Should You Put Your Rental Property in an LLC? Separating Fact from Fiction

To LLC or Not to LLC?

When considering how best to manage and protect your rental property, one option that often arises is placing the property into a Limited Liability Corporation (LLC). If you have any landlord friends or hang out in any landlord social media groups, you’ve probably heard that you need to put your property into an LLC for the tax benefits and liability protection. Let’s dig into the reality of both of those statements.

Note: For purposes of this article, we’re talking about a single-member LLC. This is an LLC that has just one member or one married couple who own a property together.

Disclaimer: I am neither a lawyer nor a tax professional! Use this information to help you identify the questions you need to ask your lawyer and/or tax professional. This is neither legal nor professional advice.

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Tax Benefits of an LLC: What You Need to Know

The Disregarded Entity Status

A single member LLC is a disregarded entity for tax purposes. This means that everything that happens with the LLC gets reported on your personal tax return, just as if the LLC didn’t exist. There is no tax benefit or additional tax due to the LLC itself.

Potential Tax Deductions and Costs

However, it is possible that the LLC will reduce your taxes because the costs of running the LLC are tax-deductible expenses. That doesn’t mean you’re saving money overall, because if you’re getting, say, a 25% tax benefit from deducting the cost of an LLC, you’re still paying that other 75% expenses.

The costs of setting up and maintaining an LLC can be significant, and the costs vary dramatically from state to state. In addition to the one-time set-up costs, you may have annual filing fees or other expenses. For example, Florida requires an annual registration that costs $138.75 every year — with a $400 late filing fee!

State-Specific Taxes and Fees for LLCs

And from a tax perspective, there may be state taxes on an LLC. Jerry Zeigler of JZ Financial Management is a retired sailor, a long-time landlord, an Enrolled Agent®, the president of the Military Tax Experts Alliance, and an expert on taxes for landlords. He shared,

"What I've been running into more are clients who set up an LLC in a state that has an excise tax or franchise tax."

This can actually increase your tax burden instead of decreasing it.

Elizabeth Colegrove is a military spouse, real estate investor, and co-founder of the Landlord Help Hub. She found this out the hard way.

"When we first started in 2011, I believed that setting up an LLC was necessary, even if you only owned a single property, based on all the online rhetoric. However, I quickly realized that most traditional landlords shouldn't have LLCs unless there is a specific need. In California, for example, maintaining an LLC costs $800 annually just for having one, plus a percentage if the property is profitable."

Colegrove dissolved her LLC pretty quickly after discovering how expensive it was.

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Liability Protection: Does an LLC Really Shield You?

Understanding the "Corporate Veil"

In theory, a limited liability corporation should limit your liability. Right? Well, yes. In theory. In reality, a single member LLC can be pretty flimsy protection.

There’s this concept called the "corporate veil" that divides the actions of the individual from the actions of the corporation. It’s called a veil, and not a curtain or a wall or something else opaque, because it’s see-through.

Limitations and Risks of Liability Protection

Zeigler also told me,

"Make sure you research (better yet consult a lawyer) on what protections an LLC actually offers in the state in question. They tend to offer less protection than many believe, and the ability to 'pierce' the corporate veil can vary by state."

It is easy for a savvy attorney to "pierce the corporate veil" and demonstrate that you haven’t kept your business dealings separate enough from your personal dealings.

For instance, did you have to dig into your personal emergency fund to fix that failed HVAC system without properly tracking the flow of money between the person and the business? Or use your personal credit card to buy supplies without properly tracking the transaction and the flow of money between the individual and the business?

More importantly, did you follow the rules of your LLC, including reporting and annual meetings? Anything that reduces the validity of the corporation increases the chances that you don’t actually have protection from liability. You want to be absolutely sure that you are keeping the corporation separate from the individual. And that can be difficult.

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Photo from iStock.com/Korrawin

Additional Considerations Before Forming an LLC for Your Rental Property

Impact on Mortgage and Lien Holders

Moving your property to an LLC might trigger action by any lien holder, a.k.a. your mortgage company. Whether that’s an actual concern for you will depend on a variety of factors, including your mortgage holder's policies. It is worth doing research on your specific mortgage before deciding.

When an LLC Makes Sense for Complex Transactions

If you’re doing more complex transactions, an LLC might make sense. Colegrove shares how she uses LLCs as part of her overall business structure.

"I now operate two LLCs specifically for flipping properties and rental arbitrage. In these cases, LLCs are essential — commercial loans for flippers require them, and the unique insurance needs of rental arbitrage align perfectly with an LLC structure. When I conclude these practices, I will cancel my LLCs, as they serve no purpose for my day-to-day traditional landlord needs."

An LLC will require more paperwork and important annual filing deadlines. How will this fit into your overall workflow? Will you do the things that are required?

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Enhancing Professionalism and Privacy as a Landlord

Operating your rental property through an LLC can enhance your professionalism as a landlord. This structure signals to tenants, neighbors, and business associates that you are running your rental operation as a business. It is possible that some potential trouble could be averted if you are perceived as a business and not an individual.

In some states, forming an LLC helps protect your privacy, as the names of LLC members may not be required to be publicly disclosed. This anonymity can be beneficial if you prefer to keep your ownership of the rental property confidential. This is very situationally dependent.

Strategic Use of LLCs in Real Estate

Colegrove’s last comment to me was this,

"LLCs have their place in real estate, but the key is to use them strategically for specific purposes, rather than applying them indiscriminately across the board."

That’s a great summary! While there are situations where an LLC makes sense, be sure you understand how much the LLC will cost you and what sort of liability protections it provides in your state. Weigh the costs and benefits to see if they make sense for you.

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