If you own rental or other income-producing property, you should consider putting it into a limited liability company. This can be a great way to protect your assets, while at the same time you can reap some tax advantages.
Suppose someone slips and falls on your rental property and sues you. If you own the property as an individual, all your assets would be at risk – your home, your investments, your savings accounts, etc. But if the property is owned by an LLC, in most cases the risk would be limited to the amount of your investment in the LLC. Your personal assets would be safe.
The same is true for other types of claims involving a property, such as fire-related claims or problems with environmental contamination.
The great thing about LLCs is that they offer the asset protection of a corporation while at the same time giving you much more tax flexibility. For instance, if you’re the sole owner of an LLC, you can generally choose to be taxed as though it were a sole proprietorship. This means that income and capital gains from the LLC will pass through directly to you and you’ll pay taxes as an individual. There’s no separate tax on the LLC, so you’ll avoid double taxation.
If an LLC has more than one member, it can choose to be taxed as a partnership. Again, the income and capital gains will pass through directly to the members.
In either case, you can generally avoid many of the hassles of having a corporation, such as boards of directors, board and stockholder meetings, and elaborate corporate recordkeeping.
(An LLC can also choose to be taxed as an S or a C corporation, if it meets the other requirements for these kinds of corporations. Many people use S corporations to reduce self-employment, Social Security and Medicare taxes.)
An additional benefit of an LLC is that you can often reduce estate taxes by forming one and then giving your children a certain number of shares in it each year.
If you own more than one rental property, you might want to put each property into a separate LLC. That way, if there’s a problem with one property, your liability will be limited to your interest in that property, and you can protect your interest in the other properties.
In some cases, you can reduce your administrative costs by setting up a single “parent” LLC with many “sub LLCs” that own individual properties.
It’s possible to set up an LLC on your own. However, it’s always better to consult with an attorney to make sure you’re getting all the asset-protection and tax advantages that are available to you.
For instance, not all the benefits of an LLC are available in every state. But it might be possible to establish an LLC in another state that offers the particular advantages you want.
Keep in mind that there are a few expenses associated with LLCs. There might be start-up filing costs, you might need to file an additional tax return (depending on how you set the LLC up), and your bank might require higher fees.
Also, while an LLC definitely helps protect your assets, it’s not foolproof. For instance, suppose you personally replace a water heater on a rental property, and as a result of your carelessness the water heater explodes and a tenant is injured. The tenant could still sue you personally, because the claim would involve your own negligence as opposed to your mere status as the owner of the property. The same would be true if one of your employees installed the water heater, because you could be sued for failing to properly supervise the employee.
For this reason, many landowners who are concerned about protecting their assets form an LLC and then hire contractors to perform all maintenance and repairs.
Of course, it’s not enough merely to form an LLC; you also have to actually deed the property to the LLC, or you will still be on the hook as the owner. You also need to change to your insurance so the LLC is the named insured. If an LLC owns the property but your name is still on the policy, the insurance company will likely refuse to cover any losses.