A Limited Liability company or LLC is a business structure that has several advantages for real estate investments as well as costs.
The compelling reason to set up an LLC is that it limits the liability of the owner to the corporation rather than the owner’s personal assets if problems occur with tenant legal issues or debt. The primary reasons not to set one up are costs – which vary by state – and weather the lending organization who holds the mortgage will consider this a change in ownership and require refinancing.
LLCs can be set up for either individual owners or partnerships. They make assets easier to move between partners within the LLC which can be husband and wife. They are regulated by the laws of each state with the costs varying for both the initial set up as well as annual fees.
Advantages of an LLC
The primary reason for setting up an LLC is that it prevents the owner from being sued. Let’s say you have a tenant who throws a party and someone gets drunks and falls over a balcony or railing sustaining major injuries. Later, after he sobers up he claims it was the result of an “Unsafe Condition” on the property.
If there is a major tenant accident resulting in serious injuries an LLC prevents the owner from being sued as an individual putting their personal assets at liability. The corporation, can be sued, but liabilities are restricted to that LLC only.
With an LLC, only the corporation’s assets are at stake. Many landlords have separate LLCs for each property to “insulate” each from liability claims from another. Banks also usually prefer a separate LLC for each property to be certain that liabilities from one property will not negatively impact the others.
There are more immediately beneficial reasons to set up an LLC however, than simply shielding the owner’s personal assets in the event of a hypothetical lawsuit. One can be tax advantages.
LLCs are usually set up to be “Pass-through taxation”, which means that the business doesn’t pay taxes. This means the income or capital gains is passed to the owner or owners to report on
their individual personal taxes while they receive the protection of shielding their assets.
LLCs are flexible in the eyes of the IRS to be able to be taxed as an S Corp or C Corp if you’d like to take advantage of corporate tax savings if you pay self-employment taxes.
Separates Rental Properties from Personal Income
A separate bank account is created for the LLC which keeps your rental property income and expenses in a single account. This can be a major time saver when it comes time to do your taxes keeping your personal and business expenses separated.
By creating an LLC, you are separating your rental income from your personal income, which may lower your income tax bracket and make you eligible for tax deductions for business expenses and medical insurance.
It’s important to keep your personal and business finances separate with an LLC also for legal reasons or you possibly lose the liability protection it affords if it can be proven you are mixing accounts, for example paying for rental repairs with a personal check.
Makes Real Estate Partnerships Easier
LLCs make a lot of sense when multiple partners are the owners as a consortium. A partner is a “member” of the LLC. The LLC will have an operating agreement that will define the rights and obligations of every member which can help resolve any future disputes.
An LLC can make the transfer of ownership and assets such as between a husband and wife much easier within this structure.
When you own property, the deed is a matter of public knowledge anyone can obtain. When people have your name and can easily search on the internet to see if you are a high-income individual that information may influence someone trying to take advantage of you with a lawsuit.
Although this varies from state to state, an LLC generally helps shield the owner’s anonymity.
Reasons Not to Create an LLC
The primary reason not to set up an LLC is that they cost money – which can vary from state to state both to initially set up as well as annual fees. For example, California has a relatively low set up fee but then charges heftier annual fees to maintain.
There is usually a $50 to $150 dollar fee to set up with each state’s governing authority.
You can hire an online service like Legalzoom.com and it will cost between $700-800 dollars. Having an attorney set one up will probably cost between $1,000 to $2,000.
Other costs involve whether the LLC is set up before buying the property or if title will need to be transferred to the LLC after purchase. There are additional tasks involved in maintaining an LLC like keeping annual notes of members meetings, and filing separate tax returns for each member.
In some states, there may be special requirements for example of having a lawyer represent you in an eviction case from rental property in the name of an LLC.
California’s new rent control law Assembly Bill 1482 makes special exceptions for single-family homes, condos, and duplexes where the owner lives in one unit. These would normally be exempt from rent control, unless they are owned by a corporation or real estate investment trust (REIT) in which case they are covered by this new rent control law. This could be a hidden cost for California landlords in this situation with this new law.
Advantages to Setting Up LLC Before Property Purchase
LLCs can be set up at any time for a rental property, but there are several advantages to setting them up before purchasing a property to avoid several costs and headaches trying to transfer title after purchase that will vary depending upon the mortgage lender.
Changing the title on a property after purchase requires changing the name on the deed. Check your lending agreement for a “due-on-sale” clause. This means your lender may consider the change in the name on the title as a sale with the original financing agreement being terminated. Another new lending agreement is set up in the name of the LLC which may have a higher interest rate, and involves closing costs to be paid to the lender.
Title Transfer Taxes may also be required to be paid which vary from state to state. These factors usually make it much easier and less expensive to set up an LLC before purchasing a property than trying to transfer title on an established mortgage.
Will an Umbrella Insurance Policy Offer the Same Protection as an LLC?
Landlords will often try to achieve the same liability protection of an LLC with an umbrella policy which goes beyond your standard insurance policy. Umbrella insurance policies add an extra layer of protection and can cover a wider array of liabilities including flood, fire and vandalism damage.
However, it’s important to remember that every insurance policy will always have a limit. If the limit your umbrella policy is set for is exceeded by a lawsuit judgment, a landlord’s personal assets are still liable. An LLC is simply a more effective way to protect a landlord’s assets so they are never vulnerable during a lawsuit.
Insurance policies also have exclusions which need to be understood and accounted for. Umbrella insurance policies are often relatively inexpensive for the amount of coverage they can provide. Depending upon what it takes to enable you to be able to sleep at night, a combination of an umbrella policy with an LLC combined will be your most ironclad form of protection.
Be Sure to Review Your Particular Situation with an Attorney or CPA
Because every state has different laws regarding LLC filing and maintenance requirements, tax laws, and every lender has different regulations regarding changing title on a deed with an outstanding mortgage, it’s essential to review your plans with a qualified attorney, your tax consultant and your bank holding the note. Failure to do any of these could result in major missteps before going forward to be certain establishing an LLC makes sense for you in your particular situation.
At Fast Eviction Service, help on any of the issues discussed in this article is simply a click or phone call away. Email firstname.lastname@example.org or call our office at (800) 686-8686 to discuss your questions for a free evaluation of your case.
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