One of the first questions I hear from new real estate investors is:
“Should I create an LLC for rental properties, rather than owning them under my personal name?”
It’s a good question, and shows foresight. After all, people love to sue landlords. And love to hate landlords for some reason, despite the fact that rental property owners offer a much-needed service.
As a general rule, the answer is yes: you should use an LLC for investment properties. But that opens the door to a slew of other questions.
As a recovering landlord who has owned dozens of investment properties, here are the questions I’ve heard most often — and their answers.
Key Takeaways:
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- Pros include limiting your legal liability to the LLC’s assets, flexible ownership, easy ownership transfer, and tax benefits.
- Cons include costs, accounting complications, imperfect protection, and financing challenges.
- You can transfer ownership of a rental property from your personal name to an LLC, but you’re better off buying it under the LLC name from the beginning.
Benefits of an LLC for Rental Property
The main reason landlords use a limited liability company (LLC) is, drumroll please… to limit their liability.
When someone sues you personally and wins, they can come after almost all of your personal assets. Your house, your car, your Magic: The Gathering card collection, your prize-winning show goldendoodle. All right, that’s a bit of an exaggeration, but you get the idea.
When someone sues a business, they can only go after the assets owned by that business. So, by using an LLC for real estate investments, you add an extra layer of protection between your rental properties and your personal assets. Litigious tenants or neighbors can theoretically only seize your rental property — not your life savings.
Granted, LLCs aren’t bulletproof. Most ambulance-chasing attorneys will name you personally in their lawsuits, even if you own the property under an LLC name. But assuming you’ve dotted all your I’s and crossed all your T’s, you can petition the judge to remove your personal name from the list of defendants. That dotting and crossing mostly involves keeping the LLC in good standing and clean accounting.
Which raises another benefit of LLCs for rental property: separate accounting and deductions. More on the tax benefits of an LLC for rental properties shortly.
You can also use LLCs to create a modicum of privacy. Determined sleuths will figure out who owns the LLC, but again, it provides another barrier.
As a final note, LLCs provide flexible ownership. You can add multiple owners easily, and change ownership shares at any time with the stroke of a pen on the operating agreement. If you want to sell ownership of your investment property to your daughter, you can simply change the ownership of the LLC. That saves you thousands of dollars on closing costs, as you don’t need to do a formal settlement.
Disadvantages of an LLC for Rental Properties
To begin with, LLCs cost money. It costs money to create them in the first place, and in most states, it costs money to renew them each year.
It also costs money (or your precious time) to prepare a separate tax return for the LLC. Plan on at least an extra $500 each year, perhaps thousands.
State laws and taxation can get tricky if the LLC is filed in a different state than the property. For example, if you live in California but invest in Kansas, do you open the LLC in California or Kansas? Or somewhere else entirely, such as Nevada or Delaware, for their business-friendly laws? Those are wrinkles you have to iron out with an attorney or accountant.
As touched on above, LLCs don’t provide perfect protection. You have to use separate bank accounts and keep your accounting squeaky clean. All rental income and other business income must go into the business bank account. If you mix personal and business funds even once — known as commingling funds — it can invalidate your personal liability protection.
It’s often harder to get a mortgage for an LLC-owned property. If you borrow a conventional mortgage rather than a portfolio loan, expect extra headaches and hoops to jump through.
Tax Benefits of an LLC for Rental Property
The IRS treats LLCs as “pass-through entities,” meaning they aren’t subject to double taxation from both corporate taxes and personal taxes. The income passes through to members for tax purposes. You then pay taxes on that income based on your personal income tax rate.
If you prefer, you can usually opt to have your LLC taxed as an S corporation or C corporation. Speak with a tax specialist about the pros and cons of doing so.
Limited liability companies also allow flexibility in the proportion of tax benefits. While the income and expenses are typically attributed based on ownership percentage, you can write into the operating agreement that one member gets a disproportionate share of a property depreciation write-off, for example.
All rental property tax deductions apply, of course. These appear on a separate schedule (Schedule E) on your tax return, and don’t require you to itemize your personal deductions. You can also deduct some business expenses that ordinary workers can’t on their personal income tax return, such as a home office expense. Again, all while still taking the standard deduction.
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How to Create an LLC for a Rental Property
Each state has a different process, but most states make it easy to file for an LLC.
A quick online search will reveal which state agency to file with. In Maryland for example, you file with the Maryland Department of Assessments and Taxation.
You fill out a simple form called articles of organization and file it with your state. Along with a filing fee, of course — you need to feed the beast!
It may take a few weeks (or months, depending on your state’s bureaucratic bloat), but you then have a viable LLC. You can now use it to buy rental properties.
Each year, you’ll likely need to pay a renewal fee to your state, plus state taxes. The government demands its cut.
When Should I Create an LLC?
You should have your rental property LLC ready before you make offers on properties.
When you submit offers, you’ll want to write in the LLC as the buyer on the contract of sale. You can amend the contract later to settle under the LLC name, but it adds more headaches.
Prepare in advance, and have an LLC ready as you look for good deals on investment properties.
How to Transfer Title to an LLC
Already own a rental property under your personal name?
While you can buy a rental property in your personal name and transfer it later, it adds complications and costs. The easiest solution is to use a quitclaim deed to transfer property title from your personal name to the LLC. That can help you avoid settlement with a title company and the attendant fees.
The risk enters when you have a mortgage under your personal name. Mortgages come with a due on sale clause, stating that if legal ownership changes, the mortgage comes due in full. Transfer the deed without paying off the loan, and the mortgage lender can call the loan. That means you must pay it in full, immediately, or face foreclosure for breaching the terms of your loan.
Some sneaky property owners create an LLC that mimics their personal name, such as “John Smith LLC,” and quitclaim deed the property to it. And simply hope the lender doesn’t notice.
As you can imagine, that gets less likely to succeed every year that goes by, as digital records improve.
For further reading, check out our article on how to transfer a rental property to an LLC.
Does Creating an LLC Impact Your Financing?
If you already own the property with a mortgage under your personal name, certainly, as we just outlined. But what if you have the property under contract to buy, and you’re looking for a new loan?
Traditional mortgage lenders don’t like lending to LLCs. Some conventional loan programs allow LLCs, but expect strict underwriting and lots of red tape.
Portfolio lenders and hard money lenders don’t mind LLCs at all. In fact, they expect them. Compare hard money lenders and portfolio lenders on our rental property loans page.
And, of course, if you borrow private money, the lenders don’t typically care.
What Is the Cost of Creating an LLC?
Most states make it relatively easy and cheap to create new LLCs. They typically charge between $100–$500 for the initial LLC formation fee.
Unfortunately, many charge more for annual renewal fees. Look up your state’s LLC renewal fee to get the exact number.
I know of at least one state that doesn’t charge an LLC renewal fee, however: Pennsylvania. After the initial registration fee of $125, you don’t pay annual fees. But you do need to pay Pennsylvania income taxes, as an LLC owner (even if you don’t live in Pennsylvania).
Note that if you open an LLC in a state where you don’t live, you’ll need a resident agent who lives there. You can use a friend or family member, or you can pay someone to serve as your resident agent. Expect to pay $100–$200 per year for resident agent services.
Other FAQs About LLCs for Real Estate
If you still have questions about LLCs for rental properties, these might help answer them.
Do I need a separate LLC for each rental property?
You have to make a judgment call, balancing the risk of lawsuits against the costs and hassles of maintaining each LLC.
As a landlord, I lumped three or four properties under each LLC. If I got sued over one property, the other properties owned by the LLC were exposed, but no others. That was the balance I chose to strike, but you may decide to put only one property under each LLC, or two, or five.
How do you name the LLC for your rental property?
If you own a property at 123 Main Street, you could literally name the LLC “123 Main Street LLC.” You can name the rental property LLC whatever you like, as long as that name isn’t already taken in your state.
Does an umbrella policy offer the same protection as an LLC?
An umbrella insurance policy for rental properties offers different protection than an LLC does. Limited liability companies only isolate your liability to the assets owned by that LLC. Umbrella policies provide actual cost protection from lawsuits. Read more about umbrella policies for rental properties for more details.
Should I Create an LLC for Rental Properties?
Generally speaking, if you own more than one or two investment properties, you should use legal entities to own them.
You should really use an LLC even if you just own one or two, but you may decide that the disadvantages of an LLC for your rental property outweigh the benefits.
The use of the property may impact your decision as well. For example, if you use your property as a corporate rental, or as a short-term vacation rental, you may decide you have less legal liability than long-term landlords do. Speak with an attorney before you make those decisions, however.
While investment property LLCs do provide some protection, they’re not impenetrable, and certainly not a cure-all. If you want them to offer any protection at all, you need to keep completely separate accounting between your LLC and your personal accounts. Do not pay for personal expenses with LLC funds, and vice versa. You can, however, transfer funds into the LLC bank account, or take distributions from the business bank account to your personal account.
I’ve said it before and I’ll say it again: talk to an asset protection attorney! Business structure and personal liability are complicated. Hard stop.♦
Do you use an LLC for real estate investing? What do you see as the main benefits of an LLC for your rental property? The disadvantages of an LLC for rental property?
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About the Author
G. Brian Davis is a real estate investor and cofounder of SparkRental who spends 10 months of the year in South America. His mission: to help 5,000 people reach financial independence with passive income from real estate. If you want to be one of them, join Brian and Deni for a free class on How to Earn 15-30% on Fractional Real Estate Investments.
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Yeah, I’ve got an LLC for my real estate investments. It helps protect my personal stuff from any rental property mess, but there are some extra costs and paperwork to deal with which are all worth the hassle.
Thanks for sharing your experiences Leonard!
I’ve never set up an LLC before. Going to try one and see how smooth the process is here in Arkansas.
Keep us posted on how it goes Jacqui!
I’m forming an LLC for my new out-of-state rental properties to protect my assets and potentially benefit from tax advantages. However, I’m not changing my existing rentals to an LLC because that could come with legal and financial complications. It’s a strategic choice.
Thanks for sharing your approach Aaron!
You said you used to put 3-4 properties under each LLC. Do you still do that?
Today I no longer invest in rental properties directly. I invest fractionally in group real estate investments through our Co-Investing Club.
I learned something new today. Thanks for sharing.
Glad to hear it Jared!