Investing in rental properties can feel like a sure bet for increasing income, especially compared to the uncertainties of the stock market. That investment also comes with risks that may not be covered by simple liability insurance, however. Wise property owners must consider the best way to protect their personal assets in the event their real estate holdings are hit with a lawsuit or other costs not covered by insurance. Forming a limited liability company (LLC) for a rental property is one strategy that not only provides such protection but also has tax advantages for the owner.
What Is an LLC and What Are Its Benefits?
An LLC is a business structure that is legally separate from its owner(s), meaning that in general they can’t be held personally responsible for the company’s liabilities and debts. This helps shield assets like a home or personal accounts from legal claims or debt collection. When set up properly, with carefully maintained records, an LLC also clearly separates business assets from personal assets. LLCs, which are regulated at the state level, are relatively easily formed, another reason they tend to be popular.
Tax Attorneys Discuss LLC benefits
Unlike some other types of corporate entities, LLCs offer pass-through taxation. Income or loss from the business is reported on the owner’s personal tax returns, and they pay any necessary tax. By contrast, corporations pay taxes on their income, and then individuals receiving income from that corporation pay taxes again, amounting to double taxation on the same money. Because LLCs “pass through” the income directly to the owner’s personal return, they pay less in tax than they would if another type of business entity is formed. In addition, they may be able to deduct up to 20% of their business income thanks to the qualified business income (QBI) deduction enacted as part of the Tax Cuts and Jobs Act (TCJA).
Setting up an LLC can also allow owners to deduct business expenses related to the rental property such as:
- mortgage payments
- property taxes
- maintenance costs
- depreciation
Rental income from an LLC is generally not subject to self-employment taxes, although that may vary depending on the type of rental. Consulting an attorney knowledgeable in how LLCs are taxed can help ensure you can take full advantage of available tax savings while following applicable regulations.
Costs and Best Practices for LLCs
Setting up an LLC will come at minimum with a filing fee, and there may be additional permitting fees depending on the state and municipality in which the LLC is formed. Owners will need to be aware of any ongoing annual costs; for example, California charges $800 annually to each LLC that is doing business or organized in the state. Any required paperwork must be filed on time, and clear records kept, to verify compliance. Hiring legal professionals to help manage this aspect of an LLC is often the best way to ensure that applicable taxes and fees are paid and that paperwork is filed on time.
Another potential cost to be aware of is that property purchased by an LLC, or transferred into an LLC, may be subject to higher mortgage interest rates than one bought by an individual. If you already own property and want to transfer it into an LLC formed later, you may have to pay a title transfer tax, and the transfer may cause your mortgage lender to close the existing loan, adding closing costs and the expense of getting a new loan (at a higher interest rate) to your costs. If possible, forming an LLC before you purchase rental property is the best way to avoid these complications.
Once you’ve formed an LLC, you should strictly separate your rental property assets and bills from your personal finances. Separate bank accounts and credit cards will keep your finances clear, simplify tax preparation, and help preserve your liability protection. Make sure you obtain property and liability insurance that is appropriate for rental properties. Verify that all rental agreements reflect that the LLC is the owner of the property, and that rental payments are made to the LLC and deposited in the LLC’s accounts. You’ll also need to stay up to date with landlord-tenant laws, licensing requirements, and local codes, as these can be subject to change.
While this may sound like a great deal of additional work, property owners tend to consider the liability protection and tax benefits provided by an LLC well worth it. In fact, owners of multiple properties often form a separate LLC for each property to protect each one from any claims or lawsuits against the others.
Setting Your Rental Property Investments Up for Success
The type of ownership structure you select for your real estate holdings can have significant effects on your exposure to liability, your tax benefits, and how your company must be managed. If you have questions about whether an LLC is the right choice for your rental properties, the expert attorneys at Bridge Law, LLP, can help. To schedule your consultation, contact us here today.