If you own rental property in the United States, it’s a murky world. Sometimes, you buy in as a solo entrepreneur and are looking for ways to minimize your tax burden. Or, you're a seasoned real estate investor that is concerned about protecting your greater portfolio from creditors and lawsuits. For a lot of these quandaries as a rental property owner, an LLC is the answer.
So, let's look at some of the benefits and considerations for creating an LLC for real estate investment purposes.
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In short, an LLC stands for limited liability company which is a corporate structure that can insulate its owners from the liabilities and debts of the company. Whether you’re the owner of a few single-family rental properties or 1,000 multifamily units, an LLC can protect you from, well, personal liability. But that’s only one reason to create an LLC for rental property.
If you’re reading this article, you know that as a property owner without legal protection your personal assets are on the line. If you own rental property and a tenant files a lawsuit against you, the lawsuit could bring any number of personal assets into the case.
However, if you create a real estate LLC, then the only assets at stake are those owned by the corporation itself.
In other words, your rental property is the only asset at stake and not your personal finances. That’s worth pursuing.
In an ideal world, you would set up your LLC before you purchase the property you want to invest in. In that case, you won’t potentially have to file multiple quitclaim deeds to transfer property or ask lenders to consent to your transaction. Along the same vein, you’ll be able to decide ahead of time whether you want to set up a separate LLC for each property or combine all of your rentals into a single entity.
Here are some other thoughts to consider:
When you’re setting up an LLC for real estate it’s important to know your own state’s laws, as that’s how LLCs are governed. However, it’s generally true that LLCs are a great option for property owners because they’re less complicated to manage than a C or S Corporation while offering significantly greater legal protection than a sole proprietorship.
LLC owners are referred to as "members", and ownership can include one member or multiple members as required by your circumstances. There is no upper limit to the number of members.
If there were an “LLC For Dummies” book (hint: there is), it would definitely mention pass-through taxation. One thing that is unique is that all of the profits and losses of the LLC "pass-through" the business, going to directly to the LLC owners/members who report this information on their personal tax returns.
What this taxation rule means is that the profits of the business are not taxed before being distributed thereby avoiding the double taxation consideration of a C or S-Corp.
Since each individual member of the limited liability company must report as an individual, it protects the real estate entity from additional tax consequences.
There are still additional tax considerations that will vary depending on if you're considered an active or passive member of the LLC, so it's highly recommended to consult your tax advisor with your specific situation.
Additional Resources:
For more details about general LLC taxation, Nolo.com is a great resource.
You can create your limited liability company with a few easy steps.
Step 1: Consult a CPA and/or Attorney
While setting up an LLC is a fairly straightforward process, there can be a number of considerations that vary depending on your personal circumstances. These include whether you're going to be an active or passive member of the LLC, if you have employees or plan on hiring in the first year, if a separate LLC is recommended for each individual rental property in your portfolio (sometimes referred to as a special purpose entity or bankruptcy-remote entity), etc. A CPA or Attorney can assess your individual business and guide you as to the best course of action.
Step 2: Draw Up The Paperwork
A lawyer can also help you draw up the Articles of Organization and Operating Agreement for a reasonable fee, but you can also do it yourself for around $150 + state filing fees by using services like Launch by Legalshield or LegalZoom.
You’ll want to make sure you’ve made some decisions when you file such as:
Step 3: File your LLC Paperwork With Your State’s Secretary of State Office
Your state will have its own paperwork and forms for you to complete to register your LLC. Some allow you to file online, and others still require mailing it all in. Either way, you’ll pay an average filing fee of approximately $100 depending on your state when you submit your paperwork.
Additional Reading: LLC Annual Fees by State
You will also need to designate a Registered Agent which is an individual that resides in the state where your Limited Liability Company is formed and has a physical street address who can accept important legal notices such as correspondence from the Secretary of State's office, service of process notices, tax documents, a notice of a lawsuit and more.
While you can pay someone to act as your Registered Agent, any member of the LLC can act as the Registered Agent as long as they meet the criteria above.
It’s a fairly simple process to transfer deeds to an LLC.
Step 1: Find your forms
You can do an internet search or go to your county recorder’s office to get your forms. As these forms vary from state to state, you’ll want to double-check the deed form you’re using is specific to your state.
Step 2: Figure out which deed you have
There are two types of deeds:
Warranty deed — this deed is the most likely one you received when you purchased your property. It should include a guarantee that the title is good and free of any interests or claims by a third party.
Quitclaim deed — this type of deed doesn’t guarantee your property title is good or proves ownership. This type of deed only states that you are passing interest you may have in the property to the LLC.
There is disagreement among experts as to the best deed to use — there are benefits to quitclaim deeds and warranty deeds but either can be used to transfer a real estate title to your LLC.
Step 3: Fill Out Your Forms
Whether you choose a warranty or quitclaim deed, you will be considered the grantor and the LLC is the grantee of the company. Double-check that all the names are correct and always use the full legal name of your limited liability company. For all questions about how to do this process, consult your county recorder for individual help for all the considerations you’ll need for the deed to be deemed valid.
Step 4: Sign It Over
As grantor, you will need to provide your signature at the time of transfer. An important note: some states require you sign in front of a witness or a notary, and some states also require a grantee so someone will also need to sign on behalf of your newly-formed real estate corporation for it to transfer.
Step 5: Record It
Once all the paperwork has been created, you’ll need to record the deed so that there’s a public record of the property transfer into your LLC. You can either submit to your local registrar or any other agency that handles real estate records in your city or county, depending on where you live.
Step 6: Update Your Lease
An important next step is to change all your leases to reflect that the new landlord is the limited liability company, not you, so that you can take advantage of all the protections now afforded you. Communicate to your tenants that they need to pay rent to the company, not to your personal name. And be sure always to deposit your rent payments into your separate LLC bank account. These steps when you transfer will help protect your assets from personal liability should something go wrong. A simple name transfer can save you a lot of headaches.
If your rental property has a mortgage, contact your lender before you set up your LLC. Let the company know that you want to create a limited liability company to manage your rental property. Most residential mortgages contain a "due on sale" clause that prevents ownership from being transferred without written permission from the lender.
If you can make arrangements to buy out your mortgage, that could be a good option. You could clear the titles and transfer to your LLC more seamlessly. If that is not possible, you may still make the transfer but could be looking at paying some closing costs as well as typically higher interest rates. We do recommend asking a lawyer in your state about ways to go about liability protections depending on whether you purchased the property as a residential property that will then be transferred to commercial use.
Despite the myriad of benefits that a property owner can realize by setting up a Limited Liability Company, some people seek alternatives due to the costs and ongoing reporting requirements. In this case, some investors have chosen to purchase an umbrella policy instead.
While this can be a more cost-effective approach to asset protection in the short term, these insurance policies contain exclusions, carve-outs and liability limits which can still leave a property owner exposed to significant risk and are generally not recommended as the sole form of asset protection.
There are so many benefits to creating a limited liability company for your rental property. Since protecting your investment is such an important goal in being a property owner, creating an LLC can help you reach that goal and protect you and your income from liability. Be sure to follow our provided steps and contact all the appropriate state resources, and you’ll be well on your way!
Additional Reading:
While every attempt has been made to provide accurate and up-to-date information, this article should not be taken as legal or tax advice. Please consult a qualified legal or tax advisor to discuss your specific situation.
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