Pros and Cons of Creating an LLC for Your Rental Property

A limited liability company (or LLC) is a business structure that is frequently created for the purpose of owning rental property in California.  This article discusses the major benefits of creating an LLC for that purpose. 

Limitation of Liability

When rental property is owned as an individual, the owner’s personal assets are at stake in a lawsuit filed against the owner.  If, for example, the tenant has an accident on the premises resulting in injuries to the tenant, and the property owner is sued, he is exposed to personal liability for the accident. 

An LLC prevents an individual member of the LLC from being sued as an individual, as the proper party to the lawsuit would be the LLC as owner. The LLC can be sued, but liabilities are restricted to assets (such as rental property) owned by the LLC only.  The LLC structure protects its owners from being personally liable for repayment of the company’s debts or liabilities.

In addition to separating the rental property from your personal assets, you should also separate your rental properties from each other to minimize liability exposure.  If you own multiple properties, you can “insulate” each property from liability claims by setting up separate LLCs for each property. If you have all of your properties under separate LLCs, then if someone files a lawsuit pertaining to one of your properties, the rest of your properties will not be affected by the lawsuit. This effectively separates and protects each of your properties.

Pass-Through Taxation

A corporation is ordinarily taxed directly on its profits and owners are taxed again when they make income from their business. With an LLC, the company’s income “passes through” to the business owner.  LLCs do not pay taxes on their profits directly.  Their profits and losses are passed through to members, who report them on their individual tax returns. Essentially, all income made by your LLC (your rental property) will flow through to your individual income tax return. This minimizes the amount of money taken out of your income for taxes.

Record-Keeping Benefits

LLCs make business record keeping easier.  A separate bank account is created for the LLC which keeps your rental property income and expenses in a single account. This makes it easier to claim rental property expenses when it comes time to do your taxes. Separate bank statements make it clear which expenses are business and which are personal. They also make assets easier to move between partners within the LLC. By creating an LLC, you are separating your rental income from your personal income, which may lower your income tax bracket and make you eligible for tax deductions for business expenses and medical insurance.

It’s important to keep your personal and business finances separate for legal reasons as well.  Otherwise, the tenant may be able to “pierce the corporate veil” of LLC liability protection, which can occur when a landlord mixes accounts, for example paying for rental repairs with a personal check. 

Privacy Benefits

When you own property, the deed is a matter of public knowledge anyone can obtain.  An LLC generally helps shield the owner’s anonymity.

Reasons Not to Create an LLC

The primary reason not to set up an LLC is that it costs money to set up – typically between $500-$2,000 depending on whether you use an online service like Legal Zoom or a law firm.  There also are additional tasks involved in maintaining an LLC, like keeping minutes of member meetings, and filing separate tax returns for each member.  Another downside is that LLC’s must be represented by an attorney in court in most jurisdictions.  The landlord would not be able to represent the LLC as that would be considered the unauthorized practice of law.   

Liability Insurance Considerations

As indicated, a compelling reason to set up an LLC is that it limits the liability by protecting an individual’s personal assets from any recovery.  If personal liability protection is of paramount concern, Landlords can receive the same basic protection by securing an umbrella liability policy with a reputable insurance company. Umbrella insurance policies add an extra layer of protection and can cover a wide variety of liabilities including flood, fire and vandalism damage.  A combination of an umbrella policy with an LLC combined would be your most comprehensive form of protection.

Lynx has substantial experience assisting clients with the setup of business organizations such as an LLC and provides these services at highly competitive rates.  Please call us today for a quote.  Alternatively, you can schedule a telephonic consultation with one of our representatives by reserving a date and time on our website.  Our experienced professionals are standing by to assist in any way we can.