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Should You Own Your Rental Property in an LLC?

We were talking to a property owner; he was going to hire a property management company in Philadelphia to manage his property for him and he brought a great question.

“Should I set up some type of ownership entity as an LLC or corporation for this property?”

This is something every real estate investor needs to consider. There are a couple of things you want to keep in mind as you are deciding how to hold your legal ownership entity.

One of the most common questions is, “Am I going to be taxed differently if I hold a property in my name or if I hold it in an LLC?”  Usually, you are not. Most entities are passed through. Meaning whatever income that property generates, it’s going to be taxed at your individual tax rate.

You need to talk to your accountant and your lawyer to confirm that. Unless if you own big properties maybe you do want to set that up as a C corporation and that would be taxed differently, but everything else is typically taxed the same.

So, if there isn’t any reason to hold your property in a different entity as far as taxes are concerned. You may think:

“Why do I want to go through the headache and hassle of setting up an LLC? Why can’t I just own it in my name?”

The answer is protection. The whole purpose of a separate legal ownership entity is to protect the property and to protect you.

See, if you own a rental property, you have vendors, tenants, neighbors. All of these people as well as many more represent potential legal liability that could happen at your property. If one of them is out at your property and they slip and fall that person could sue you. We live in a very litigious world.

This is all assuming you already have your insurance in place because all of this is secondary to having strong insurance on your property. You want your liability insurance and landlord’s policy in place and maybe an umbrella policy.

Once you have that insurance, the second way to protect is to set this up. So, you are protecting the property from these types of instances that could conceivably happen. Let’s pretend that the tenant is on your property, they slip and fall and the worst happens and they hurt themselves. And they sue you for everything you have. Well, if that property is owned by an LLC all they can do is go after that property. They may get the property. But all that is owned by that LLC is that property. So, their landlord is that LLC because that’s who owns the property. They sue and let’s say they win and they max out the insurance and your worst case scenario happens and they get some value of the property. They get the property. But they can’t touch your assets, because the property is protected by that umbrella of an LLC.

Now keep this in mind, an LLC also protects the property from yourself. Let’s pretend that you own a rental property and you own it in an LLC and one day you’re driving down the road and you are not paying attention and get in a terrible car wreck and hurt someone. And that person you hurt turns around and sues you. If they win, they are going to get everything you have.

But if you own that rental property in a separate LLC, they can’t get that rental property. Because it’s not yours, it’s owned by the LLC. So, the protection of an LLC goes both ways. You are protecting yourself from things that could happen at the property, but you’re also protecting the property from things that you could do that may infringe on the property. It’s a double benefit that way of having this in place.

There are many different types of legal entities that are out there. LLCs are the most common, limited liability company. That is most commonly used for the majority of our investors.

What are the costs associated? Very minimal. If you start an LLC, you need to register that with the state of Pennsylvania.  If you’re going to have an attorney involved for that to draw up that paperwork, they are going to charge you some costs associated with that, but very little costs to start up.

There are two questions to keep in mind to help you decide.

Number one, what is the length of your ownership time? If you have a rental property and you plan to rent it out for six months and then you’re going to sell it or it’s going to be a short term deal, then it may not be worth the headache, the hassle, the cost of setting up a legal ownership entity. It may just be best to keep it in your name and sell it.

If, however, this is a long term buy and hold, then you want to put that property into an LLC. Take the time to set up the legal protection if you’re holding it for a duration that we recommend 12 months or more. And certainly, if you’re holding it permanently.

The second thing to consider is what is the value of the property and the portfolio. Sometimes we’ll get this question,

“I have three properties. Should I have each of them in a separate LLC or can I put them all into one LLC?”

Our recommendation as far as the value of the portfolio before you want to set up a second LLC is $5,000,000. What we mean by that is to create your LLC, and put properties inside of that LLC. Once the value of all the properties portfolio together totals $5,000,000 now it’s time to go get another LLC and start putting it into that new one.

You may ask, why $5,000,000? Because you can typically max out your insurance coverage with that amount. So, if you have insurance coverage in place that’s going to cap out at $5,000,000 for that LLC, you’re safe. If you want to do it for a million, two million, that’s great. But you don’t need to necessarily put every property into different LLCs. That can be very labor intensive, and time intensive, and then it does get a little bit costly.

There are a lot of things to consider.

Make sure to consult tax advisor and legal counsel before making any decisions.

Give us a call at TrustArt Realty. We can give you some thoughts, and recommendations on who to talk to help you get this structured for yourself, protect your property, and be very successful with your real estate investing.