The Tax Benefits Of An Llc For Rental Property
A Limited Liability Corporation or LLC is a popular business structure for real estate investors because it offers flexibility, legal protection, and tax advantages. But you have to know how to properly set up and maintain your business to reap the rewards. Here is a look at a few benefits of llc for rental property owners, along with some of the disadvantages.
Key Points
Limit Your Personal Liability
If you own your property as an individual and someone files a lawsuit against you, then your personal assets are at stake. However, if you create an LLC, then the only assets at stake are those owned by the LLC. In other words, your rental property is the only asset at stake and not your personal finances.
Are There Tax Considerations Related To Incorporating My Rental Property Business
If you choose a sole proprietorship model, you must report all of your rental revenues as income. This could put you in a higher tax bracket than you would face if you incorporated your business and paid yourself a salary instead.
Another potential consideration has to do with transferring real estate into an S-Corporation. If you transfer property that is subject to a mortgage into an S-Corporation, you could be subject to corporate taxation on the transfer under Internal Revenue Code Section 357.
As part of Congressional pandemic relief action taken in 2020, business owners including landlords may be eligible for additional tax benefits. The Rocket Lawyer Rental Income Tax Guide and COVID-19 Tax Relief for Rental Property Owners, both published prior to the passage of the second stimulus bill in 2020, outline possible tax deductions and credits for landlords.
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Higher Interest Rates And Fees
Banks and other lenders often charge higher interest rates to those purchasing a property with an LLC and they likely wont lend to you if you dont already have solid banking and credit history. This is because if anything goes wrong, its easier to walk away from an LLC than if the mortgage is in your name. Therefore, its a riskier deal for the lender and they may charge higher interest rates and other fees to compensate for that risk.
Limiting Your Personal Liability
If you choose to operate without a formal business structure, you risk becoming personally liable for any business matters. When you operate under an LLC, you and any relevant members have legal protection against any possible company wrongdoing.
For example, if your property requires any repairs, but the contractors go unpaid and eventually sue, your personal assets will be protected.
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What Is A Holding Company
A holding company is a type of firm that owns other investments, including whole companies, instead of engaging in operating activity itself. Its a way to reduce risk and liability when it comes to investing in property. The financing, deed, and contract are under the name of the holding company, not you as the individual investor. In this blog, we will refer to one of the most popular forms of holding companies, the LLC.
Is It Better To Buy Property Under An Llc
If you plan on purchasing rental properties, it is best to have your LLC first. When you purchase a property without an LLC, you will have to transfer the title to your LLC.
Getting an LLC to buy any property helps you avoid paying any additional costs if your mortgage lender decides to close the loan in your name. You also will avoid having to pay a title transfer tax.
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How Do I Calculate Depreciation
Depreciation is a deduction taken over several years. You generally depreciate the cost of business property that has a useful life of more than a year, but gradually wears out, or loses its value due to wear and tear, weather damage, etc. To figure out the depreciation on your rental property:
1. Determine your cost basis
Your cost basis in the property is generally the amount that you paid for the property , including any money you borrowed to buy the place.
If you are converting your property from personal use to rental use, your tax basis in the property is calculated differently. Your basis is the lower of these two:
- Your acquisition cost
- The fair market value at the time of conversion from personal to rental use
If the property was given to you or if you inherited it, or if you traded another property for the current property, there are special rules for determining your tax basis in your rental property.
2. Allocate the cost by type of property
- If your rental is a condo or other property that shares property within a community, you’re deemed to own a portion of that property.
- A portion of the land and a portion of the purchase price must be allocated to the land on which the building sits.
Benefits Of Creating An Llc
The biggest benefit of creating an LLC for your rental property is that it can insulate you from personal liability. Yes, you may have liability insurance, but if someone is seriously injured on your property, they can sue you personally for medical expenses and damages above and beyond the limits of your policy. If your property is owned by an LLC, your personal assets are protected in the case of an extreme loss or lawsuit.
Another benefit of setting up an LLC for your investment property is pass-through taxation. This means that the business does not have to file a separate tax return. Rather, any profits or losses will be reported on the owners personal income taxes. This is because the LLC is treated like a sole proprietorship or partnership and corporate taxes and regulations generally dont apply.
The same protection is true if, as an owner, you are unable to pay contractors for work completed. Lets say some unexpected renovations become necessary and you significantly underestimated the financial burden. Rather than continue at a loss, you choose to forgo development of the rental property and abandon the project. If your property is owned by an LLC, unpaid contractors can sue the LLC for compensation, but your personal assets are protected.
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Llc Vs Sole Proprietorship For Rental Properties
Aside from an LLC, a sole proprietorship is one of the most popular options for property owners. A sole proprietorship is essentially a one-person business. These types of businesses handle taxes the same way as self-employed people do, and they dont require the same types of fees that setting up an LLC does.
There are certain benefits to using a sole proprietorship business model instead of an LLC.
- Lower start-up costs. Sole proprietorships usually only require permits and/or licenses to get started.
- Fewer name regulations. Sole proprietorships can choose almost any name for their company, as long as there isnt already a company with that name in your state.
- No separation needed. Theres no reason to separate personal and business funds with this type of business, as they are considered one and the same.
- Very few regulations. While LLCs are heavily regulated, sole proprietorships arent subject to a lot of state laws. Its not the Wild West, but you can forgo annual fees, registrations, and diligent record keeping.
On the other hand, this may not be the best option for you.
For these reasons, a sole proprietorship is probably best for a single property owner who doesnt do much renting, or who has insurance to cover liability concerns. For managing just a few single-family homes , a sole proprietorship can be a more useful tool.
How Do I Set Up An Llc For A Rental Property In California
When setting up your LLC for a rental property in California, you must first come up with a unique name for your business. The name you select must not be the same as or similar to an already existing name listed in the California Secretary of State records.
If you already have a name in mind, you will want to make sure it is available before submitting your application. When creating your business, make sure that you put LLC or Limited Liability Corporation after your business name. For example, if your business name is Lucys Salon Studios, it will need to look like Lucys Salon Studio LLC.
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Legal And Professional Fees
Landlords can deduct certain professional fees in relation to the rental property. If you use a CPA or computer software to prepare your tax return, be sure to deduct the cost. Hire a lawyer to oversee rental paperwork at any point in the year? Deduct those exorbitant hourly fees. If you used a real estate agent to find your tenants, deduct the commission. Advertise the property in the newspaper, over the radio, or online? Deduct those ad dollars.
Even advisor services can be written off so long as you meet to discuss the rental property. If you have to evict someone, this deduction would help cover the legal and court filing fees. These are all considered operating expenses and should be deducted as such. You cannot, however, deduct legal fees used to defend the title of your property or recover and improve the property.
Filling Out Forms And An Annual Report
When transferring your property to an LLC, youll be required to submit your Articles of Organization, Operating Agreement, and IRS form SS-4 for your Employer Identification Number. In addition to these upfront documents, youll be required to submit an annual report. The annual report, however, is a recurring submission youll need to file every year.
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The above article is intended to provide generalized financial information designed to educate a broad segment of the public it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other business and professional matters that affect you and/or your business.
Builds Credit For Your Business
One of the more underrated real estate LLC benefits is the ability to build credit for your business. When an investor determines an LLC is the right corporate structure for them and their business, they can obtain an Employer Identification Number . This essentially allows for your business to build credit without using or impacting your credit. It can be an excellent tool for investors, as it enables you to build a dominant credit rating for your business, including the ability to qualify for credit lines under your business name. This could essentially provide double the borrowing power for investors with both personal and business credit profiles.
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How To Use An Llc For Rental Property
If you choose to use an LLC for your rental property, this means that your company will officially operate as the landlord, rather than you as the individual. This business structure will give you added personal liability protection, as well as additional benefits, such as a more professional business appearance. If you use an LLC for your rental property, you will also have some flexibility in how you choose to structure your company. You can be the sole owner of your company or you can include a spouse or other business partners in your ownership. The way your LLCs taxes are handled can vary depending on how many owners your company has and how you choose to set this up with the IRS. As is discussed later, you have some options in this area and can decide which tax situation is most beneficial for you. You will then acquire your rental property in the LLCs name. Ideally, it can be simpler to form your new company before acquiring rental properties. This way, your LLC can hold the property title from the start, which saves you a bit of time. oOn the other hand, transferring existing property ownership from yourself to the LLC will require a few additional steps. Once you register your LLC, there are a few basic steps you will need to take in order to set up your rental company, such as the following:
Making It Easier To Claim Business Expenses
Creating an LLC for your rental property can make it easier to claim business expenses, like mortgage interest, insurance, and advertising expenses. In addition, by setting up an LLC, you can deduct payments to a property manager and professional services you use, including legal and accounting services. You should also set up a bank account to keep operating funds separate from rent payments.
Setting up separate LLCs for your rental properties can keep them separate from one another, which is especially important if you own multiple rental properties. This way, if a lawsuit occurs against one property, it wont affect the other. In addition, separate bank accounts for each property can make it easier to claim business expenses on your taxes.
Setting up an LLC allows you to separate your personal and business expenses. This can make claiming business expenses easier and help you avoid compromising your finances. Having separate bank accounts for business and personal funds will also help you keep track of business expenses.
Another reason to create an LLC for rental property is the opportunity to deduct business expenses through a pass-through taxation system. This means you will have more opportunities to claim business expenses on your taxes than ever before. It will also be easier to claim these expenses because youll have a separate bank account for your rental property.
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Sales And Employer Taxes
You will need to register with the appropriate California taxing authority in some cases. For example, if you have employees or are selling goods and collecting sales tax, you will need to make sure that you register your LLC with the proper taxing authorities. Your accountant or tax professional can help you sort this out if needed.
An example of a taxing authority you may need to register your business is the California State Board of Equalization. If you plan on selling goods and collecting sales tax, you will need to register with them. You can do so online or go in person at a Board of Equalization office.
Should I Put My Rental Property In An Llc
A Limited Liability Company is a type of business entity that limits the personal liability of the owners. When clients own rental property in their individual name, or are considering purchasing rental property, we advise them to create an LLC to own the property instead. An LLC does exactly what its name suggests, it limits the clients liability to the asset owned by the LLC. An LLC acts to separate the assets owned by the LLC from the clients other assets.
To illustrate: If someone injures themself on your rental property, that person can sue you for amounts above your liability insurance coverage, putting your personal assets, including your home, in jeopardy. But, if the property is in an LLC, your liability is limited to the assets owned by the LLC, insulating your personal assets from lawsuits.
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Make Your Tax Breaks Count
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Who Is A Good Candidate For A Limited Liability Company
Creating rental houses with an LLC creates benefits for any landlord, such as pass-through taxation and liability protection.
To form an LLC with multiple owners, youll need an operating agreement that outlines the rights and obligations of the LLCs various members. This will allow you to manage the property and protect each member of the LLC in the event of a legal dispute.
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How Does Owning An Llc Affect My Taxes
Owning an LLC comes with significant tax benefits when you put your rental property in an LLC. This tax benefit is called pass-through taxation. This type of taxation allows any losses or profits to pass through your business to your income tax return and is taxed at a personal rate.
You have the opportunity to deduct up to 20% of your LLCs net income from your income taxes, which can amount to financial savings on your income taxes.
Ensure that you reach out to your accountant or a licensed tax professional for more information. It is best to have a professional handle your rental LLC tax information to avoid making any mistakes when submitting your taxes.
Travel And Transportation Expenses
If youre a landlord that travels to multiple properties or your rental is located far from your residence, your transportation expenses are deductible. This includes paying to show your rental property, collecting rental income and conserving your rental property throughout the year. Excluded from this policy, however, are any reasonable commutes made regularly.
You can deduct travel using two methods: actual expenses or the standard mileage rate. For 2021, the standard mileage rate for business use was 58.5 cents per mile.
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