Investing in a rental property can produce considerable financial benefits. You generate a steady stream of rental income and possibly see an increase in the value of your property. If you make improvements and follow a regular maintenance schedule, you should reap the financial reward of owning a rental property.
The question is not whether investing in a rental property is a good idea. Instead, the question is, should you form your investment as a real estate trust or a limited liability company (LLC). Both types of investments deliver advantages and disadvantages.
Investing in a Rental Property as a Real Estate Trust
A trust represents a legal option that allows you to give assets to one or more beneficiaries. Forming a real estate trust passes on your investments to named beneficiaries, which is an effective way to improve estate planning.
Let’s see why a real estate trust is a good idea for rental property investors.
Designating Multiple Owners
If you decide to partner with one or more owners, a real estate trust improves your documentation system. You get a clearer picture of the relationships between the owners and the percentage of rental property owned by each investor.
Effective Estate Planning Tool
Depending on the state where you form a real estate trust, you can avoid paying costly estate taxes. You can transfer the rental property to your beneficiaries without them having to pay taxes on its value.
Real estate trusts used to be a great way to remain anonymous as an investor. The rise of online record keeping such as deeds and tax information has removed some of the anonymity enjoyed by rental property investors. However, enough anonymity remains to make a real estate trust appealing for many rental property owners.
The one disadvantage of a real estate trust revolves around the ever-changing rules that concern estate planning. It would help if you spoke with an attorney with the Cloud Peak Law Group to determine which state offers you the best estate planning benefits.
Investing in a Rental Property as an LLC
A real estate LLC operates as a business entity that is legally separate from the investors. Considered a “pass-through” tax strategy, forming a real estate LLC means you report the income or loss from the LLC on your income tax form.
Here’s why forming a real estate LLC makes sense.
Rental properties managed under a real estate LLC provide limited liability to the owner(s). If the owner of a real estate LLC gets sued, only the LLC is liable for any damages, not the rental property owner.
Real estate LLCs typically provide owners with more anonymity than what the owners of a real estate trust enjoy. Once again, digital technology has eroded some of the anonymity enjoyed by the owners of a real estate LLC.
If you plan to invest in a commercial property to generate rental income, you should consider forming a real estate LLC. Because you are vulnerable to more financial risk, creating a real estate LLC shelters you from any legal actions taken by any of the tenants operating on your commercial property.
The primary disadvantage of creating a real estate LLC for a rental property is the annual fee you have to pay each year. States charge an annual fee that varies from $75 to $250.
The Bottom Line
Whether you decide to form an LLC or a real estate trust for your rental property depends on your priorities. If shielding assets from legal action is your goal, then forming an LLC makes more sense. On the other hand, a trust offers you a more powerful estate planning tool.
Find out which legal entity is best for you by contacting the Cloud Peak Law Group.