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How to Effectively Use LLCs in a Property Rental Business

Using a limited liability company for a rental property business is one of the better decisions you could make. If you rent property in your name, you could be held liable if someone gets hurt. However, if someone falls and decides to sue the landlord, and your LLC is the landlord, then the person suing may only go after the LLC's assets—not your personal assets. Another great reason for having an LLC is that the debt for the rental is kept separate, and creditors cannot come after your personal assets because of the liability protection an LLC offers. However, before you make that decision, you must look at all of the advantages and disadvantages of having an LLC own your rental property.

Protecting Your Assets

If you are sued because someone is injured on your rental property, including a guest of the tenant, your personal assets are not protected if the rental does not belong to an LLC. Even if the lawsuit is trumped up, you will be out of pocket for attorneys' fees and costs to defend your assets. If you put rental properties in an LLC, you will still have to come up with money for an attorney; however, your personal assets are protected. The person suing may only go after the assets held in the LLC. Thus, if you have several properties, you may want to have a separate LLC for each property.

Once you register an LLC, obtain a Tax Identification Number (otherwise known as an Employer Identification Number or EIN) and open a bank account in the name of the LLC. If your rental homes are currently in your name, file the appropriate deed—usually a quit claim deed—to transfer the title of the property to the LLC. If possible, refinance the property into the LLC's name or ask your bank if it could transfer the mortgage to the LLC's name without refinancing. Always contact your lender/bank. If your mortgage has a due-on-sale clause, it could cause you to have to pay the mortgage in full if you transfer without contacting the mortgage company first.

Co-Mingling Money

Once you set up an LLC, do not co-mingle money earned through the LLC with your own personal money. In other words, do not buy supplies or make repairs for a rental home owned by an LLC with your personal money, and do not go out and buy personal items such as clothing or food for yourself with money from the LLC. If you do, and you are sued by a tenant or the tenant's guest, you could forfeit the limited liability protection you have by putting the rental property in the LLC in the first place. Additionally, if you co-mingle your personal funds and funds earned through the LLC, you could breach the liability protection. Therefore, if you are sued over a debt, your creditors may be able to go after your personal assets.

Managing Your Money

When you put your real estate rentals into an LLC, you are able to manage your money more easily. If you have more than one rental property, then putting each property in its own LLC makes money management almost simple. It also keeps you from co-mingling funds between properties. Each property has its own LLC, which in turn has its own bank account. Rental income goes into the bank account, and mortgage payments, repair costs, and other property costs come out of the same bank account. You will have a separate bank statement tracking the cost of each property that is kept separate. This way, you will not have to remember to mark the receipts to determine which property they belong to.

When it comes to doing your taxes, everything is separate. That way, the deductions that should be taken against a certain property are sure to go with that property. This could make a big difference in how your tax burden is handled, depending on the amount of interest you are paying on the mortgage for one particular property. This also depends on how you set the LLC up. You may have to file additional forms, such as a Schedule C, if you set the LLC up a certain way.

If you prefer using a credit card for costs, each LLC may be able to get its own credit card. When you need to purchase items for upgrades or repairs, use the credit card or bank account for that property only.

When you apply for loans for the properties, a property that is not doing well financially will have less effect on a property that is doing well. Because the properties are in different LLCs, a property doing well has the income to support the loan. However, if you have a property that is struggling, the losses will bring down the income for the property that is doing well if both are contained within the same LLC. If they are kept separate, you will have an easier time getting the loan for the property that is doing well.

Marketing Strategies and Professionalism

If you have more than one rental property or you plan on having more than one rental property, setting up an LLC makes it easier to market those properties under a brand name. With branding, people will look for a company name that might be easier to remember than your own name. You also look more professional to investors if you need to borrow money for additional rental properties. Furthermore, it is easier to keep track of the money your business earns and spends if it is kept separate from your personal finances. Setting up a bank account for the LLC allows you to easily track business expenses and income as long as you do not co-mingle money.

Liability Protection: Insurance or LLC?

Some people may prefer to use liability insurance rather than an LLC for protection. However, liability insurance has several disadvantages, including but not limited to:

  • policy limitations;
  • exceptions;
  • addendums that might convolute the insurance coverage; and
  • additional insurance required, such as hurricane insurance.

If your insurance does not cover a dog bite, for example, because the small print states that the insurance will not cover damage or injury from certain breeds, the injured person may be able to go after your personal assets unless you have an LLC set up. The ideal situation is to put a rental property in an LLC and then insure the property.

Tax Benefits

One of the benefits of using an LLC for your rental properties is pass-through taxation. This means that the LLC does not pay taxes; the business owner pays the taxes, thus eliminating the double taxation that you get if you incorporate. If you are a single-member LLC—that is, you are the only member—you are taxed like a sole proprietorship, but get the benefits of liability protection.

If you own a multi-member LLC, even if the other member is your spouse or you have several members, the taxes are handled differently. The taxes are still passed through the LLC to the members; however, the members must complete a Schedule C, Schedule K, or Form 1065 with their income tax return. The only income claimed is your share of the income, not the entire income the LLC earned.

If you do have to pay self-employment taxes, you might set up the LLC as an S corporation or a C corporation. Prior to setting up the LLC, it is advisable to discuss your situation with a tax professional to find out the best way to set up the company to minimize your tax burden.

Additionally, if your property is held by an LLC, you will be able to take certain deductions on your taxes that you otherwise would not be eligible for. And, if your LLC is run out of a home office, you may be able to realize additional deductions.

Adding Properties to an LLC after the Fact

In some cases, you may wish to transfer a real estate rental property that you already own into a new limited liability company. Always check with your mortgage company about transferring a property from your name to the name of your LLC. It is much easier to create an LLC and then start purchasing rental properties in the LLC's name rather than trying to transfer the properties and mortgages into the LLC.

If the loan is in your name and you transfer it to the LLC's name, the mortgage company could look at that as a sale and may call in the loan. By contacting the mortgage company, you could save yourself a lot of grief. Explain the circumstances to the lender. You may be able to transfer the loan to the LLC or you may have to refinance.

If the lender will not extend either option, you still have another option: you can lease the property to the LLC and the LLC then subleases the property to a renter. Therefore, you can run all of the income through the LLC. Be sure to obtain the advice of a professional regarding the appropriate documents and tax consequences when you lease and then sublease the property.

When you have a chance, refinance the property, even if you must go with another lender. It may take a year or two to be able to get financing in the name of the LLC since it is a new company.

Using an LLC to Structure a Trust

Should something happen to you, your personal and business assets could be eaten up by medical bills or you may become incapacitated because of an illness or accident. Certain types of trusts allow assets to automatically go to your children. You may then set up a trust and the trust owns your interest in the LLC. This adds another layer of protection for your assets, particularly for your heirs or in the event you become incapacitated. Because certain trusts do not protect your assets from creditors, you should speak with a probate attorney about the proper trust for your specific situation.

Disadvantages of Using an LLC for a Real Estate Rental Business

Using a limited liability company to protect your rental properties has many advantages, but a few disadvantages too. One of the major disadvantages of using an LLC for a real estate rental business is the fees involved with setting up the LLC. However, it is considerably less expensive if you complete the forms yourself. An attorney could charge you $1,000 or more. If you set up the LLC yourself, you are responsible for the filing fee. The filing fee varies from state to state and is the same whether you file the entity yourself or an attorney files it for you.

Another disadvantage of using an LLC for real estate rental properties is the tax consequences. However, with the proper tax advice, you may end up on the sweeter side of the of the deal, even if you have more than one LLC and they are all multi-member companies.

Consult with Professionals

Before you form your new company—or companies if you have more than one real estate property and wish to keep them separate—consult a tax professional, accountant, and other professionals to learn which is the best form of a limited liability company you should set up. Working with the appropriate professionals makes the process of creating your LLC much easier and more profitable, especially if you take a tax professional's advice before you set up your company.

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