Several of our clients own rental properties. Often times these properties are owned personally, rather than in an entity, such as a limited liability company (“LLC”). The perception is that an LLC will add complexity and hassle, and does not add much benefit because the property is already covered by insurance. However, in most instances, utilizing an LLC to hold rental properties offers protection that far outweighs any burden.
- Liability Shield. The main reason to use an LLC is liability protection. When utilized properly, an LLC provides a layer of protection for your personal net worth with respect to liabilities related to the operation of the LLC.
- What about insurance? Many people will point to the fact that they have insurance to protect them in the case of a liability. Insurance is important and protects against many potential losses. But insurance generally has limits and likely there are various exclusions. All policies have coverage limits and all policies exclude certain types of losses or liabilities. The LLC shield, therefore, can act as a backstop when a loss is not covered by insurance or exceeds limits.
- Litigation Leverage. If litigation were ever to arise related to harm caused to someone on the property, the looming personal liability potential gives more leverage to any plaintiff’s attorney.
So, there is clearly some benefit to having the LLC, but it must be weighed against the costs/burdens.
The “burdens” of an LLC are minimal.
- Setup costs. For a single-owner LLC, the costs are minimal. With filing fees and attorney’s fees to setup the LLC and transfer the property into the LLC, an estimated cost is between $1,000 and $2,000. Keep in mind, unlike liability insurance premiums these are one-time costs. You will also have to setup a separate bank account and assign any existing leases to the entity.
- Maintenance costs. Maintaining an LLC is very inexpensive. Most attorneys recommend doing annual meeting minutes reaffirming officers and the actions of the prior year. There does not have to be much cost in this, as your attorney can provide a template to use.
- What about the hassle and cost of an extra tax return for the LLC? For single-owner LLCs, the entity is disregarded for tax purposes, so there is no extra tax return. The tax effects of the LLC are reported on your individual tax return just as if you had owned the property directly.
Note that even when an LLC is in place, there are some limitations. If you personally commit a wrong that happens on the property, you will be subject to being sued personally. The liability shield only protects you personally from the liabilities of the entity.
Furthermore, there are certain areas where the law provides for the liability shield to be “pierced” and personal liability to be imposed. Examples are areas like failing to pay required payroll taxes if there are employees, or not respecting the LLC as an entity separate and distinct from yourself (e.g., treating the company checkbook like your personal checkbook should be avoided).
DISCLAIMER: THIS IS INTENDED FOR EDUCATIONAL PURPOSES ONLY AND CANNOT BE RELIED UPON IN TAKING ANY ACTION. YOU SHOULD CONSULT YOUR ATTORNEY AND TAX ADVISOR TO DISCUSS YOUR SPECIFIC SITUATION. THE SPECIFIC FACTS OF YOUR SITUATION MUST BE FULLY ANALYZED AND CONSIDERED BEFORE TAKING ANY ACTION.