By Joe Dyton, WCI Contributor

When a new business venture is formed, one of the first questions to consider is if the owner should form a Limited Liability Company (LLC). An LLC can help protect a business owner and their assets from personal liability.

It’s that protection an LLC can offer that also makes rental property owners ponder if they should form one and put their properties in it. Unfortunately, the answer isn’t usually a simple “yes” or “no.” Different factors, including asset protection and taxes, must be weighed before entering the LLC arena. For some, it seems easier to sidestep the complexities that come with forming an LLC and just add more insurance coverage. But there are no guarantees with increased insurance either.

That is why when a rental property owner asks if an LLC is their best option, the most honest answer is it depends. While not entirely helpful, it is the truth—at least until you’ve weighed all the options at your disposal. Keep reading to better understand the pros and cons of creating an LLC for your rental properties and how that compares to simply increasing your insurance.

 

What Is an LLC?

A limited liability company is a business setup that shields its owner’s personal assets from lawsuits. It can also protect the owner’s personal assets from creditors in the event the business incurs unpaid debts. How LLCs are regulated varies by state. They are a combination of a corporation and a partnership or sole proprietorship.


Pros of an LLC

Given the protection an LLC can offer, it can be tempting to want to create an LLC for your rental properties. Here are a few benefits of doing so:

 

Tax Benefits

LLCs can have several different tax designations, but a “pass-through” entity is the one you’ll likely use for your rental properties. The pass-through tax entity is beneficial because you receive the income and capital gains from the LLC directly and pay taxes as an individual. Meanwhile, you still receive the protections that come with the LLC. It’s the best of both worlds. Be sure to discuss with your CPA to ensure an LLC works to your tax benefit.

 

Asset Protection

Perhaps the biggest draw of an LLC is minimizing your personal liability. The protection is especially crucial for a rental property owner. If a tenant decides to take legal action against you for whatever reason, your LLC can help keep your personal assets out of any lawsuits.

 

 

Privacy

Without an LLC, your name as the rental property owner is on the deed, which is public knowledge. If a bad actor discovered you were a physician (and assume you’re a high earner), they could be tempted to file a lawsuit for financial gain. With an LLC on the deed, however, it makes it more difficult to know who actually owns a given rental property. Some states allow for total anonymity, which would guard your identity even further.  

 

Cons of an LLC

Between the personal asset protection opportunities and tax advantages, it may be hard to imagine a downside to forming an LLC for your rental properties. Rental property LLCs, though, do have their disadvantages as well.

 

Expenses

There are significant out-of-pocket costs associated with forming an LLC for your rental properties. Lawyers can charge hundreds, even thousands, of dollars to set up an LLC for you. Online sources such as LegalZoom could also help you, but there are no guarantees that will be enough depending on your situation. You may also have to pay an annual fee to maintain that LLC based on the state your rental property is located. Plus, if the property is originally in your name, you might have to pay a title transfer fee when you move it to an LLC.

 

Lack of Guaranteed Asset Protection

An LLC is designed to protect your personal assets from your business dealings, but unfortunately, it’s not 100% foolproof. There could be situations where you and your personal assets aren’t as protected as you’d like—often in personal misconduct situations or if you’ve made a personal guarantee. Other situations where your assets could be in jeopardy aren’t as clear and unfortunately do not become clearer until an actual lawsuit arises.

 

Difficulty Getting a Mortgage

You might have trouble getting financing for a rental property under an LLC. Residential lenders typically want someone personally liable—they’re also hesitant to loan to LLCs because of the limited liability protection they provide. Your options in this case are to purchase the rental property in cash or attempt to deed it to your LLC after you buy it in your own name.

That plan could lead to a new set of problems, however. Turning ownership over to an LLC may lead your lender to consider the move as a change of ownership and ask for the loan to be repaid in full. This might not happen, but if a lender forces your hand, you’d either have to pay off the loan in cash, refinance, or sell the property.

More information here:

Top 16 Asset Protection Strategies for Doctors

 

Obtain More Insurance Instead of Forming an LLC

A liability and umbrella insurance policy could also help protect you when owning a rental property. Tenants could sue you personally without the LLC protection, but with adequate insurance, you should survive any financial fallout. Just like with an LLC, however, there are advantages and disadvantages to going the insurance route.

 

Pros of Increasing Insurance for Your Rental Property

 

Simplicity

Your rental property is already insured. There’s not a lot of paperwork to deal with as there is with an LLC. Here, you’re simply increasing your coverage—just make sure your policy covers the proper limits and you add umbrella insurance.

 

Cost Savings/Benefit

Umbrella insurance is pretty inexpensive, considering it goes beyond the limits and coverages of any of your other insurance policies. It costs a portion of your primary insurance premium, but it will save you from having to pay any excess out of pocket that your main policy won’t cover, safeguarding your personal assets.

 

Cons of Increasing Insurance for Your Rental Property

 

Potential Personal Asset Loss

An LLC’s main benefit is to shield your personal assets from a lawsuit that’s filed because of your rental property. You lose that shield if you opt to get more insurance rather than form an LLC. That means if the lawsuit costs more than your policy will cover, you could be on the hook to make up the difference. Your personal losses could wind up being more than that rental property.

 

Policy Exclusions

Be sure to read your insurance policies carefully. They tend to have exclusions (things the policy won’t cover) for which you’re responsible. What doesn’t your liability insurance policy cover? Are you willing to be responsible for making up the difference for those exclusions?  

More information here:

Real Estate Investing 101

 

Final Verdict: Should You Put Your Rental Property in an LLC?

Whether you decide to put your rental properties in an LLC comes down to your level of risk tolerance. You could save money on the setup costs associated with an LLC, but your personal assets could be left vulnerable to a tenant lawsuit. Are you willing to risk everything you’ve worked so hard for personally when a decent shield is at your disposal? The money spent on forming an LLC will likely be a lot less than what you’d spend out of pocket if you were ever found liable in a lawsuit involving your rental properties.

 

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