If you own investment properties or are thinking of buying some, you have probably asked yourself ‘Should I buy rental property under an LLC?’ or ‘Do I need an LLC for rental property?’ Over the past few years, more and more real estate investors are choosing to buy rental properties for sale via limited liability companies (LLCs).
What Is an LLC?
As the name suggests, a real estate limited liability company is a business structure where the owners are insulated from the debts and liabilities of the company. The real estate LLC owners are known as ‘members’, and ownership can include multiple members or just one member. There is usually no limit to the number of members you can have in a limited liability company.
Before making a decision to create a limited liability company for your real estate business, you should first consider the LLC for rental property pros and cons.
Benefits of an LLC
- Limit your personal liability – Every landlord is vulnerable to potential lawsuits connected to their rental property. Let’s say your tenant’s child fell down the stairs and got injured. The tenant might decide to file a lawsuit based on the ‘unsafe conditions’ of your apartment. If you have an LLC, the only asset at stake will be your rental property investment. Buying rental property through LLC protects your personal assets.
- Separate rental properties from each other – If you own multiple rental properties, you can protect each individual property by creating separate LLCs. If someone files a claim related to one of the properties, the other rentals will not be affected.
- Pass-through tax benefits – This basically means that the capital gains and passive income of the LLC ‘pass-through’ to the members/owners. The members will then reflect these details in their personal tax returns. Pass-through taxation, therefore, protects your real estate entity from double taxation.
Related: The Tax Benefits of Real Estate Investments
- Separate personal and business expenses – Buying property through LLC allows you to open a separate bank account for your business. This way, you can easily claim business expenses when filing your taxes.
- Anonymity – When you buy rental property as an individual, your name will be displayed publicly on the deed. If you would like to remain anonymous as a real estate investor, setting up an LLC would be a good idea.
- Credibility – Real estate investors that are doing business via an LLC appear more credible to lenders and customers.
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Downsides of an LLC
- Cost – Forming and maintaining an LLC for rental property owners comes with a cost. If you hire an attorney to create one for you, it could cost you up to $2,000. In addition to the setup costs, some states will also charge annual taxes or fees.
- Difficulty getting financing – Getting a mortgage under the name of a limited liability company can be tricky. Many lenders will want you to be personally liable in case something happens. This means that you might have to purchase investment property fully in cash or change ownership to an LLC after buying in your own name.
Now that you’ve weighed some of the major pros and cons, you might be leaning toward setting up an LLC for rental property. There are clear benefits that you may want to take advantage of. So what is the next step?
How to Set Up an LLC for Rental Property
If you’ve taken on a mortgage, talk to your lender first before setting up an LLC for rental property. If you register an LLC for rental property with a mortgage, your lenders might charge you a higher interest rate, or require you to pay a fee to change the mortgage ownership. You should also check if there is a ‘due on sale’ clause on the mortgage agreement. If so, the lender might require you to pay your mortgage balance in full before the transfer.
If everything is in order, follow these steps for forming an LLC for rental property:
1. Consult an attorney or CPA
An attorney or CPA will examine your rental business and advise you on whether or not you should create an LLC. If you are not familiar with legal or business documents, your attorney can draft the paperwork, as well as help register the business.
Related: When to Hire a Real Estate Attorney
2. Choose your real estate business name
You need to think of a unique name that is not already being used by another business. The business name should also be creative and provide a clue regarding the business you are involved in. For instance, if you are operating in the Chicago real estate market, you could try ‘Chicago Real Estate Holdings, LLC’.
If your business name is unique enough, you could decide to get it trademarked. Obtaining a trademark from the U.S. Patent and Trademark Office (USPTO) will mean that no other business in the country can use the same name.
3. Draft your operating agreement and articles of association
These are the most important legal documents for your LLC. Your operating agreement should describe the procedure for transferring new investment property in the future and adding new members. Don’t forget to list your rental property as a capital asset in your operating agreement. It would be advisable to hire an attorney to prepare these documents, especially if your limited liability company will be managing multiple rental properties.
4. Register your LLC with your state
You can either fill in physical forms from your state’s Secretary of State or register your LLC online. The registration fees charged for an LLC for rental property vary from state to state. As mentioned earlier, you might also be expected to pay annual fees or taxes to maintain your registration. Visit your Secretary of State’s website to learn more about your state’s registration process. (Keep in mind that you can set up an LLC for rental property in another state. Be sure to speak to a lawyer before doing this).
5. Publish a ‘note of intent’
When you change ownership of real estate, your state might require you to alert the public via a notice in a newspaper.
Setting up a limited liability company for rental property is a smart choice for anyone thinking of investing in rental properties. Once you have registered the LLC for rental property, be sure to update your rental leases, security deposit accounts, and insurance policies. In addition, you should transfer all permits and licenses to your LLC. Since your LLC is a separate entity, you might be required to obtain an employer identification number (EIN) from the IRS.
Keep in mind that there is more to know about forming an LLC. Consulting an attorney is best.
Related: Should You Form an LLC for Your Investment Property?
Be sure to find a profitable, cash flow rental property for your LLC. To start looking for and analyzing the best investment properties in your city and neighborhood of choice, click here.