If you own and rent property, whether as a first-time investor or a seasoned landlord, it’s worth forming a Limited Liability Company (LLC) to house your operation. An LLC works a lot like an umbrella: it’s easy to set up, easy to use, and protects you from being exposed. By filing some paperwork, paying some fees, and clicking the link to grab one of our fillable operating agreements, you can set up an LLC that shields your assets from lawsuits associated with your property. This means if a tenant or a contractor or even a delivery person sues you, only your property is at stake — not your life’s savings. Let’s take a look at how and why you might benefit from forming an LLC for your rental property.
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For the sake of simplicity, we’ll imagine an LLC as a sort of legal middle ground between an individual and a corporation. An individual can easily do business, either as a sole proprietor or partner, but also takes full responsibility for any liability incurred as a result of that business activity.1 A corporation is more complicated and costs more to run, but fully protects its owners from being personally sued over its dealings.
An LLC exists somewhere in between. The State of Wyoming authorized the first one in 1977, marking a historic moment for business in America. Now business owners could limit their liability using the shield of a business, but without being taxed twice like a corporation. Corporations then, as now, underwent double taxation. Profits were taxed, and then shareholders paid out by those profits were also taxed on what they were paid. The LLC, designed by an oil company’s lawyers, represented a win for business people and a problem for the Internal Revenue Service.2
In 1988, following more than a decade of negotiation, the IRS ruled that an LLC could opt to be taxed as a sole proprietorship or a partnership. It could undergo “pass-through taxation,” which occurs when income and losses “pass through” a business and appear on the personal tax returns of its owner(s).3 In other words, the company wouldn’t have to pay its own, separate tax. Today, the LLC is a popular choice; a majority of the companies registered in the United States are LLCs.
Imagine you rent your property to a tenant who gets hurt at home and sues you for damages. Or a tenant takes you to court over the way you decide to use her security deposit.4 Or a delivery person slips and falls at your doorstep and sues you for medical expenses. Historical precedent shows none of this is outside the realm of the possible.
If you are commingling your property and your personal income, a claim can be made on all of it. But if you’re running your property through an LLC, your liability is limited to only what the LLC owns. People who rent out multiple properties often set up a separate LLC for each property, so that if there’s a legal issue at one property, liability is limited to only investments in the LLC that owns it, and not all the others, too.5
As in the case of any law, there are loopholes. If you aren’t meticulous about keeping your personal and business expenses separate, for example, or if you don’t have an operating agreement, a court could find you liable. But if you’ve done everything according to the letter, an LLC can be a barrier between a court of law and your personal income.
There are other benefits, too. If you own a rental property in a different state, forming an LLC allows you to avoid a lengthier, more expensive paperwork process. An LLC also makes it easy for your property to be distributed to beneficiaries upon your death.
Setting up an LLC is easier than setting up a corporation. You don’t have to appoint officers or a board of directors. You don’t have to have a series of meetings to clarify your governing board’s vision.
First, you choose a name that isn’t being used by anyone else. The next step is to click the link below for our operating agreement, which helps you to define the ownership, management, and life cycle of your LLC. Some states don’t require you to file this agreement, but not having and signing one exposes you to a greater degree of liability, largely defeating the purpose of setting up an LLC.
Next, you file your articles of organization, a document that goes by different names in different states, including certificate of organization and certificate of formation. You can find it on the website of your state’s relevant agency, usually the Secretary of State. The articles of organization ask for such details as your company name, a statement of purpose, the specific amount of time for which the LLC will operate, and your principal place of business.6
There are fees to pay when you file your articles of organization. These also vary by state, from $45 to $500, and so do annual fees. Some states don’t charge an annual renewal fee; others do. But anyone sued over a property will tell you $500 a year pales in comparison to the cost of losing all your assets. This is the principle that underlies insurance: that to protect your money, you have to spend a little money.
You can choose how you want your LLC to be taxed. Through a sole proprietorship LLC, you’re taxed the way any self-employed person is. You claim the expenses associated with owning the property on your tax returns, and you’re taxed on earnings. You can also file as an S-Corp or even a C-corp, which makes it easier to access financing and outside investment.7
It’s never too late to put your property under the umbrella of the LLC. Be sure to click the link for our operating agreement so you can get the process started today.