Most investors who enter the rental property game are aware of LLCs and have either set one up or considered it. While LLCs offer many benefits to landlords, they are not necessarily the best approach in every case.
The primary benefit of forming an LLC (a limited liability company) for real estate investors is that if something goes wrong at a rental property — such as a tenant or a visitor getting hurt or injured — members of an LLC are not liable. The members’ personal assets, such as their homes, cars, bank accounts and investments, are protected from an injured party that intends to sue. Nor are the members personally liable for the LLC’s debts.
If an investor owns one or two properties, an umbrella insurance policy, or extra liability coverage, will protect an owner’s assets in most cases. But once a property owner’s assets exceed the amount of liability insurance being carried, an LLC will offer an additional layer of protection.
For instance, if an owner has $5 million worth of properties in multiple homes and only $2 million in liability insurance, an LLC should be considered.
“When you get to a certain level, that’s when an LLC starts to make sense,” said Thomas Stepp, Director of Investor Services at Mynd. The calculation is also different if there is a multifamily, multi-use or commercial property in a portfolio, he added.
Forming an LLC in most states is an inexpensive and straightforward process that a real estate attorney can handle. Online services like Legal Zoom, Rocket Lawyer, Incfile or Avvo can also help with the paperwork, but be aware that state laws vary and fees, tax rates, liability laws and requirements for registered agents also differ.
“Not all LLCs are created equally,” Stepp notes.
Costs associated with forming an LLC
Forming an LLC in Delaware or Texas, he said, allows an investor to purchase properties in other states. An LLC that owns property out of state is required to employ a registered agent where it is doing business to provide a mailing address, but there are companies that provide that service for as little as $99 a year.
A Delaware-based LLC allows the purchase of properties in multiple states, while consolidating the tax returns to Delaware only. In other words, the pass-through tax reporting for an investor who has properties in multiple states can be channeled through a Delaware LLC.
In Texas, there are additional legal benefits associated with LLCs formed there. But in many cases, if an investor plans to buy property locally, it makes sense to establish the LLC where he or she lives.
“It’s really dependent on where you own,” said Stepp.
In New York, there is a $200 application fee and it requires all newly formed LLCs to publish a notice of formation in local newspapers, which can run up to $1,500 in New York City, though registered agents outside the city can allow an LLC to use the agent’s address and lower the price.
Filing fees range from a low of $40 (Kentucky) and $45 (Arkansas) to a high of $425 (Nevada) and $500 (Massachusetts). Seven states charge no annual fee, and the others start at $10 a year and go up to $500. (Again, Massachusetts). Some states require an out-of-state LLC to register as a “foreign LLC,” which can require additional paperwork.
“If you are thinking of an LLC, it’s important to plan ahead and reach out to an asset protection attorney,” Stepp said.
A real estate investor should assess their goals for their business and get tax and legal advice before deciding where to form an LLC, or whether to skip it.
However, an LLC is not bulletproof, especially if the members fail to keep careful records separating business and personal expenses, a savvy lawyer can “pierce the veil” of LLC protections and its members may be held liable.
This approach works for real estate investors who own multiple properties but do not want to set up separate LLCs for each of those investments.
The Series LLC model has been approved in 23 states, and in Washington D.C., and Puerto Rico. It is a complicated structure that poses risks that are not present with a regular LLC, and a consultation with a legal professional is encouraged. State laws that govern the formation and function of series LLCs also vary greatly.
A series LLC can save on formation costs and offer more flexibility — as opposed to forming a separate LLC for each property owned — but some of the tax and compliance issues related to them can be inconsistent from state to state. Commingling funds for assets by the members of a series LLC can present significant risks.
How property owners benefit from forming an LLC
“The big key to leveraging an LLC is that you control more of the bottom line,” said Stepp. “It will show how your property is performing after expenses.”
And aside from the liability protection offered by an LLC, Stepp said there are several other benefits that flow from such an ownership structure, including:
Protects the identification of the actual owners of a building. Prevents real estate agents from reaching out directly to try to get an owner to sell a property.
An LLC can become an entity that can get financing on its own after three years.
Income that passes through an LLC can be claimed on its members’ personal returns, meaning profits are not taxes on the company level.
If the rental property records a loss, either through
LLC members may take tax deductions for legitimate business expenses, including the cost of forming the LLC, on personal returns. LLC owners may also be eligible for the Qualified Business Income deduction, which permits a 20% deduction from their business net income.
The management structure is flexible so all members share in the decision-making, or designated managers can make decisions for you. The LLC can
If rental properties are the primary source of income, an LLC member can deduct all health insurance costs.
Some of the downsides of forming an LLC for rental properties
Debt costs are higher than they are for a
Insurance premiums are higher because there is no personal guarantor.
Annual renewal fees and coping with an ever-changing regulatory environment.
LLC members cannot pay themselves wages.
If the LLC is sued, a judge can rule that it doesn’t protect your personal assets, and LLCs that do not separate business transactions from personal are at a particular risk.
Forming multiple LLCs for each property means paying multiple formation fees and annual fees.