Setting Up an LLC for a Rental Property

Benefits of a Rental Property LLC

LLCs are business entities that combine the pass-through tax status of a sole proprietorship or partnership with the liability protections more commonly associated with corporations. Limited liability is of primary concern for rental property owners, but owners may also stand to benefit from the tax advantages allowed by an LLC.

Liability Protection for Rental Businesses

There are many risks when renting property to tenants. Tenants might not pay rent in a timely manner, and legal restrictions might limit your ability to enforce rent—leaving you short on funds when the mortgage is due. Or an accident on your property can lead to a lawsuit threatening major damages.

If you are operating as a sole proprietor or partnership, either of those examples could leave you liable for those costs, and you might risk losing your property, or even other unrelated personal assets. Forming an LLC can shield you from that danger—and with several different ways to run your business as an LLC, it’s easy to find one that best suits your needs.

• Single LLC: As an owner or member of an LLC, you benefit from liability protection. When an LLC faces legal action or financial penalties, the only assets at risk are those that the LLC owns itself. For example, a lawsuit might take the building your company owns, but you wouldn’t lose your own home! This method is best for an owner with just one rental property, or a small number of closely-linked properties.
• Multiple LLCs: Someone owning several separate rental properties might take the extra precaution of siloing each property into its own individual LLC. This approach results in more paperwork and fees with multiple articles of organization and maintenance requirements like annual reports. However, there is the substantial benefit of putting each property under the control of legally distinct entities. This means a debt or legal action against one individual LLC will not result in the loss of other properties an owner set up as separate LLCs. Learn more about forming multiple LLCs for rental properties.
• Series LLCs: 21 states and jurisdictions (such as Delaware, Nevada, Wyoming and DC) currently allow the creation of series LLCs, which establish subsidiary LLCs to a “master” LLC. This practice is designed to grant similar protection for each subsidiary LLC as distinct, separate LLCs receive, but without the extra formation fees that fully separated LLCs require. Such a structure is well-suited for rental businesses that own many properties. That said, series LLCs are not yet available nationwide, and may not be recognized as legally valid when dealing with states where series LLCs have not been implemented. Learn more about Series LLCs.

Tax Advantages

LLCs are taxed as pass-through entities by default, much like partnerships are. This means the company itself pays no income tax, passing tax requirements on to the members’ personal income tax returns. This is advantageous because it avoids the double taxation of a corporation, which pays income tax on both the company and personal level.

In addition to the pass-through tax benefits of an LLC, due to the qualified business income deduction established in the Tax Cuts and Jobs Act, LLC members may be able to deduct up to 20% of their LLC income from personal taxes. Owners of pass-through entities (like a real estate LLC) are eligible for a 20% deduction under this law if making revenue up to a phase-in threshold of $163,000—and qualify past that point for reduced deductions on up to $213,300 in revenue. The phase-in threshold is $326,600 for married couples filing jointly, and reduced deductions continue up to $426,600.

The Tax Cuts and Jobs Act is limited to certain types of trades and businesses, but rental properties are eligible under an exception for businesses using “qualified property” to generate profit—such as real estate used for rentals.

Disadvantages of a Rental Property LLC

Forming an LLC for your rental business has many benefits, but no business structure is perfect—otherwise all rental companies would be LLCs! Certain aspects of an LLC may present difficulties to rental owners, most notably avoiding the entanglement of personal and business assets, restrictions on lending to business entities, and technicalities arising from the transfer of property.

Liability Restrictions

The flip side of an LLC’s liability protection is that it relies on following rules and regulations to a “T”—particularly when it comes to keeping personal assets and those of the LLC separated. If a lawsuit is filed against your LLC, and a judge determines that your personal money was used to pay for upkeep on one of the LLC’s rentals, you could be determined to have co-mingled those assets, and your LLC could lose its liability protection as a result—and in turn, you could lose personal property in recompense for the lawsuit as well! Obviously, those rules also apply in the case of using LLC-owned property for personal use, such as staying in a rental owned by the company without paying rent, or paying for personal expenses with the LLC’s money.

Other LLC Real Estate Issues

LLCs often have difficulty getting funding for purchasing property for use in rentals, due to mortgage regulations being written to favor individual home buyers–and because newly established LLCs have difficulty providing an established financial track record.

Another problem that can happen when an LLC acquires a property for use as a rental is a “Due on Sale” clause. This triggers when a property being exchanged between a partner and the LLC has a mortgage that stipulates that it must be paid in full before being transferred.

The clause can be overridden by means of a waiver from the mortgage lender.

For more on LLC mortgages and Due On Sale clauses, check out our article on LLCs and Real Estate.

Creating a Rental Property LLC

Forming an LLC for a rental property requires filing state formation paperwork, typically called “articles of organization.” This filing requires a state fee (around $100 on average) and basic information about your business, such as its name and registered agent. (For step-by step instructions on forming an LLC, see our Start an LLC page.)

Once your LLC is formed, you’ll also need to fill out deed forms for any property you want transferred to the LLC, along with a signature for the transfer (in some states, this must be notarized).

These documents must be submitted to your county registrar, or to whichever local agency handles real estate records.

Lastly, you will need to update any preexisting leases in your name to show that the LLC is now the official landlord. Make sure your tenants understand that rent now needs to be paid to the LLC rather than being paid to your personal account.

Rental Property LLC or Trust?

One alternative to an LLC that rental owners may find tempting is putting the property in a trust, a legal entity that holds assets for someone else (the beneficiary) on behalf of the grantor (the person who created the trust).

An irrevocable trust, which is inaccessible by creditors during the life of the grantor and can’t be changed or dissolved without third-party approval, might seem like a good alternative to forming an LLC for rental properties. Trusts also tend to be cheaper and offer even more privacy than an LLC.

Unfortunately, an irrevocable trust limits the amount of control the grantor has over those assets, as they become property of the trust itself, and those protections only last for the grantor’s lifetime. Upon assumption by the beneficiary, those assets are once more at risk of liability.

With limited control over rental property placed in a trust, and risk of exposure upon the grantor’s death, many people ultimately decide an LLC is the better solution, as it provides broader protection to their assets while granting greater control.

For further information, see our article on Trust vs LLC.

Ready to form an LLC? Check out our step-by-step guide or have us form it for you!

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