Should You Form an LLC for Your Rental Property?

If you own a large rental company and want to limit your liability, consider forming an LLC.

By , Attorney · Penn State Dickinson School of Law

A limited liability company (LLC) is a popular business structure because the entity is simple to form and it protects the owners from personal responsibility for the debts and obligations of the business. LLCs are a popular choice for real estate rental companies, too, but in fact the entity does not meet the legal needs of every kind of rental company.

Before you file LLC formation paperwork for your rental company, take time to consider the needs of your business and the cost to form and maintain an LLC. If you rent out one or two properties, you might decide to avoid the fees and paperwork involved in forming an LLC, and instead manage your financial risk with adequate insurance. On the other hand, if you manage dozens of commercial properties, the increased risk of debts that insurance will not cover (such as unpaid business bills and lawsuits that exceed your policy limits) might make an LLC the ideal business structure. Overall, the larger the rental business, and the lower your tolerance for risk, the more you should consider forming an LLC.

Protecting Your Personal Liability

One of the main reasons to form an LLC is to protect your personal assets, like your car, bank accounts and your home, from the debts of the business. But forming an LLC is not the only way owners can protect their personal assets. All rental companies (LLCs or not) should have adequate insurance.

Insurance can protect you and your company against financial loss resulting from accidents, natural disasters, and defending (and losing) lawsuits. Depending on the nature of your business, the types of insurance you should ask an insurance agent about include:

  • general liability insurance (covers the cost of bodily injury and property damage claims against your business)
  • homeowner's insurance (provides financial protection against damage to your home, but might be available only if the home you rent out is your primary residence)
  • host protection insurance (provides coverage for bodily injury or property damage that occurs at a short-term rental)
  • landlord insurance (provides financial protection against damage to the home, other structures on the property, and lost rental income due to property damage), and
  • umbrella insurance (after you reach the limit of other policies, umbrella insurance provides additional coverage).

Keep in mind that insurance does not provide the same protection as that provided by an LLC because you will be personally responsible for business obligations that insurance does not cover.

Tax Considerations

Depending on your state you could end up paying more or less in taxes if you form an LLC. Consult with an accountant or tax attorney for information on how forming an LLC could affect your tax liability. Some of the taxes you should consider include:

Franchise tax: Some states impose a minimum franchise tax on all LLCs for the privilege of doing business in the state, which is either a percentage of your revenue or a set minimum (such as $800 in California).

Pass-through taxation: LLCs enjoy "pass-through taxation," which means that the LLC does not pay corporate tax (as corporations do). Instead, the income passes through the company, and the owners pay tax for the first time on their personal tax returns. In addition, LLC owners can take advantage of the 20% pass-through deduction on their personal tax returns, which you can read more about here. If you run your business as a sole proprietorship (meaning you do not register the business), you can take advantage of pass-through taxation and the deduction without forming an LLC. You cannot take this deduction if you form a C Corporation.

Title transfer tax: If you transfer property into an LLC, you might be responsible for title transfer tax. See below for more information on transferring property.

LLC Formation and Business Licenses

To form an LLC, file formation paperwork with your Secretary of State and pay a filing fee. To learn more about the registration process, see our article How to Form an LLC. Many states, counties, and cities require rental company owners to apply for a business license, as well as other permits such as a certificate of occupancy, a housing business license, or both. Check with your local licensing division to determine the requirements for your company.

How to Transfer Property to an LLC

If you purchased rental property before you formed your LLC or purchased the property in your own name after formation, you must transfer the property rights to the company to avoid personal liability for anything that happens to the property. If you have a mortgage on the property you want to transfer, you must first contact your bank. Your bank might require you to pay the full mortgage amount before transfer, allow the transfer but only if you remain personally responsible for the mortgage, or permit you to refinance the mortgage and list the LLC as the borrower. Pay special attention to the possibility that the bank might require a personal guarantee: If you're forming the LLC in order to shield your personal assets, the personal guarantee will destroy that protection, which means you'll have spent a lot of time and money in pursuit of protection that you won't have.

To transfer the title of the property, you must prepare a deed form, sign the deed, and record it in your county or city. Check with your state's tax agency to determine if you must pay a title transfer tax. Because the rules for deed creation and title transfer vary by state, check your local laws or consult with an attorney.

After you have transferred the title, review, and update all existing leases to reflect the change. You should list the LLC as the landlord and ask tenants to pay rent to the LLC.

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