answer may vary. Because LLCs are regulated at the state level, the process of forming one depends on your location. But, if you choose to have an LLC it can provide you with significant advantages and protections.
Ultimately, whether or not you need an LLC comes down to a question of personal interest and goals. To discover if it’s the right move for you, we’ve got some important key factors you should know about and some of their benefits and downsides to help you make the right choice.
ADVANTAGES OF AN LLC FOR LANDLORDS
PERSONAL LIABILITY
Creating an LLC to serve as a buffer between you and your investments can protect you from the inherent risk that comes with being a sole proprietor. If the property is in your name and someone decides to sue you, your personal assets remain unaffected. An LLC is a distinct and separate entity, enabling you to mitigate risk if something goes amiss or you happen to run into a legal issue. Simply put, an LLC serves as a barrier between your investments and personal finances.
TAX BENEFITS
According to the IRS, a real estate LLC is considered a “pass-through entity”. With this structure, any rental income or losses “pass through” from the business to an LLC owner. That said, the U.S. government allows you to benefit from profits made through your LLC by reporting that information as your personal earnings. In turn, it results in lower tax rates for both the business owner and the rental property. It’s important to note however, that although LLCs pass through taxation at a federal level, some states require annual LLC taxes.
A BETTER BUSINESS PROFILE
Forming an LLC for your rental property business can also be good for establishing an independent business profile and a credit history that’s separate from your personal one. As your business expands, having an LLC may qualify you for non-recourse loans, further decreasing potential risks to your personal assets and finances.
TRANSFER OF OWNERSHIP
Should the desire to transfer or sell your property ever arises, an LLC makes the legal process less complicated. Transfer of ownership can be done without causing disruptions to your rental’s daily operations.
A MORE STRUCTURED ORGANIZATION
In case your rental property business includes business partners or investors, establishing an LLC can help you define distinct roles and responsibilities, as well as offer a structured approach to allocating profits and losses. In addition, if you intend for your rental properties to be a long-term investment, establishing an LLC will help you manage your portfolio in a more organized and efficient way.
MANAGEMENT FLEXIBILITY
Opting for an LLC provides more managerial flexibility, since it gives you an opportunity to hire an unlimited amount of employees to help you run your rental property. While you may want to have complete control over your investments, delegating tasks to others can significantly ease your workload so you can focus on other business-related priorities.
DOWNSIDES TO CREATING AN LLC FOR LANDLORDS
REQUIRES ONGOING MAINTENANCE
It’s not uncommon for states to require periodic maintenance, fees and renewals. As a landlord with an LLC, you will also need to ensure your documents and any records remain up-to-date. Some of the ones you may be responsible for include:
- Statement of Information
- Operating Agreements
- Articles of Organization
Neglecting to keep up with these tasks can lead to severe consequences, even though they are typically not complicated. Late fees and penalties may result, and failing to maintain your LLC properly could lead to its suspension, thereby negating the protection it provides.
INCREASED COSTS
LLCs require formal registration with the state, and there are ongoing fees associated with maintaining one. Along with the above mentioned responsibility to upkeep paperwork and records, when you set up an LLC, you will need to:
- File paperwork with the state
- Register for an Employer Identification Number (EIN)
- Create a spreadsheet that includes property expenses and rental income
While these tasks are not complicated, they can be time-consuming. And if you need to hire someone to handle it all, you will need to account for the added cost in your budget.
RISK OF COMMINGLING
To maintain the liability protection that comes with your LLC, it’s crucial to separate your personal finances from your rental property income and expenses. This means having a separate bank account for each LLC to avoid mixing business and personal funds or commingling. If you deposit rental income into your personal account or use LLC assets to cover personal expenses, you risk losing your liability protection.
RESTRICTIONS ON OWNERSHIP AND MANAGEMENT
LLCs typically require that all owners be listed on the formation documents, which can limit the ability to add or remove owners. LLCs may also have restrictions on who can manage the business, which can limit flexibility.
TAX CLASSIFICATION LIMITATIONS
Although LLCs provide pass-through taxation, they may not be the ideal choice for every rental property owner. Sometimes real estate investors may be required to file taxes as corporations instead of pass-through entities due to the number of owners or other factors which can lead to more complex tax filing requirements and higher tax rates. In addition, LLCs may not qualify for the same tax benefits as other business structures, like S-corporations or partnerships would usually be eligible for.
CREATING AN LLC
As mentioned, when you create an LLC the process will differ depending on which state you reside in. Regardless of geography however, some parts of the process remain the same for every landlord. Most times you will be required to:
- Move your mortgage title to the business entity
- Address any potential interest rate changes with your mortgage holder
- Notify current tenants about the transfer of ownership
- Conduct research on relevant taxes, such as Title Transfer taxes, and evaluate their financial impact on your budget
WHERE TO START
If you’re looking to take the DIY route, start with the Secretary of State for your state. If you’re looking for a more convenient option instead, you may want to hire a lawyer. Keep in mind, however, that outsourcing the process can be quite expensive.
THE KEY TAKEAWAY
The decision to form an LLC for your rental property business should not be taken lightly. While an LLC comes with numerous benefits, individual risk tolerance should be carefully considered before making a final decision. It’s always best to consult with a legal or tax professional to ensure that you fully understand the implications of forming an LLC and can make an informed decision that’s most suitable for your specific situation. Ultimately, the goal is to protect yourself and your business while also maximizing your profits, and the right choice will depend on a variety of factors unique to your situation.
