The short answer – in my opinion – is, yes, it is better to use an LLC to own rental property.
The main reason for using an LLC to hold rental property investments is for liability protection.
But there are also tax advantages to using an LLC, along with the logistical benefits of keeping income and business expenses – and bank accounts – separate from your own personal finances.
In this article we look at each of these factors and make the case for why using an LLC for rental property investment makes sense.
Legal Protection with A Limited Liability Company (LLC)
Investing in rental property through an LLC is safer from a legal perspective.
If the property is held through an LLC, your personal assets are not exposed in the event of a lawsuit, say from a tenant or some other party.
Whereas if you hold the property in your own name, the litigant (who could be the tenant or even a guest of the tenant) could potentially access your own home or other assets held in your name if they were successful in suing you.
An LLC offers the benefits of the so-called “corporate veil” whereby the member or members of the company are not legally liable for its actions. As the name suggests, an LLC protects the personal assets of its members.
If you do opt to hold the property in your own name, it is important to get liability insurance that plays a similar role in terms of protecting your personal assets.
Tax Benefits of an LLC for Rental Properties
In general terms, an LLC acts a “pass through” entity for tax purposes. What means is the income earned by the LLC is not taxed at the corporate tax rate, rather it passes through to the beneficial owner of the LLC.
In a single member LLC, that’s pretty simple – it is the single member who accounts for that income and pays applicable tax on it in their income tax return.
This eliminates the double taxation that occurs with a corporation whereby the corporate pays corporate taxes on the income and then the beneficiary pays tax again through income taxes.
Trading as a sole proprietorship offers the same pass-through taxation benefits, but none of the personal liability protection that an LLC provides.
Taxation implications for multi-member LLCs are a bit more involved as the income from the LLC is distributed across multiple owners effectively. This is where an accountant can provide more accurate advice on pass through tax taxation.
In general, though, applicable taxes are still passed through the LLC to the members; however, the members must complete a Schedule C, Schedule K, or Form 1065 with their personal tax returns. Each member of the LLC will claim their share of the income, not the entire income that the LLC earned that year. Having your LLC taxed as an S corporation or a C corporation means the tax treatment will be different. If you have queries about this it is best to discuss with an accountant or a lawyer.
How to Form an LLC
Check out our complete guide to forming and LLC for the full process, but here is a summary of the steps involved in forming an LLC.
1. Decide on a business name
Your business needs a unique name that hasn’t been taken before. The government business entity – usually the Secretary of State – website will have a search tool that let’s you determine if the name you’ve chosen for your LLC is available.
2. Designate a registered agent
A registered agent is someone who receives correspondence and legal documents on behalf of the LLC and setting this up is a requirement that must be completed before you can form an LLC. Your accountant or lawyer can serve as a registered agent if they are in the state in which you are incorporating. It is often simpler to use a reputable national registered agent service to handle this important function. They will take receipt of legal documents and communications with the state and scan and send this material on to you, as well as reminding your of compliance obligations such as deadlines to file your annual report.
3. Prepare and File your Articles of Organization
This is the paperwork that formally establishes your business as an LLC.
4. Create and file your LLC Operating Agreement
This document sets out who are the members (or shareholders) of the LLC, what percentage each owns and what voting rights or share of income they are entitled to.
5. Receive confirmation from the state
This ensures everything is set up correctly.
There are a range of reputable national LLC formation services (see our guide to the best ones here) that take care of these steps for you in any state. Some also offer registered agent services. Our faves are listed below!
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Recommended next steps include obtain first an EIN (Employer Identification Number) for the LLC and the establish a separate bank account for the LLC. We recommend using Mercury Bank – an online only back with a great platform and customer service – to set up the LLC’s account.
What If I Have Multiple Investment Properties?
If you have multiple investment properties, an LLC arguably makes even more sense. I have several rental properties that I hold in an LLC keeping my personal finances completely separate.
I do this so I don’t have a personal liability in the event something goes wrong, and for the LLC tax benefits. I find the LLC is also beneficial for simplicity in terms of having a separate bank account for the properties. Personally, I don’t want to be juggling money around different bank accounts and like to keep the real estate investing account separate to my own personal accounts. And above I want to protect my personal assets.
Rental property owners do have the option to set up an separate LLC for each property to provide additional personal liability protection.
Creating an LLC for each rental property you own can be a valid model. Obviously there is more complexity and compliance involved in this than if you held each rental property in the one LLC.
One way around this is to set up a Series LLC, which is a model offered by Delaware and 17 other states. Basically a Series LLC allows you to have one master LLC and a series of child LLCs inside it, each of which can be used to hold a single property. The assets inside each child LLC are protected against legal action taken against one of the other child LLCs. This is a whole topic in itself, which we have written about in this guide to series LLCs.
The preferred business structure is really a judgement call for the individual rental property business owner. Putting all properties in the one LLC means that they are all vulnerable in case of a successful lawsuit (the owner’s personal assets are of course still protected).
I have two rental properties and have opted to put them in the one single member LLC. It helps that both are in the same state. If they were in different states, I would probably go with an LLC to hold each property rather than having an LLC in one of the states and then having to register it as a foreign LLC in the other state.
Maintaining the legal protections of an LLC
To retain the asset protection benefits of an LLC, you not only have to form the LLC the correct way, but also maintain your registration as a business with the state and also make sure you use the LLC’s bank account for all business expenses and rental income.
This is really important as the lawyers for any potential litigant, whether they are a tenant who was injured or a tradesperson citing unpaid bills, can attempt to argue that the individual is the actual owner to pierce the corporate vale to access the owner’s personal assets in the event they win.
You want to do everything you can to allow the court to reject such attempts.
Downsides to Using an LLC for investment property
The main downsides to owning a rental property in an LLC (Limited Liabillity Company) are costs and complexity.
There are costs involved in setting up an LLC (usually between $100 and $300 initially) and some ongoing costs associated with required filings such as annual reports, which attract a filing fee. These are usually fairly cheap. (See here for our guide to the cheapest and best states in which to form an LLC).
There is some additional complexity in using an LLC in that you have to have a registered agent (see this guide on choosing a registered agent on our sister site registeredagentsreviewed.com) in the state that the property is located and you have to file an annual report plus pay any applicable state taxes.
But there is some red tape involved in rental property investment regardless of whether you hold rental properties in your own name or in an LLC.
The other downside is that some banks will prefer lending to an individual rather than an LLC. This is largely because the LLC means that they can’t access the beneficial owner’s assets in the event the loan falls into arrears (although they can access the rental property within the LLC).
That’s not to say that banks won’t lend to an LLC, but the loan that you do get is likely to carry a higher interest rate and have a shorter term as it will be effectively a commercial loan rather than a owner-occupier home loan.
Final Thoughts on The Best Business Structure for Real Estate Investing
As a rental property owner, I prefer to invest through an LLC for the reasons above – while it does expose me to some extra cost and red tape, the benefits of having limited liability protection are a must.