Do I need an LLC for my rental property?

September 1, 2022
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Creating an LLC for investment properties is a smart move for many landlords. LLCs offer liability protection, which can help with organization, and can be used to co-invest with friends and partners. However, there are also some disadvantages to having an LLC. The very nature of an LLC can make financing complex, and the cost and admin hassle of setting one up may not be worth it for some.

So how do you know what the smart move is? When you're getting those gears turning about whether to create an LLC, there are some key things you'll want to keep in mind. Here's a helpful guide for the things you should consider.

What Is an LLC?

An LLC is a Limited Liability Company. This type of company is a hybrid between a corporation and a partnership. 

Like a corporation, an LLC limits the liability of its owners. This means that the member's personal assets are protected if the LLC is sued or incurs debt. And like a partnership, an LLC has pass-through taxation. This means that the LLC does not pay taxes; instead, the members pay taxes on their share of the LLC's profits.

LLCs are a popular choice because they offer the limited liability of a corporation but are simpler to set up and maintain than a corporation. They are also less expensive to operate than a corporation. Plus, the pass-through taxation of an LLC means that the members can avoid the double taxation that occurs with corporations.

Pros of Holding Investment Properties in an LLC

Limited Liability Protection: One of the most significant advantages of an LLC is that it offers limited liability protection. If the property is sued, your personal assets are protected. This is a big deal because if a tenant slips and falls on the property, the landlord could be held liable. 

Organization: Another advantage of an LLC is that it can help the organization. For example, if a landlord owns multiple properties, they can create an LLC for each one. This can help keep things separate and organized and can make it easier to sell a property in the future. 

Co-Investing with Friends: LLCs can also be used to co-invest with friends. For example, if four friends want to buy a property together, they can create an LLC, and each be a member. This can help provide some legal protections and make things simpler from a tax perspective. 

Tax advantages: There are also some tax advantages to putting investment properties in an LLC. For example, LLCs can help landlords deduct expenses like repairs and maintenance. LLCs can also help landlords defer taxes on capital gains.

Cons of Holding Investment Properties in an LLC

Cost: One of the biggest disadvantages of an LLC is the cost. It can be expensive to set up and maintain an LLC. The fees associated with forming the LLC and the ongoing costs of complying with the state's requirements may be expensive. In many cases, the cost of setting up and maintaining an LLC will outweigh the benefits.

Administration Hassle: Another disadvantage of an LLC is the administrative hassle. If the LLC is in a different state than the one the landlord lives in, a registered agent may be necessary. This can be a lot of work and expensive in terms of both labor and money. Holding properties in an LLC also means certain tasks have to be done by lawyers or agents.

Financing Complexity: LLCs can also make financing more complex. Some lenders will want to see the property in the landlord's name. If the property is in an LLC, the landlord will have to buy the property in their own name (eg. Mortgages). This can be a hassle and it can delay the loan process. 

Lack of Flexibility: LLCs can also be inflexible. The landlord may have to get formal approval from the LLC, and its members, before making changes to the property or selling the property. This can cause delays if there's a tight timeline.

Takes Time to Form: One of the most significant disadvantages of an LLC is that it takes time to form. The landlord will have to file the necessary paperwork with the state, and then wait for the LLC to be approved. This can take weeks or even months to sort out.

Do I Need a Separate LLC for Each Property?

Many landlords have one LLC for all of their rental properties, while others choose to create a separate LLC for each property. There is no right or wrong answer, but each option has different benefits and drawbacks that you should consider before making a decision.

One LLC for All Properties

The main advantage of having all properties in one LLC is that it is simpler and cheaper to set up and maintain. You will only have to file one set of paperwork with the state, and you will only have to pay one annual fee to keep the LLC in good standing.

The main disadvantage of having one LLC for all your properties is that if you are sued, the other properties held by the same entity can also be at risk. Since the LLC is a single entity, all of the assets of the LLC are considered to be jointly owned. Other properties could be seized in order to satisfy a judgment.

Separate LLCs for Each Property

The main advantage of having a separate LLC for each property is that it offers better asset protection. If one property is sued, the other properties will not be at risk because separate entities own them.

The main disadvantage of having separate LLCs for each property is that it is more expensive and time-consuming to set up and maintain. You will have to file paperwork with the state for each LLC, and you will have to pay an annual fee for each LLC.

Complementary or Alternative to LLCs

There are also a few options you can consider to complement or replace holding your properties in LLCs.

  • Getting insurance: As a landlord, you can get Umbrella insurance, Landlord insurance, and more to limit your liability. Umbrella insurance is often a good complement for maximal liability protection, even if you have your properties in LLCs.
  • Using technology to keep finances separate: Nophin allows individuals and businesses to create checking accounts for each property. Doing so allows you to stay organized and make sure your funds for each property stays separate.
  • Requiring tenants to get insurance: You can also require tenants to get their own renters insurance or tenant's insurance. Tenants often need to report any damages to their own policy before impacting the landlord's policy.
  • Using a Series LLC: Certain states like Illinois, Iowa, Nevada, Oklahoma, Tennessee, Texas, Utah, and Delaware recognize Series LLCs. This type of tiered LLC structure separates assets between lower-tier LLCs while only having one top-tier LLC entity.

The bottom line

It often makes sense to have properties in an LLC that is separate from the LLC that owns other properties. However, for maximal protection, you'll want to also get insurance to cover your liability. The best way to decide what is right for you is to speak with expert accountants and lawyers who are familiar with LLCs and asset protection.

When you're ready, whether you hold your properties as an individual or within a corporation (LLC, Partnership, etc.), Nophin can handle your banking and property finance needs.

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Please note: Nothing above should be construed as legal, investment, tax, nor financial advice. This content is for informational purposes only. Consult a lawyer and/or an accountant if the above is right for your personal situation.

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