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Protection for Landlords
| What is an LLC? A limited liability company is a general partnership and a corporation merged together. It is charted like a corporation with articles of organization and a certificate of charter from the state. The LLC then functions more like a partnership than a corporation from that point on skipping the board meeting minutes and corporate resolutions. The LLC does not have the same limitations as the S-Corporation and can have more favorable tax treatment than an S Corp. Single member LLCs are common, with the sole owner acting as managing member. How should I set up my LLCs? Once you organize your LLCs, you will want to place all of your rental properties in their own entity. This will protect assets from liabilities created by virtue of your ownership of the rental properties. Let's face it.. Accidents happen. People can get hurt on your property. When people are hurt on property that they do not own, the injured victims and family members of deceased victims, frequently sue the property owner for damages. In the event of a lawsuit, or if your business should fail, your personal assets cannot generally be touched if your property is held (deeded) by the LLC. However, as a sole proprietorship or partnership, (an unincorporated business) the individuals or partners are personally liable for all business debts. Just think, what would happen to you if one of your properties has a fire, or someone gets hurt in an accident, and you are found liable! The LLCs will create a "Fire Wall" around your rental properties which keeps any legal "fires" inside the LLC so they cannot get out and burn up your assets and other properties as well. The LLC, therefore protects the assets you hold outside the LLC from the assets you put inside the LLC. What should I name my LLCs? Many landlords would like to name their LLCs after themselves. Part of a good asset protection plan involved keeping things quiet. Privacy is important. You don't want to walk around with a target on your back. If it is difficult to find out who the true owner of an LLC is, it is more likely you won't be targeted in a lawsuit against your LLC. The name of the LLCs should be the address of the property, such as 1600 Pennsylvania Ave, LLC. Should I use more than one LLC? Using more than one LLC will further protect your assets. With each additional LLC you use, you are creating additional fire walls to protect rental properties from liabilities arising from other rental properties. For example, if one of your rental properties has a serious mold problem and you have that property in an LLC, only that LLC would be liable for any multi million-dollar judgement from the mold problem, as opposed to all of your rental properties and your personal assets. Even if you have liability insurance for the rental property, the coverage my be limited or non-existent for the mold problem or the liability-insurance carrier may go out of business. Can I have too many LLCs? The practical side of owning one LLC per property is that it can become expensive, especially for those who own more than five properties. Legally, the ideal asset protection plan would involve one LLC per property. Each LLC requires an annual fee to the state, and some states require a separate tax return each year. Each LLC needs to have financial records for tax purposes. It comes down to a matter of risk tolerance verses the cost of protection. But remember you can pass down theses fees to the renters. What about protecting the properties inside the LLCs? With rental properties, it is a bit different, because it is the ownership of the property itself that can create the greatest liability. You cannot lease your rental property to your LLC to accomplish protection of that asset. Now matter how you set it up, there will be an owner and the owner will be subject to potential lawsuits based upon ownership. The only way to protect the properties inside the LLCs from being taken from you, is to decrease the value of the asset itself by mortgaging the property. If you have one rental property inside the LLC worth $100,000, and you have no mortgage on the property, you stand to lose up to $100,000. If the same property inside your LLC, has a $90,000 mortgage on it, you stand to only lose $10,000. If you choose to "strip" the equity from your property to devalue it for asset protection purposes, you can either use a commercial and take the cash out to invest it in stocks and bonds, pay off personal debt, purchase more rental properties, or utilize it any other way you choose, of you can use a private lender, including a controlled entity and hold the paper yourself. Either way, you have taken most of the value out of the LLC. But what If I already have insurance? Proper insurance coverage is the first line of defense to protect you from claims on your property. But, judgements can exceed the amount of your insurance coverage, and sometimes insurance coverage is denied! So, if your coverage is $1,000,000 and you have a $2,000,000 claim, where do you think they are going to get the "extra" $1,000,000? Your personal assets!! Ideally, you will strip all of the value from the properties inside your LLCs so that you lose no value if your insurance doesn't cover the liability. You will not lose the property itself either, because it has no value, the judgement creditor will abandon it. Even if it producing rental income, the income had to go to the mortgage holder(s) first, before it can go to a judgement holder. If the judgement holder is content to place a judgement lien on the property, and will wait till the rents pay down the mortgage(s) and create equity, foreclosure on the mortgages can release the judgement lien. Complete asset protection is possible to achieve. Why settle for anything less? If you can use an LLC to protect all of your personal assets from all liabilities created by rental property ownership, and you can also protect all of your rental properties inside the LLCs from ever being taken away from you, what are you waiting for? It's never too expensive to save your assets from law suites. What are some schedule E tax tips for Landlords? If you form and S Corporations or Partnership, you may be exposing yourself to unlimited liabilities that arise from lawsuits and other legal risks. If you form a regular C Corporation, you have limited liability protection and you lose the ability to pass-through your income and losses to your personal 1040. If you form a Limited Liability Company, you have limited liability protection and your pass through all profits and losses to your 1040. From a tax perspective, forming LLCs to own your rental property sounds appealing. None the less, setting up an LLC, transferring title, and getting the tenants to sign new leases with the LLC as the owner, may prove to e a time-consuming project, but well worth the effort. Besides limited liability, the landlords can transfer ownership of their company to their children and other heirs. Generally, most real estate experts advise the use of an LLC to hold title (deed) to the property. There are less formalities in operating an LLC and they are "tax free" entities, since the taxes are paid by the members (owners) of the company at the personal level (No "corporate" income taxes). |