If you have been a real estate investor for any length of time, you have no doubt heard about placing your real estate investments in a LLC (Limited Liability Corporation). Some swear that it is not necessary. Others claim that you’re a fool if don’t. Should you put your rentals in a LLC? What are the benefits? Are there any risks to putting your rentals in a LLC? Consider these points.
What a LLC Does for Real Estate
A LLC provides personal protection against a lawsuit. A LLC forms a legal entity the actually owns your rental property. Because the LLC owns your investment real estate and not you as an individual, your personal assets are safe from a judgement.
Placing individual properties in their own LLC can also separate assets from each other. For example, let’s say you own a property a duplex and another property with 25 apartments. Say a tenant in the duplex slips and falls on some ice and is paralyzed. He then sues you and wins a judgement of $600,000 but the property is only worth $350,000. If the 25-unit apartment building is not in its own LLC, then the value of that building can be used to pay the difference. Placing each property in their own LLC separates the assets from each other.
Holding real estate investments in a LLC can also make it easier to transfer your properties into a self-directed retirement account. This can create some very desirable retirement benefits as we addressed in a past article, “How to Choose the Best Self-Directed Retirement Account for Your Rentals.”
There are some tax benefits to holding your rentals in a LLC. Rather than paying corporate taxes or shareholder dividends as in a standard corporation, the income from a LLC is passed on to the individual or the retirement account thus advoiding double-taxation. The owner also can claim all the tax deductions on their personal return.
What a LLC Does Not Do for Real Estate
Remember how we said that a LLC will protect your personal assets from a lawsuit. Well, in most cases that is true. If the property owner is negligent, however, the lawsuit can be directed at the owner/manager and not the LLC. Additionally, a LLC will not protect against any illegal acts which includes any unlawful evictions.
In some cases, the prosecuting attorney has tied the LLC to the “owner” because of a lack of personal separation. If a landlord pays property expenses from his or her personal accounts rather than the LLC, an attorney can make the case that the LLC is simply a shell and this can put their personal assets at risk. If it looks like you and the company are one in the same, a judge could easily rule that your personal assets are accessible.
One of the most obvious downsides to putting your rental property in a LLC is that it can make it much more difficult to obtain bank financing. Many lenders will not write loans to a LLC. If they do, then the loan will be based entirely upon the performance and the equity of the asset and not personal credit.
How to Put Your Rentals in a LLC
The first step is to discuss the matter with your tax advisor to see which setup would benefit you the most. If you decide to go ahead, you will need to setup the LLC with your local State Corporation Commission. There is a registration fee that ranges from $50 to $150. You can also have your attorney set it up for you but that will generally push the fee over $1,000. You can expect to also pay a small annual fee levied by the state.
In our next article, we will discuss another less expensive way to protect your assets. Stay tuned.
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