Setting up an LLC for an investment property is simple, and not terribly time-consuming. Doing it well does take research, attention, and professional support. But it may be worthwhile.
Here are some basic considerations to have on your radar if you wonder whether forming an LLC could be a worthwhile goal. This is not legal or financial advice — just a checklist to help guide your own due diligence.
Why Register a Business? The LLC as Self-Protection
Life is unpredictable. And every day, businesses get sued for something unpredictable — something that has happened on their premises or somehow involved them.
Perhaps someone gets injured, and blames faulty property maintenance for the accident. The injured party can always sue. A court might not agree with the person making the claim, but the property owner’s assets are nevertheless at risk while the case plays out.
For most people, it’s better to be primarily liable as a business than targeted for individually owned assets. So, some property investors do their best to limit their exposure to the holdings of a company set up to contain just one particular property. If they want to buy more than one building, they might place each one into the name of a unique LLC. This can confine the liability to the property where the claim arose. And it can offer some protection to the property owner’s personal home and assets.
Yet the liability shield established by an LLC can be quite limited.
No Impenetrable Wall: LLC Protection Only Goes So Far
Owners of one or two investment units might do just fine without an LLC, if they and their renters are sufficiently insured. But those who want to keep investing will need to consider founding an LLC, as mishaps and lawsuits become more likely.
And still, the liability shield of an LLC has limits. This is mainly because an LLC is a pass-through entity. Form an LLC, and you’re taxed based on your own social security number. This makes LLCs very easy to run. And yet the LLC is not walled off from its members’ personal identities and assets the way a corporation would be. An umbrella insurance policy might shield the members’ assets more effectively than the LLC can.
General liability insurance is a must for each investment property. An owner also needs personal liability insurance, and should speak to a broker about umbrella insurance, too. The lease can direct renters to carry liability coverage and renters’ insurance. It can also specify what the renters need to do to maintain basic safety (clear entranceway snow and ice, for example).
If you have an LLC but you commingle business and personal funds, litigants can target you. Same goes for underinsuring or undercapitalizing the business. If your LLC is sued, and it turns out that the LLC is little more than a veil, a court may hold you personally accountable for claims. This presses companies to keep sufficient insurance and funds on hand to properly cover claims.
So, you need to fortify your LLC to treat it as an entity of its own, separate from yourself. A court could be especially willing to find the individual owner of a single-member LLC liable for mishaps.
People can always sue you personally over your own actions or inactions. Yet if you have an LLC, and treat it as a formal business, you can limit your liability — to some extent.
How It’s Done: Forming an LLC
Forming an LLC for your investment real estate will have your tax returns well organized and your accounting straight. It will help prevent commingling of business and personal funds. State tax departments have their own rules for taxing LLCs and their owners (“members”), and for allowing business-related tax deductions each year.
Forming an LLC is a common-sense, step-by-step process:
- Choose a business name. It can’t be the same (or practically the same) as another investor’s similar business. If the name you want turns out to be available when you search the state database, you can take the next step.
- Register the business. For instructions, visit the Secretary of State’s website for your state. Most new businesses apply to reserve their names and file their articles of organization online, and receive the state’s responses by mail. Check the requirements for a registered agent. You might need to name one to accept the LLC’s legal correspondence.
- Apply online with the IRS for an Employer Identification Number (EIN). Even if your LLC has no employees, this will allow the business to apply for credit and bank accounts.
- Open a business bank account for the LLC. You might wish to choose a local bank, for example, that can offer you an interest-bearing checking account, a debit card, and a credit card to start building a credit profile for your real estate investment business.
With a registered LLC, you have a business structure for your investments. When closing on your investment property, you can do business under your LLC’s name.
Note: Expect to pay higher down payments, interest rates, and fees when applying to finance a property in an LLC.
Re-Deeding Property: From Personal Ownership to an LLC
Some investors buy real estate in their own names, then move it into an LLC. Before moving your mortgaged property into an LLC, avoid triggering your mortgage due-on-sale clause! Alert your mortgage servicer before making changes to your deed. Also, ask if you’ll need a special endorsement to keep your owner’s title coverage.
And be sure your lender knows what type of deed you will use to transfer property into the correct legal name of the LLC.
Some investor-owners establish series LLCs. Then, they can add new investment properties to their portfolios while fencing in the liability of each new acquisition. A deed that transfers a property into a series LLC will name the LLC and the specific series (such as “Series B”) for each unique property.
Your county recorder of deeds has more on the requirements for a valid deed transfer to the LLC, such as minimum consideration amounts and filing procedures.
A Word to the Wise
A wise investor considers the pros and cons of placing residential property in the name of an LLC well before doing it. Local accountancy and real estate law professionals can help the investor structure the business and maintain state LLC requirements. They can also supply indispensable guidance in planning and document drafting. Lawyers think of things their clients might not consider. For example, certain words in a business name trigger the need for licensing or special permission from the state.
Reputable advisers can provide important advice that fits your vision, long-term goals, current circumstances, and jurisdiction. Not ready to meet with the pros yet? Get the general idea of real estate LLCs from experienced peers, and ask your own burning questions. Search for your city or your state, plus “Real Estate Investors Association” (“REIA”) in Facebook/Meta and Meetup groups. They offer local meetups and conferences where new investors can learn from others’ mistakes and successes.
Deeds.com: Thinking of Forming an LLC for Real Estate? A Few Considerations for Property Investors (Jan. 8, 2021).
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