Rental Property: Should I put it in an LLC?

Posted May 18, 2016

Apartment buildingPersonal v. LLC Rental Property

Investment property is real estate purchased to buy and sell for a profit or to produce rental income.  Many investors who purchase rental properties own them personally. A more prudent way to own rental property for investment purposes is to form a Limited Liability Company (LLC) to own each property. This method protects it’s owner-member’s personal assets—cash, equity in real estate, primary residence, investment accounts, retirement accounts, etc. – from litigation.  It also allows for more flexible profit distribution and estate planning.

Liability Protection Benefits

If the owner of real estate rental property has a personal creditor, the creditor generally cannot make a claim on real estate owned by an LLC.  Should tenants, guests, or anyone else on the property sustain injuries, and if the rental property is owned in the client’s name, the owner’s personal assets are at risk.

Example: An owner has a rental property occupied by a young couple. The couple has a holiday party.  One of their guests falls down stairs and is hospitalized. The guest sues the owner for her injuries, claiming the stairs were hazardous. If the guest successfully wins the claim against the owner, any judgment in excess of the liability insurance can be satisfied from the owner’s personal assets.

Tax Benefits

An LLC formed with two or more members is classified as a “pass-through” company for tax purposes.  This means the LLC’s income is passed through to its owners and claimed on those owners’ individual tax returns. Hence, it is subject only to capital gains rates on the ownership shares of the member, and not to corporate capital gains taxes.  So there is no double taxation. LLCs with just one owner-member, however, are taxed as a sole proprietorship.  No separate tax return is required.  So the actual tax dollars saved from holding real estate in an LLC, as opposed to personally holding the properties, is zero.  However, if you actively participate in the management of the income property, and your adjusted gross income is less than $150,000, you can write off up to $25,000 in rental losses. Losses may occur, for example, due to depreciation or repair expenses.  The amount of rental losses that you can write off is phased out between $100,000 and $150,000.

For example, if your adjusted gross income is $125,000, you can write off $12,500 in rental losses in the year of the loss. If your adjusted gross income is $150,000 or more, you cannot write off any rental losses in the year of the loss.  Even if the loss is disallowed for that particular tax year, it is not completely lost. When you sell your income property, you can write-off any unused rental losses that have accumulated while you have owned the property.

Estate Planning Benefits

Holding rental property in an LLC has advantages for estate planning. It allows for transfer of ownership in a more seamless manner than if personally owned.

For example, when property owners owning real estate individually wish to gift certain percentages of their real estate to family members, the process can require many trips to the court house to update deeds every time percentages of ownership change. However, when the real estate is LLC owned, the owner can simply issue membership certificates to the family member.  No changes need be made to the deed.

Whether you own twenty properties or one, owning them personally can be a major liability. All your hard work and planning could be wiped out with one misfortune. Understanding the benefits of forming an LLC and the pros and cons of ownership structures are important considerations when purchasing rental property.

If you have any questions about buying or selling investment real estate, please feel free to email your questions to chris@shenfieldlaw.com