Purchasing an investment property is a big decision. Making important decisions regarding location, type of property and how to manage that property are all things that you will consider as you negotiate and purchase a property.
Often clients will ask me if they should hold their rental property in an LLC. The answer is almost always “it depends.” Here are the factors to consider when deciding how to hold rental property:
Do you own the property with multiple partners (other than husband and wife)? If the answer is yes, you should hold the real estate in an LLC and report the taxes on Form 1065 for partnerships. The net rental income will be reported to partners as pass-through income to be taxed on their individual returns.
Don’t hold real estate in a corporation. An LLC entity is better than a corporation for real estate assets. The potential tax consequences as you sell the property or transfer ownership are not as advantageous in a corporation. Overall, corporations are not tax efficient options for rental real estate.
An individual investor (or married couple) may consider setting up an LLC for their real estate investment. If this is something you are considering, you should dig into why you want to hold the asset in an LLC.
Here are the considerations:
Getting a mortgage for the property is easier when you hold title in your personal name and you may get better financing options. You can purchase a property in your personal name and finance the purchase with a mortgage in your name and then you can use a “Quit Claim Deed” to transfer ownership to an LLC. However, make sure that you are not violating any clauses in the mortgage when you do this.
Holding property in an LLC will not protect you from all liability. You can protect yourself and minimize your risk of owning an investment property by purchasing a good umbrella policy. The LLC will provide some separation between your personal assets and your rental business, but it won’t protect you from tenant claims regarding the safety of the building. An umbrella policy can provide coverage for bodily injury and property damage.
Your rental real estate is a business and you want a clean separation of business and personal assets. This includes using a separate bank account and separate credit cards for your rental transactions. Using an LLC entity may encourage you to keep transactions separate and run the investment like a business. Of course, even if you decide not to hold your real estate investments in an LLC it is still best practice to keep separation between your rental real estate and personal assets.
The drawback to putting your real estate in an LLC is that you have an increased complexity in tax filing, you reduce access to financing options and you have higher administrative costs.
The answer to how to hold your real estate is complex and spending the time and money for a consultation with a professional may save you thousands in the long run. We are not providing legal advice in this article and we highly recommend consulting an attorney and working with a professional tax advisor when making these big decisions regarding your real estate investments.
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