Let me start this off by saying this isn’t legal advice and you should consult an actual legal professional about creating an LLC for a rental property. 🙂
Alright, now that we have that out of the way, let me cut to the chase and give you my 2 cent about this topic…
Unless you’re already a wealthy individual, you’re wasting your time trying to figure out if you should LLC rental properties or not. Your time is MUCH better spent trying to get your investment business off the ground.
With that being said, let’s get you some context around LLCs so you can make a sound decision for yourself.
Let’s dig in.
What is A LLC?
Wikipedia offers the following definition:
A limited liability company (LLC) is the US-specific form of a private limited company. It is a business structure that can combine the pass-through taxation of a partnership or sole proprietorship with the limited liability of a corporation. An LLC is not a corporation under state law; it is a legal form of a company that provides limited liability to its owners in many jurisdictions. LLCs are well known for the flexibility that they provide to business owners; depending on the situation, an LLC may elect to use corporate tax rules instead of being treated as a partnership, and, under certain circumstances, LLCs may be organized as not-for-profit. In certain U.S. states (for example, Texas), businesses that provide professional services requiring a state professional license, such as legal or medical services, may not be allowed to form an LLC but may be required to form a similar entity called a professional limited liability company (PLLC).
In other words, a LLC is a legal entity that, as the name implies, helps limit one’s liability in a particular interest.
Benefits of establishing a LLC for a rental property
Let’s start by outlining the the various benefits of establishing a LLC for a rental property.
Forces you to run it like a business
Probably one of the best arguments for creating an LLC for rental properties from the start is that it will force you to think in actual business terms. Too many real estate investors become too emotionally attached to their first rental property and it ends up causing issues down the road.
With that being said, you don’t HAVE to have a LLC to start thinking in business terms.
Here are a few related things you’ll want to consider:
- Bank Accounts – Regardless of whether or not you LLC rental properties, you should go ahead and open up separate bank accounts. At a minimum, I’d suggest you open up three; rental income, security deposits, and a business operating account. However you go about it, just make sure to always keep your financial separate.
- Mail – Next, how will your rental business receive mail? You could have mail come to your house if you really wanted. Or you could possibly set up PO box.
- Managing Tenant and Business Records – Financial records, maintenance requests, lease agreements. Regardless of whether or not you LLC rental properties, you should start to think about how you are going to maintain the various data points you’ll need to maintain. Here at Holland & Picht, at the time of this writing, we use Buildium as a primary property management software (in addition to a number of other tools). There are a number of different solutions out there though. Make sure you do your research and find what best fits your situation.
Helps protect your assets
One of the primary reasons people create an LLC for a rental property is that a LLC, as you might suspect, limits the liability for the Owner.
While this is important, it really only matters if you have actual assets to protect.
If you’re a new Investor, consider focusing on the following instead of the nuances of a LLC:
- Provide a great rental property and experience – Put yourself in your tenant’s shoes for a moment. What situations would result in them coming after you legally? Now, instead of trying to play defense and shield yourself from a legal effort, go on the offense and try to address the issues that would result in them suing you. Most likely, this will come down to you providing a clean and safe living environment. Once you’ve taken care of the basics, try to provide great service as well. It’s difficult for someone to come after you legally if they like where they live and like you as a person.
- Increase your insurance – I’m not an insurance expert here so I won’t go into much detail. However, if you really wanted, you could establish some sort of insurance protection as a short term risk mitigation solution.
Builds Business Credit (Kind of)
When you set up your business’ financials, consider putting your normal business expenses on a business credit card and automatically paying off those expenses at the end of the month.
That, coupled with consistently paying off any loans you have in your LLC’s name, will help your business build its credit over time.
However, again, this is pretty insignificant compared to actually getting your real estate business off the ground in my opinion.
Assuming you’ll borrow money from the banks, you’ll likely max out the number of residential loans that a bank will provide you (10) before ever needing to finance a rental property using your business. For this reason, your business’ credit is fairly insignificant until you near the 10 rental property mark.
Pass-through Taxation
When you put your rental property in a LLC, it essentially creates a situation in which the income is not taxed twice (once at the business level and again when it’s given to the Investor).
In addition to this, assuming you’ve set up proper bookkeeping and bank accounts, you are able to more easily track expenses related to the rental property. With these records, your CPA can help you determine what can be written off and what can’t.
It’s important to note here that this stuff varies in details from state to state. So please work with professionals who are familiar with local laws.
If you’re in Tallahassee and need a recommendation on who to work with, feel free to email us. We’d be happy to share with you a few local professionals we work with regularly.
Disadvantages of Having a LLC for rental property
Now that we’ve laid out the benefits, let’s take a moment to identify any disadvantages of having a LLC for rental property.
Lost Focus
I’ve hinted at it a few times already, but most people really get tied up in the nuances of setting up LLCs when they should really be focusing on getting their real estate business off the ground.
I’ll get off my soap box now (no I won’t)…but you get it.
Focus on stuff that makes you money.
Forming an LLC for Rental Properties Cost Money and Increases Complexity
Speaking of money; creating and maintaining a LLC will cost money.
If I remember correctly, it cost Jason and I around $600 to set up Holland & Picht, LLC. Your cost may vary a bit, but you should be able to use that as a general rule of thumb.
In regards to maintenance, assume a few hundred dollars per year in various related costs.
Along with increased cost, setting up a LLC for your rental property will increase the complexity and result in more paperwork that you’ll need to manage. This is, in part, why you’ll have various maintenance related costs each year.
As you can see, if you were to setup a LLC for every rental property you owned, it’d quickly become an issue from a cost and management perspective.
Commercial Loans are Less Desirable than Residential Loans
I hinted at this a bit early but it’s worth reiterating here in the disadvantages section; the loan terms available to people are much better than the loan terms available to a business.
Unless you’ve already maxed out the number of residential loans available to you as a person, it doesn’t make sense for you to jump straight into a commercial loan.
For this reason alone, it typically doesn’t make a lot of sense to set up a LLC for investment properties when you are first starting out.
Can Still Pierce the “Corporate Veil”
Lastly, it’s important to note that, just because you’ve set up a LLC for your rental properties, it doesn’t mean that you’ve mitigated all risk.
At the end of the day, you need to place a heavier focus on providing a great living space for your tenants.
Final Thoughts on Setting up an LLC for Rental Property
Alright, so here are our final thoughts on forming an LLC for rental properties and a recommendation for how you move forward:
- First, get your 1st rental property under your belt and figure out if you really want to build out a rental portfolio or not. Run it as a business, just without a formal LLC in place. Keep in mind that you can always create a LLC for rental property with a mortgage at a later date.
- If you want to get serious, create a written plan that outlines how you will get to 10 rental properties. This should describe your investment strategy, criteria and your plan to finance each of the rental properties.
- Once you have written out that plan, schedule some time with your CPA and a local attorney who practices in real estate space.