The LLC Option for Owning Residential or Commercial Rental Property
November 06, 2017
As seen on the WJAR NBC 10 Smart Advice Series
Owning and managing rental real estate is a business venture that presents risk of claims from creditors and litigation for which insurance may not provide full coverage. Any shortfalls in insurance protection could become the personal liability of the owner of the rental real estate. Creating a limited liability company (LLC) for the purpose of operating the rental real estate business is one way to insulate the owners’ personal assets against this risk. When properly formed and maintained, the LLC provides a separation of personal assets from business assets, and generally any creditors with claims arising out of the business are limited to recovery from the business assets.
Forming an LLC
While it is not particularly difficult to form an entity, it’s generally recommended to engage legal professionals to draft the governing documents. To establish an LLC, necessary paperwork must be filed with the Secretary of State and create an LLC operating agreement.
Depending on whether the property owner goes it alone or hires a professional, associated costs may include:
- Potential attorney fees for document preparation
- Filing fees for initial registration with the Secretary of State
- Income tax filings and return preparation for the entity each year, for which minimum taxes may apply and will vary by state
- Nominal annual filing fees to the Secretary of State for the entity’s corporate annual report
The LLC entity may elect to be taxed as a partnership so income flows through the entity to the property owners. In that case, income taxes would be the same as when the real estate is owned outside of a corporate entity. Ownership of an LLC can be held by one or more individuals, trusts, and other entities, in any case, all members of the LLC are protected from claims against the LLC.
Single or Multiple Property LLCs
An owner of multiple properties who chooses the LLC structure must decide whether to form one LLC in which all rental properties are included, or to form multiple LLCs. The LLC can hold more than one property, which reduces the administrative work, expenses and taxes relating to maintaining books and records for separate entities for each property. While there are potential cost savings to the single LLC approach, the risk of doing so is exposure for all the properties in the entity to liabilities of any one property. If the main goal is to insulate personal assets, a single entity holding multiple rental properties may be attractive. However, if one property has high value and low risk, while the other has high risk but minimal value, the exposure that a single entity presents for the high value property may outweigh the savings of the single LLC approach.
When rental property business represents a significant portion of the value of an owner’s estate, the structure of the business entity should involve consideration of estate planning concerns. Revocable trusts are vehicles that may hold title to LLC interests and avoid costs and delays of probate and maintain privacy at death. By proper planning and action to manage a business venture, the financial risks may be minimized for the owner’s entire family.
While owning residential or commercial rental property may present a great opportunity, there are potential liability business risks. Taking steps to structure your business properly is a prudent approach to the investment and will help to minimize these risks. Consultation with legal and tax advisors is important for every business owner to understand and assess corporate planning options..
Contact a Washington Trust Planning Officer at 800-582-1076 or email us at [email protected] for smart advice that’s focused on your unique financial goals.
Connect with a wealth advisor
No matter where you are in life, we can help. Get started with one of our experts today. Contact us at 800-582-1076 or submit an online form.
This document is intended as a broad overview of some of the services provided to certain types of Washington Trust Wealth Management clients. This material is presented solely for informational purposes, and nothing herein constitutes investment, legal, accounting, actuarial or tax advice. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. Please consult with a financial counselor, an attorney or tax professional regarding your specific financial, legal or tax situation. No recommendation or advice is being given in this presentation as to whether any investment or fund is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors, or markets identified and described were, or will be, profitable.
Any views or opinions expressed are those of Washington Trust Wealth Management and are subject to change based on product changes, market, and other conditions. All information is current as of the date of this material and is subject to change without notice. This document, and the information contained herein, is not, and does not constitute, a public or retail offer to buy, sell, or hold a security or a public or retail solicitation of an offer to buy, sell, or hold, any fund, units or shares of any fund, security or other instrument, or to participate in any investment strategy, or an offer to render any wealth management services. Past Performance is No Guarantee of Future Results.
It is important to remember that investing entails risk. Stock markets and investments in individual stocks are volatile and can decline significantly in response to issuer, market, economic, political, regulatory, geopolitical, and other conditions. Investments in foreign markets through issuers or currencies can involve greater risk and volatility than U.S. investments because of adverse market, economic, political, regulatory, geopolitical, or other conditions. Emerging markets can have less market structure, depth, and regulatory oversight and greater political, social, and economic instability than developed markets. Fixed Income investments, including floating rate bonds, involve risks such as interest rate risk, credit risk and market risk, including the possible loss of principal. Interest rate risk is the risk that interest rates will rise, causing bond prices to fall. The value of a portfolio will fluctuate based on market conditions and the value of the underlying securities. Diversification does not assure or guarantee better performance and cannot eliminate the risk of investment loss. Investors should contact a tax advisor regarding the suitability of tax-exempt investments in their portfolio.