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Whether you own a rental property or are considering buying one, you should consider the benefits of forming a limited liability company (LLC). This is a widespread method for landlords to structure their property holdings to protect them against legal liability while reducing their tax burdens.
Read on to learn the benefits of forming an LLC for your rental properties and whether creating one is the right decision for your needs.
What is an LLC?What is an LLC?
Have you ever rented a property where your rental payments went out to a company name rather than your landlord’s name? If so, then you have first-hand experience working through an LLC. In the simplest terms, an LLC is a business structure that combines the elements of a corporation, a partnership, and a sole proprietorship into a single entity. They can be owned by one or more people and provide various benefits that aren’t available to other types of business structures.
Setting up an LLC for a real estate investment can be very beneficial if you plan to purchase a rental alongside a business partner. This is especially true for foreign investors looking to purchase independently or through a partnership with another foreign or domestic investor.
Advantages of Forming an LLC for Your Rental PropertiesAdvantages of Forming an LLC for Your Rental Properties
1. Liability Benefits1. Liability Benefits
The most significant benefit of forming an LLC for your rental property is that it reduces your liability if you are sued or have a judgment against you. This usually happens when someone is seriously injured on your property and sues you for damages and medical expenses. The LLC ensures they can’t personally sue you and must instead sue the LLC. This protects your assets against any losses from the lawsuit.
Investors who plan to own more than one rental property are advised to create a separate LLC for each one. Holding each property under a single LLC might make administration a lot easier, but it puts all your properties at risk if a lawsuit is filed against the LLC.
2. Tax Benefits2. Tax Benefits
Since the IRS does not have a specific tax classification for LLCs, they are taxed as either a partnership or a sole proprietorship. This allows you to take advantage of pass-through taxation, which means that the LLC does not have to file a separate tax return. Instead, any profits or losses are reported through the owner’s (or owner’s) personal income taxes. This prevents your rental income from being double-taxed. In addition, single-member LLCs allow you to deduct mortgage interest since the IRS treats single-member LLCs the same as sole proprietorships.
3. Easy to Form3. Easy to Form
LLCs are one of the most straightforward business entities to form and operate. Contact your attorney, and you can have one up and running with minimal fuss. This contrasts with a corporation requiring officers, directors, board or shareholder meetings, and other administrative burdens.
4. Additional Business Opportunities4. Additional Business Opportunities
Managing your rental through an LLC allows you to use services strictly limited to businesses. For instance, you can receive rental payments through credit cards or e-payments.
Drawbacks of Creating an LLCDrawbacks of Creating an LLC
While forming an LLC for your investment property can look very appealing, there are also some drawbacks. For a start, single-member LLCs must demonstrate that they are entirely separate from the owner. Otherwise, they risk undergoing a legal challenge to their liability protection in a lawsuit. The only way to do this is by maintaining separate bank accounts and an accounting system different from the owner’s expenses. In addition, leases and contracts must always be in the LLC’s name. This creates ongoing administrative costs that must be factored into your operating expenses.
Another downside is that taxes and deductions can become significantly more complicated with a multi-member LLC. Some people may also find themselves in an unusual tax situation that is not ideal for an LLC formation. Consult a tax attorney before making any moves towards forming an LLC.
How Much Does It Cost to Form an LLC?How Much Does It Cost to Form an LLC?
In NYC, the main cost of forming an LLC is the $200 fee to file your LLCs Articles of Organization. This is paid to the New York Department of State. In addition, New York requires all LLCs to publish a copy of their Articles of Organization in two newspapers (one daily, one weekly) within 120 days of formation. There is a Certificate of Publication filing fee of $50, but the actual publication fee varies depending on the publication.
How to Form an LLCHow to Form an LLC
Forming an LLC is relatively easy and can be accomplished in only a few steps.
Step 1: Name your New York LLCStep 1: Name your New York LLC
The name of your LLC will need to be available for use in the state of New York, meet New York naming requirements, and be available as a web domain. Perform an internet search to see if your chosen name is available; it’s also a good idea to purchase the domain name early in the process.
Step 2: Choose a registered agentStep 2: Choose a registered agent
By default, the New York Secretary of State acts as the registered agent of all New York LLCs. That said, you do have the option to designate someone in addition to the Secretary of State. Your registered agent will be the first point of contact if your LLC is sued.
Step 3: File the Article of OrganizationStep 3: File the Article of Organization
When forming your LLC, you must file New York Form 1336-f: Articles of Organization. This can be done by mail, fax, online, or in person.
Step 4: Complete publication requirementsStep 4: Complete publication requirements
Submit your Certificate of Publication (form 1708-f) along with affidavits of publication to the New York Department of State. Once done, your Articles of Organization must be published in two newspapers within 120 days of the formation of your LLC.
Step 5: Create an Operating AgreementStep 5: Create an Operating Agreement
All New York LLCs are required to have an Operating Agreement, a legal document that outlines the ownership and operating procedures of the LLC. This ensures that every LLC partner is on the same page so there are no legal conflicts in the future.
Step 6: Get an Employer Identification Number (EIN)Step 6: Get an Employer Identification Number (EIN)
An EIN is a nine-digit number issued by the IRS to identify a business for Tax purposes. You will need this for opening a business bank account.
Can I Transfer a Property I Already Own to an LLC?Can I Transfer a Property I Already Own to an LLC?
If you purchased the rental property before forming your LLC, you have the option to transfer the property rights to the LLC. To do this, you’ll need to record a new property deed that reflects this change. A title company can help you with this.
However, things may be much more complicated if the property has a mortgage. Your lender may require you to pay off the mortgage in full before allowing the transfer. Also, pay attention to whether your lender requires you to provide a personal guarantee. This guarantee will forfeit liability protections if you are forming the LLC to protect your assets from an impending lawsuit.
After the title is transferred, ensure that you update all existing leases to list the LLC as the landlord rather than yourself.
Final ThoughtsFinal Thoughts
Forming an LLC for a rental property is considered a smart move, especially for investors with many personal assets. The LLC will provide liability protection for those personal assets while providing many tax benefits. However, investors are still advised to seek consultation from a professional tax attorney before proceeding with a formation.