You already have a lot on your plate as a property owner, especially if you own several rentals. From maintenance to tenant applications, these properties can take a lot of time and energy. On top of that, tenant disputes regarding rental property can and do happen. This is one of the biggest reasons that property owners decide to create a limited liability company (LLC) for their rental property – so that they have extra protection in the event of a lawsuit.
Why should you create an LLC for a rental property? What are the benefits and drawbacks? This guide will walk you through what an LLC is and the pros and cons of taking that next step.
What Is an LLC?
An LLC is a business structure that allows owners or partners to separate their business from their personal liability. This means that the owner is not responsible for the company’s debts or liabilities, which can be beneficial to many types of businesses, including rental properties. A few facts to keep in mind:
- Each state has its own process for creating an LLC, but it generally involves selecting a business name and filing the articles of organization with your state.
- There is a fee involved with forming an LLC that varies widely.
- Your business will also obtain an employer identification number (EIN) and create an operating agreement.
An LLC is different from other business structures, such as a sole proprietorship, partnership, or C corporation. Many landlords and property owners decide to create an LLC because they’re easy to form and manage, and the additional liability protections are a big plus. The owner of a sole proprietorship would not have any separation between personal and business assets, for example. Is an LLC right for you? We will look at the top reasons to take the leap.
4 Reasons to Create an LLC for Rental Property
Many property owners decide to create an LLC for their rental property or properties. Consider the pros and cons so you make the right decision for your situation, including how much time and money you can dedicate to managing the LLC. Here are the top four benefits.
1. Separate Personal Liability
One of the most important reasons to consider an LLC is to limit your personal liability for your rental property. What does this mean, exactly? Say a tenant was to file a lawsuit against you for sustaining an injury on the property. With an LLC, your personal assets and finances wouldn’t be involved in the dispute, just those of the business. This is a high level of extra protection for property owners.
2. Pass-Through Taxation
LLC owners also enjoy pass-through taxation. Pass-through entities are not taxed directly, and all profits made are taxed like a sole proprietorship or partnership. The LLC owner or owners only report the taxes on their personal tax returns. This helps you save time on filing a business tax return.
3. Create an LLC for Each Property
You also may want to consider setting up separate LLCs for each of your rental properties. This step further protects your investments because when a lawsuit is initiated against one LLC for one property, the others won’t be impacted at all. For example, you can still own and maintain your other properties even if you lose a property in a dispute.
4. Partnership Opportunities
An LLC also gives you more options for partnerships and investments than other corporations. LLCs can have foreign owners or investors. They also have no restrictions on the number or type of owners they can have. Having an operating agreement in place for your LLC will help you manage these relationships.
Creating an LLC for your rental property or properties limits your personal liability and helps you avoid filing a business tax return each year. They are easy to set up and maintain, so they are a popular option for property owners.
4 Reasons Not to Create an LLC for a Rental Property
There are many reasons that starting an LLC might help a property owner grow their rental business, but the structure doesn’t work for everyone. Here are the top four drawbacks.
1. Costs of Creating an LLC
Remember that there are fees associated with LLC creation, which will vary based on your state but are generally between $50 to $250. There are also annual reporting fees that may be required to keep adequate LLC records and stay compliant, in addition to other costs that may arise.
2. Separating Your Finances
Another potential downside of LLCs is that you need to create a separate bank account for the rental property as well as a separate bookkeeping system, apart from your own personal financial processes. It needs to be clear that the LLC is a separate entity from you and other owners. This could create additional work and can become time-consuming.
3. The Rental Housing Act
Properties located in the District of Columbia will be subject to the Rental Housing Act of 1985 if an entity owns the property instead of an individual. This means you could have to follow certain rent-control regulations and other restrictions.
4. Mortgage and Financing
Sometimes it can be more challenging to qualify for a mortgage if you create an LLC, and your interest rate could be higher. Keep in mind that if you already have a mortgage before creating an LLC, the transfer of property to the LLC could impact your financing.
These are all substantial reasons to consider not creating an LLC, but make sure you figure out if the benefits outweigh these drawbacks. Many landlords find the extra legwork to be worth it, in the end, to have their personal assets protected.
Working with Property Experts
Talk to the experts at Nomadic Real Estate if you have questions about creating the right business structure for your rental property. We are dedicated to helping landlords in the District of Columbia, Maryland, and Northern Virginia regions.
Contact us for more information about your Greater D.C. property management needs.