Is Creating An LLC For Your Rental Company Worth It?
Generating passive income through real estate is a dream come true. But sometimes, unexpected issues, lawsuits, and taxes can pull you back to the harsh realities of life.
These are just universal truths that can happen to any real estate owner. All we can do is prepare and try to mitigate the damage as much as possible. This is where an LLC comes in.
What Is An LLC?
An LLC (Limited Liability Company) helps business owners, including real estate-related businesses, mitigate damage to their finances. It’s open to single owners or partners. You can even create a multi-member LLC.
LLCs are structured to protect your finances by separating personal accounts from the business. Let’s say you face a lawsuit because of an accident in one of your properties.
Without an LLC your personal finances might be at stake. But, with an LLC, the only assets liable would be those under it—in this case, your property.
The best part is, it’s simple to do. Here’s how you can create one for your rental properties.
How Do You Create An LLC For Rental Property?
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Rental properties can be expensive. There’s a likely scenario that it still has an existing loan under your name.
If this is the case, be sure to contact your lenders and ask if you can transfer the title to your LLC. There could be additional charges that come with this.
For example, your interest rates might be recalculated or you can get charged an assumption fee. So before anything else, check the contracts.
Once that’s out of the way, here are the six steps to help you start your first LLC:
- Choose the business name for your LLC. You can choose literally any business name as long as it’s not used. In most cases, landlords use the property’s address. For example, it can be “123 Main Street New York LLC”.
- Start filling out the “Articles of Organization” for your LLC. This is just basic information about the LLC you’re trying to create.
- Create your LLC Operating Agreement. This entails the rights and responsibilities of each member within the LLC.
- Obtain the necessary licenses and permits (if required by your state) for your rental business.
- Gather all the required documents and register the LLC with your state.
- Finally, transfer the property’s title from your name to the LLC.
In order to do the last step, a Quit Claim Deed is needed. This signifies that you are the “Grantor” and your newly-made LLC as the “Grantee”.
Note: A “notice of intent” might be needed for creating an LLC. The notice needs to be published in an official newspaper. But, this is only required in a few states.
What Are The Pros And Cons Of Creating An LLC For Rental Property?
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Investing in a rental property is one of the best real estate investment strategies. Once you have one in your name, make sure it’s protected. This is the main feature an LLC provides.
But despite all the benefits and protection provided to rental property owners, it does come with some drawbacks. So, before creating your LLC, consider the following:
Advantages Of Creating An LLC For Rental Property
The pros of an LLC for rental property owners include:
Limits Personal Liabilities: The main advantage of having an LLC for your rental property is the protection it gives you from personal liabilities. The LLC separates your personal accounts from the assets owned by the LLC.
You can even create an LLC for each individual property you own. This means that your rental properties are separate assets, ensuring protection from liability claims.
Insulate Personal From Business Expenses: Each of your LLCs needs to have its own separate bank account and credit card. This ensures your business and personal expenses are clearly defined.
Doing this helps you claim business expenses with ease compared to if you were using a single account for every transaction.
Pass-through Taxation: Having an LLC includes tax benefits for the business owner. This is possible because LLCs are not corporations. Instead, they’re treated as a sole proprietorship.
If you have an LLC, the earnings received from your rental business “pass-through” to you. This means you only need to pay tax on the income from your LLC assets.
Disadvantages Of Creating An LLC For Rental Property
Here are the cons associated with creating an LLC for your rental property:
Expensive Setup Costs: Creating an LLC is simple enough. However, it’s not a free process. You’d need to pay filing fees, permits, licenses, and more. But, these depend on the state you’re in. Some can cost up to $500.
Loans for LLCs usually have higher interest rates. There’s a possibility that you’d be required to get a commercial loan that has higher down payments and shorter terms.
Heavy Paperwork: After creating your LLC, (which already involves a ton of paperwork) you need to maintain it. This means updating and filing required paperwork on time. You also need to manage your documents and keep records ready in case it’s needed for legal matters.
Increased Interest Rates: In most cases, mortgages transferred to an LLC has higher interest rates. Another consideration is the possibility of a “due on sale clause” when transferring property you own to your LLC. This will require the mortgage to be paid in full upon sale. To avoid this issue, consult an expert and research the state-specific laws in your area.
Increased Taxes: Creating an LLC could mean you’d have to pay additional taxes. In some states, you’re required to pay a franchise tax—the cost of doing business in a certain area.
There could also be a flat fee or a percentage of your rental business’ net worth that you need to pay depending on where you live.
Even transferring the title from your name to your LLC might incur additional taxes. This is charged by a state based on the valuation of your rental property and how it’s classified.
Key Takeaways
Creating an LLC isolates your business assets from your personal ones, protecting them from potential liabilities and mitigating your risks. Here’s a quick recap of important details:
- If your rental property still has a mortgage, contact the lenders and see if they allow transferring the title from your name to the LLC.
- Secure your “Articles of Organization” and other important documents.
- Some states require a “notice of intent” if you want to create an LLC.
- There are tax benefits for an LLC, but it can also add taxes depending on your state