One of the priorities of a rental property owner is to maximize revenue (rental income) while at the same time minimizing costs and protecting personal assets. Creating a limited liability company (LLC) offers several benefits regarding tax, legal, and management issues.
According to the Internal Revenue Service (IRS), a Limited Liability Company is a popular business structure because it blends the benefits of starting a corporation and a partnership.
LLC laws differ among the 50 states, meaning you must understand state-specific statutes when forming and running an LLC.
Let's review the benefits of creating an LLC for rental properties.
If you form an LLC for your business, you must file a tax return as a partnership, a corporation, or the sole proprietor of your business. The greatest tax advantage of forming an LLC refers to a legal concept called pass-through taxation. If you are the sole owner of a business, you should want to be taxed as a sole proprietor because any income and capital gains that are generated “pass through” the business directly to you as an individual taxpayer. You should have separate bank accounts for your business and personal finances.
An LLC allows you to avoid double taxation on business income and the capital gains earned from the appreciation of your business. A single-owner LLC can also deduct mortgage interest similar to that of a sole proprietor. However, taxes and mortgage interest deductions become more complex for multi-owner LLCs compared to single-member LLCs.
Excluding your rental business financial records from your personal expense and financial records allows rental property owners to stay better organized when it comes to managing their businesses. You have the legal power to establish a separate bank account for your LLC apart from your personal bank accounts. The LLC bank account facilitates every rental transaction and pays every expense that is related to running your rental property business. Having separate bank accounts reinforces the separation between your business and yourself which can help protect your personal property from litigation in the future. Although you can create an LLC bank account on your own, you should consider working with a lawyer to take advantage of all tax breaks and business asset protection.
Another significant advantage to forming an LLC for a rental property business is that an LLC limits your personal liability and offers legal protection of your personal property. This is especially true for owners that manage multiple real estate properties.
Each rental investment property should form an LLC to prevent the assets of other properties from coming under legal scrutiny caused by legal action, such as the filing of a lawsuit against another property. If one property gets sued, only that property is legally liable to pay monetary damages. You can consider the forming of an LLC as a way to protect your personal assets. If someone slips and falls while on your rental property, only the assets listed in the LLC can be liquidated to pay monetary damages.
Timing is Important
Should you form an LLC before or after you purchase a rental property? Although you can form an LLC at any time, the best option is to create an LLC before you buy a rental property. Forming an LLC before the completion of your purchase transaction helps you avoid several issues and will best protect your personal property.
- Paying new taxes that include a Property Title Transfer Tax
- Telling the mortgage holder that you plan to transfer the title to the LLC
- A mortgage lender might close the loan, which can increase closing costs and the interest rate on a new loan
- Notifying every tenant about the transfer of the property to the newly formed LLC
Working with a lawyer specializing in handling rental property transactions can help property owners make all the right decisions when it comes to forming and running their LLCs. Connect with us today to discuss how an LLC for your rental property can offer you peace of mind, protection of your personal assets, tax benefits, and more.