If you have a rental property and you’re wondering what legal structure it should have, you should consider the Limited Liability Company. While an LLC isn’t a perfect fit for all situations, it does offer several advantages that you need to be aware of.
Pros and cons of setting up an LLC for your rental property
Perhaps the most important advantage of an LLC is protection from lawsuits. As the name suggests, members (they’re not called owners or shareholders) carry ‘limited liability’. This means members’ personal assets are legally protected if the LLC is ever sued. This is not the case for sole proprietorships; so if you’re currently running your rental property as a sole prop, you should really consider setting up an LLC.
A second advantage LLCs offer is pass-through taxation. This means the business itself does not pay any taxes. Instead, gains are passed through to the members, who report earnings on their personal tax returns.
The disadvantages are that LLCs cost money to establish (unlike a sole prop), and are subject to annual taxes or fees in some states. If a property is transferred to an LLC, it may also generate a transfer tax. Talk to a real estate accountant to see how this specifically impacts you.
If I have multiple rental properties, how should I structure them?
If you put several rental properties into one LLC, and one property is sued, every other property could be impacted by the lawsuit. Any assets inside the LLC are fair game. The same applies if you are sued as a sole prop: assets owned by the sole prop could be seized as part of the lawsuit.
You can work around this by setting up a separate LLC for each of your rental properties. This does mean more paperwork and fees, but in the long run, it provides the best legal protection.
Other entities to consider for your rental property
Besides the LLC, there are other legal structures you could use, like a Limited Partnership. Under this structure, limited partners have limited liability (just like with an LLC), but are completely passive investors in the operation and do not manage the business. The general partner runs the business and carries unlimited liability. One way around this legal caveat is to use a corporation as the general partner.
You could also consider an S corporation (small business corporation) as the legal entity for your rental properties. Like an LLC, the S corporation structure offers pass-through taxation, although it typically requires more red tape than an LLC.
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