One of the priorities of a rental property owner is to maximize revenue (rental income) while at the same time minimizing costs. Creating an LLC offers several benefits regarding tax, legal, and management issues.
According to the Internal Revenue Service (IRS), a Limited Liability Company (LLC) is a popular business structure because it blends the benefits of starting a corporation and a partnership.
LLC laws differ among the 50 states, which means you must understand state-specific statutes when it comes to 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.
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 in a similar manner that as a sole proprietor. However, taxes and mortgage interest deductions become more complex for multi-owner LLCs.
Excluding business financial records from personal 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 bank account for your LLC that remains separate 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. 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 asset protections.
Another significant advantage to forming an LLC for a rental property business is the legal protection your personal property receives. This is especially true for owners that manage multiple properties. Each rental investment property should form as an LLC to prevent the assets of other properties from coming under legal scrutiny caused by 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 completion of your purchase transaction helps you avoid several issues.
- Paying new taxes that include a 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 who specializes in handling rental property transactions can help you make all the right decisions when it comes to forming and running your LLC.