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Should I Create an LLC for my Rental Property?
Should You Create an LLC for Your Rental Property?
by Kyle Wallace
Whether you currently own rental properties or are a homeowner contemplating leasing your own home or purchasing a rental property, it’s important to consider how you should protect yourself. One of the more popular options is to create a Limited Liability Company (LLC) and transfer ownership of that property into the LLC.
The Application Process
Creating an LLC involves filing the appropriate paperwork with the Secretary of State, which will require that the LLC has a member or manager as well as an address where notices can be sent. In addition, LLC filings require a copy of the operating agreement and/or bylaws. These are the documents that specifically state the business financial and operational rules and regulations for the business and its owner. In layman’s terms, it establishes the scope and authority in which the LLC can do business. The initial LLC filing can cost up to several hundred dollars upfront with annual renewal fees. Once your LLC is filed and you have created the operating agreement and bylaws, the protection of your property as an asset is almost complete. To complete the process, the property must be transferred into the LLC, or you must sell the property to the LLC even if the sales price is zero.
Pros and Cons of LLC for Rental Properties
This brings us to the pros and cons of transferring the property into an LLC. Starting with the pros, once your property has been transferred into an LLC, you can insulate yourself from personal liability. The most common example of this is a scenario where someone is injured on your rental property, and they sue for medical expenses and damages. If you own the property in your name, you could be held liable for damages that exceed any insurance policy that you have. Putting the property into an LLC eliminates the personal liability and limits loss to only those assets within the LLC. However, this often requires that each rental property be placed in its own LLC to prevent cross liability between rental properties.
Additionally, an LLC is a pass-through entity for tax purposes. This means that no additional tax filing must be made on behalf of the LLC and the profit or loss is passed directly through to the owner or member of the LLC and that owner can write off many of the business expenses on their personal taxes.
The cons of an LLC are the cost. The average LLC for a rental home, costs more than $150 per year. The annual fees for an LLC must be paid. When those fees are not paid to the state, the LLC will become inactive and cannot dispose of or refinance the property until those fees are brought current. That process can become very expensive as the late and delinquency fees add up.
The second drawback of placing a property into an LLC is that if you plan on financing or refinancing a property that is held by an LLC, lenders tend to be very more demanding about the documentation. Many lenders will not loan money to an LLC unless they have a long history of income and a strong profit and loss statement. Generally, when a lender loans money to an LLC, it will require personal guarantees from the LLC members.
Some Things to Consider
Some additional things to consider when putting a property into an LLC is that said property must be transferred into the LLC by a deed. This means that there has technically been a sale of the property, which can trigger the “due on sale” clause from an existing lender on the property. While this is rare, it could mean that, because the property was transferred or sold, even as a zero-dollar transfer, the lender can call the entire note due and payable immediately.
It is also worth noting that an LLC does not avoid probate. Any corporate ownership that is held by a deceased party member must be transferred through probate. Similarly, any existing lease agreements on a rental property will need to be assigned to the LLC from your name personally if you have transferred a property into an LLC.
Despite some of the shortcomings or challenges with an LLC, many thousands of individuals have chosen to transfer properties into an LLC for the limitation of liability and beneficial tax treatment.
Kyle Wallace is Chief Operating Officer of Driggs Title Agency.