Create an LLC

Should I create an LLC for my rental property?

Do you have a rental property you’re planning on using to generate additional income? Learn the pros and cons of creating an LLC for your rental property in our article.

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Investments in real estate have long been a popular choice for entrepreneurs to expand their personal assets. Therefore, whether you currently have a property or are thinking of purchasing a real estate property for the purpose of running a rental income business, then you may want to think about creating an LLC as well. 

LLC stands for limited liability company. A limited liability company is a form of business structure. As a business owner, you are able to create an LLC on your own, with a business partner, or a group of people. Each owner of an LLC is considered a member of the business. Unlike other business structures in the United States, a limited liability company provides members with personal liability protection. This means that the personal finances and assets of each member are considered separate from their business entity. Therefore, in the event that your LLC is sued or goes bankrupt, you will not be required to forfeit your personal assets as collateral as you are legally protected. 

Now, you’re probably wondering, “should I create an LLC for my rental property?” Are there any benefits to doing so? What about the disadvantages? We’re going to be answering these questions throughout our article today. Therefore, keep reading for more information. 

Pros and cons of creating an LLC for a rental property

Before moving ahead with a rental property LLC, future business owners should understand the pros and cons so they can make an informed business decision. Let’s take a closer look at the advantages and disadvantages in more detail below. 

Pros of creating an LLC for a rental property 

  1. Asset protection 

As we said, one of the most important aspects to forming an LLC for your rental investment property. This means that in the event that you are sued by a third-party for damages or injuries that occur on your property, your personal assets will not be at stake. In other words, you will not need to give your personal assets as collateral1

  1. Single-member LLC or multiple-member LLC 

Furthermore, another benefit to having your own LLC is the ability to operate as a sole proprietorship, or single-member LLC or with a group of real estate investors which may offer you more opportunities to expand your real estate LLC business. 

  1. Pass-through tax benefits 

Another benefit to having an LLC for rental property is the ability to experience tax advantages also known as pass-through taxation. This means that rather than being taxed on the profits your rental business makes, you would instead, pay taxes through your personal tax return. This saves you from double taxation which corporations must pay, meaning they pay more income tax with a higher interest rate. On the other hand, if you are operating with multiple members, you would only pay taxes on your portion of profits which is typically determined in an LLC operating agreement between you and your partners. 

  1. Keep your rental properties 

Moreover, in addition to keeping your assets separate from your business, you are also able to keep all your rental properties as a separate LLC. This means that your properties are protected should a third-party file a lawsuit against one of them. Thus, no additional rental properties will be affected as a result of any legal action, giving you an extra layer of protection. 

  1. It is inexpensive 

While the rules of forming an LLC can vary slightly from state to state, generally speaking, forming an LLC for your real estate property management business is relatively inexpensive. Therefore, with all of the benefits that a limited liability company can provide you, it makes sense for business owners to go ahead and begin the filing process. 

  1. More professional 

Furthermore, if you are looking to impress investors and expand your real estate business to multiple properties, then forming a limited liability company is a great way to appear more professional and reliable. This is also true for those who wish to rent your properties as well. All in all, it is a sound decision to make for your overall branding and marketing. 

  1. Flexibility with management 

An LLC property business also provides business owners with management flexibility. This is typically associated when there are multiple partners involved, rather than working as a sole proprietor. For example, just as you would indicate how profits are distributed in your operating agreement, you are also able to put in your agreement the responsibilities of each member. This could include, who is in charge of handling daily operations, or who has the right to vote on any decisions that involve the future of the business. 

Cons of creating an LLC for a rental property 

Moreover, now that you have an understanding of the benefits to creating an LLC for your rental property, it is also important that we go over the cons as well. Let’s take a closer look at some of these disadvantages in more detail below. 

  1. Transfer tax liability 

While not required in all states, some jurisdictions require a title transfer tax when ownership of a property changes. Therefore, if you have members coming in and out of your business or you decide to sell some of your real estate properties, you may be required to pay an additional fee. This is also known as a stamp tax, and they are typically equal to the appraised value of the property you are attempting to sell. 

  1. Financing can be difficult 

Another disadvantage to forming an LLC for your real estate rental properties is to obtain a loan, the majority of lenders will require all members to personally guarantee the loan. In other words, this means that all members will be held liable for outstanding debts towards the mortgage on the property and will be required to sign their name on the loan as well. Therefore, if not everyone has a good credit score, it may be more difficult to get approved. 

  1. More difficult setup process 

If you are going the route where you’re considering forming an LLC for each rental property that you purchase, be prepared to do a lot of additional paperwork. Forming an LLC takes time and if you are looking for a quick process, you won’t find one. From filing documents, to getting the appropriate licenses, getting a new loan, and setting up new bank accounts, the entire process can be lengthy. Therefore, be prepared for potential delays and other filing mishaps that may occur. 

  1. Your assets are not guaranteed to be protected 

As we said, a limited liability company is a business structure that helps business owners protect their personal assets, should their business be sued or go bankrupt. However, this doesn’t insinuate that LLCs are completely protected from lawsuits. For example, should your LLC or a member of your LLC be found guilty of negligence or fraud in a third-party lawsuit, then the plaintiff (the party that sued you) may be successful in what is known as “piercing the corporate veil.” This means that they may be successful in holding your LLC or member accountable for damages. Thus, requiring you to pay for damages. 

  1. More costs over time 

Owning and running a vacation property is not easy. Therefore, along with additional insurance costs, maintenance fees, and other expenses such as for cleaning services, and amenities, owners can expect to pay numerous fees throughout the year that may not be viable for entrepreneurs who are looking for more of a passive income venture. 

As you can see, the pros and cons for this type of business balance each other out greatly. Nonetheless, before deciding to move forward with making your rental property an LLC it’s important to weigh the pros and cons with your overall objectives as a business owner. Additionally, you will also want to make sure you are in a sound financial position to take out a loan, pay for all the required licenses and filing fees, and keep up with maintenance costs. 

How to create an LLC for your rental property

Are you ready to create an LLC for your rental property? If the answer is yes, then keep reading because we are going to break down all the necessary steps you will need to take in order to do so correctly. Here is a closer look: 

  1. Choose whether you will work alone or with a business partner(s) 

The first step to creating an LLC for your real estate property is to choose whether you will be working alone, or with a group of people. This will directly influence how your LLC will pay taxes each year and how your business will be managed. Therefore, some things to consider is how the mortgage will be paid, whether you want to keep your personal and business taxes separate with the IRS, or whether filing as an S corporation to receive an additional tax benefit may be worth pursuing.

  1. Choose your LLC location 

This may not come as a surprise but choosing the location of your LLC is an important decision you will need to make as each state and jurisdiction has different laws and regulations. For example, not all states require business licenses for real estate investors. Therefore, to find out more information about the requirements in your area, check your local and state government websites for specific laws and filing fees you will need. With that being said, when registering your LLC, we suggest filing in the same location as your rental property as it will be easier to keep organized this way, especially if you plan on having multiple properties in various states. 

  1. Choose an LLC name 

The next thing you will want to do is select a business name. While you are able to operate under your own name, you may wish to select one that represents your business as a whole, in order to sound more professional. Once you have narrowed down a name, you are then able to register said name online to ensure that no other business can operate under the same one as you. 

  1. Choose a registered agent 

A registered agent is a separate third-party from your business who will send and receive official legal documents on your behalf. Essentially, they are an individual or business that helps you maintain and protect your privacy as a business. For example, if you were to get sued, the legal documents would be sent to their location, rather than to you, directly. A registered agent must be: 

  • Anyone who is over the age of 18 years old 
  • Has a physical address in the state that you are operating your LLC in
  • Is available during normal business hours to receive any documents on your behalf in person 

Generally speaking, you will want to choose someone who is in the area that is closest to your business location. That way, pick a local business that is easily accessible to you. In addition, you will not be able to use a P.O box as a physical address. Nonetheless, there should be multiple registered agent businesses in your area. Thus, make sure to shop around for a price for services that work for your budget. 

  1. File your articles of organization 

Your articles of organization is an official document that must be filed at your Secretary of State Office. The document should include the following information, including: 

  • Your business name 
  • The name, address, and contact information of your chosen registered agent
  • The names and contact information of all LLC owners 

When filing your articles of organization, you will be required to pay a filing fee. The fee will vary depending on the state you are filing in. However, on average, you can expect to pay approximately $100.00 for this. 

  1. Apply for an employer identification number (EIN) 

An employer identification number is essentially a social security number for your business. It is required by the IRS when you file your taxes. If you take out a mortgage for new properties, you will need to use this number for the loan. In addition, you will need an employer identification number (EIN) to open up a business bank account. Having a separate bank account will help keep your business expenses separate from your personal assets and give you an extra level of liability protection. In addition, to build the credit for your business, you may also wish to take out a separate business credit card with your EIN to build credit. Ultimately, this will help you obtain a mortgage later down the line. 

  1. Open a bank account for your LLC 

As we just mentioned, it is important that you keep your personal expenses and assets separate from your business expenses. Therefore, once you have filed your articles of organization and obtained an employer identification number, you will then need to open up a new business bank account for your LLC.

  1. Add your LLC to your property 

Once you have registered with your State Secretary Office and opened up a new bank account, it’s now time to add your limited liability company to your new rental property! Essentially, adding your LLC name to the property title of your rental property allows you to use your official business name rather than your personal one. As a result, you will be able to use your entity name for any marketing purposes and for official correspondence between internal partners and external parties. All in all, by doing so, it helps you look more professional as a business, especially to potential renters who are thinking of renting your property. 

  1. Add your LLC to your mortgage loan 

If you have yet to purchase real estate for your rental properties business, then adding your LLC to your mortgage can help you increase your business's credit score. In addition, using your official LLC title will also help your chances of being approved for a loan by a lender. Overtime, your LLC business will have a history of timely payments which will ultimately allow you to grow your business in the future. As a result, you can then purchase more properties and even dabble into the commercial real estate realm as well. Remember, it’s all about building a reputable business that is backed by a sound credit score. 

  1. Consider insurance coverage for your LLC 

Furthermore, another highly important step that you will need to make when creating an LLC for your rental property is ensuring that you have necessary liability insurance policy coverage that will protect you and your interests from any liability. This is especially important when your business directly interacts with third-parties, aka your renters. Therefore, you will need to consider coverage including, homeowners’ insurance, property management insurance, professional liability insurance, and landlords’ insurance.

While these insurance policies will cost you extra money throughout the year, they can help provide you with the peace of mind knowing that your business, property, and personal finances are protected at all costs in the event that someone is to injure themselves or damage your property during their stay with you. Business owners should always keep in mind that it is better to be safe than sorry when it comes to their real estate investment business. 

Final thoughts on creating an LLC for your rental property business 

As mentioned throughout our article, creating a limited liability company for your rental property comes with its advantages and disadvantages. Nonetheless, if you are willing to put in the work and are interested in pursuing the real estate investment industry as a long-term career plan, then having the proper protection in place is key to ensuring prosperity in a competitive market.

Therefore, whether you’re considering working as a sole proprietor, or single-member LLC or with partners, remember to flush out a detailed business plan that outlines how profits will be distributed, which tax classifications you plan on qualifying for, and the duties that each member will be responsible for. That way, you will have all rules of management in writing that are legally binding to your business. Once you have figured this out, you will then need to choose a business name before finding a registered agent in your local jurisdiction before filing your articles of organization. Just remember to choose an agent you can trust and file your articles in the same city as your real estate property as the laws and regulations can vary between local and state governments. 

Then, after applying for your employment identification number and opening up a separate bank account, you can move forward with purchasing your property and applying for all the necessary insurance policies that will keep your business protected from liability. 

References

Roof Stock Retrieved From https://learn.roofstock.com/blog/pros-cons-of-llc-for-rental-property

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