The LLC Option for Owning Residential or Commercial Rental Property

As seen on the WJAR NBC 10 Smart Advice Series

Owning and managing rental real estate is a business venture that presents risk of claims from creditors and litigation for which insurance may not provide full coverage. Any shortfalls in insurance protection could become the personal liability of the owner of the rental real estate. Creating a limited liability company (LLC) for the purpose of operating the rental real estate business is one way to insulate the owners’ personal assets against this risk. When properly formed and maintained, the LLC provides a separation of personal assets from business assets, and generally any creditors with claims arising out of the business are limited to recovery from the business assets.

Forming an LLC

While it is not particularly difficult to form an entity, it’s generally recommended to engage legal professionals to draft the governing documents. To establish an LLC, necessary paperwork must be filed with the Secretary of State and create an LLC operating agreement.

Depending on whether the property owner goes it alone or hires a professional, associated costs may include:

• Potential attorney fees for document preparation
• Filing fees for initial registration with the Secretary of State
• Income tax filings and return preparation for the entity each year, for which minimum taxes may apply and will vary by state
• Nominal annual filing fees to the Secretary of State for the entity’s corporate annual report

The LLC entity may elect to be taxed as a partnership so income flows through the entity to the property owners. In that case, income taxes would be the same as when the real estate is owned outside of a corporate entity. Ownership of an LLC can be held by one or more individuals, trusts, and other entities, in any case, all members of the LLC are protected from claims against the LLC.

Single or Multiple Property LLCs

An owner of multiple properties who chooses the LLC structure must decide whether to form one LLC in which all rental properties are included, or to form multiple LLCs. The LLC can hold more than one property, which reduces the administrative work, expenses and taxes relating to maintaining books and records for separate entities for each property. While there are potential cost savings to the single LLC approach, the risk of doing so is exposure for all the properties in the entity to liabilities of any one property. If the main goal is to insulate personal assets, a single entity holding multiple rental properties may be attractive. However, if one property has high value and low risk, while the other has high risk but minimal value, the exposure that a single entity presents for the high value property may outweigh the savings of the single LLC approach.

Business Planning

When rental property business represents a significant portion of the value of an owner’s estate, the structure of the business entity should involve consideration of estate planning concerns. Revocable trusts are vehicles that may hold title to LLC interests and avoid costs and delays of probate and maintain privacy at death. By proper planning and action to manage a business venture, the financial risks may be minimized for the owner’s entire family.

The Takeaway

While owning residential or commercial rental property may present a great opportunity, there are potential liability business risks. Taking steps to structure your business properly is a prudent approach to the investment and will help to minimize these risks. Consultation with legal and tax advisors is important for every business owner to understand and assess corporate planning options..

Contact a Washington Trust Planning Officer at 800-582-1076 or email us at info@washtrust.com for smart advice that’s focused on your unique financial goals.