If you are thinking about purchasing or already own rental or other investment property, you should consider transferring it to a Limited Liability Company (LLC). This can be a great way to protect your assets, while at the same time you may be able to 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 should be safe. The same is true for other types of claims involving a property, such as fire-related claims or problems with environmental contamination.
A significant benefit of 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 are 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 will pay taxes as an individual. There is no separate tax on the LLC, so you will avoid double taxation.
If possible, you should consider establishing a multi member (two or more members) LLC instead of a single member LLC. In the case of spouses, one spouse can transfer half of a property to the other spouse with no adverse gift tax consequences. Then, each spouse can transfer his and her half interest in the property to an LLC to each receive a half interest in the LLC. In one case (In re Ashley Albright (Cas. No. 01-11367 AVC, Ch. 7: Bankr. Colo. (2003 Bankr. LEXIS 291) (4/4/03))), the court disregarded a single member LLC for asset protection purposes. So, a multi member LLC should provide better asset protection than a single member LLC. Also, the state where you choose to establish the LLC may be more or less favorable than another state with respect to asset protection. If an LLC has more than one member, it can choose to be taxed as a partnership. The income and capital gains of the LLC will pass through directly to the members.
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 for operating businesses to reduce self-employment, Social Security and Medicare taxes.
By operating as an LLC, you generally can avoid many of the hassles of having a corporation, such as boards of directors, board and stockholder meetings, and elaborate corporate recordkeeping.
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 interests in it each year using discounts and annual gift tax exclusions. Instead of making gifts of cash or property to your children, consider making gifts of LLC interests to them. If you make gifts of cash or property to your children, such gifts can be attached and taken by their creditors. However, if you instead make gifts of LLC interests to them, such gifts will be more difficult and less desirable to be attached and taken by their creditors.
If you own more than one rental property, you might want to put each property into a separate LLC. That way, if there is 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. Alternatively, if you own several rental properties, you may want to establish a Delaware Series Limited Liability Company. Each property will be owned by a separate series of the LLC. Such an entity will reduce your administrative costs (filing fees and tax returns) while providing you with asset protection for each property owned by each series.
It is possible to set up an LLC on your own. However, as you can see from this article, it is best to consult with an attorney and a Certified Public Accountant to make sure you are getting all of the asset-protection and tax advantages that are available to you.
For instance, not all of the benefits of an LLC are available in every state. It might be possible to establish an LLC in another state that offers the particular advantages you want. For example, if you are interested in taking discounts for estate tax purposes and making annual exclusion gifts of LLC interests, a state like Delaware may make the most sense where to establish your LLC.
Keep in mind that there are a few expenses associated with LLCs. There will be start-up filing costs and you might need to prepare and file an additional tax return (depending on how you set up the LLC (single member vs. multi member)).
While an LLC helps to protect your assets, it is not foolproof. For instance, suppose you personally replace a water heater in 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 landlords who are concerned about protecting their assets form an LLC and then hire contractors to perform all maintenance and repairs.
It is not enough merely to form an LLC. You also have to 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 may refuse to cover any claims.
If you transfer your existing property to an LLC, there may be potentially problematic implications. Assuming you purchased an owner’s title insurance policy for the property, if you did not purchase an enhanced policy, you may loose the respective protection by transferring the property. If you have a mortgage on the property, the mortgage probably requires the lender’s permission in order for you to transfer property. Lenders typically require commercial financing for LLCs. Commercial financing is not as favorable as residential financing (higher interest rate, shorter term). If you already have commercial financing, your respective mortgage payments should remain the same. However, if you have residential financing and your lender requires commercial financing, your respective mortgage payments will probably be more expensive.
With offices in Massachusetts, New Hampshire, and Florida, our business law firm can help with the growth and success of your business. We represent clients in the Greater Boston, Massachusetts and Metro West, Massachusetts areas, Salem, New Hampshire and Southern New Hampshire areas, and Naples, Florida and Southwest, Florida areas. For a confidential appointment to discuss your business goals, business plan, or business tax issues, contact the combination business law attorneys and Certified Public Accountants (CPAs) at the Beliveau Law Group.