So, you are looking to buy rental properties?
You’ll be happy to know that rental properties are an excellent long-term investment, especially if your finances are in order, says Cynthia Meyer, a certified financial planner (CFP).
But, despite the many benefits, it isn’t all hunky dory. Like in the case of any significant investment, there are some things to consider before buying properties.
For example, you must consider the best ways to manage your assets, income, and legal obligations.
Another fundamental aspect you must consider is whether or not to form an LLC – Limited Liability Company.
(Psst, forming an LLC to buy rental properties can help you address most of your worries.)
So, in this post, we will address everything you need to know about LLC.
Let’s get started.
What is an LLC?
A Limited Liability Company, or LLC, is a business structure that protects its owners from personal responsibility for their debts or liabilities. You can establish an LLC on your own, with a partner, or as part of a group.
4 Benefits of an LLC That You Should Know
1. Limited Liability
Suppose you buy your new rental property as an individual and find your first tenant. But unfortunately, there was a faulty electric line in the house, and upon finding out, your tenant is filing a lawsuit against you.
As an individual owner, your assets are now at risk along with the rental property.
Suppose you buy your house under an LLC, and a similar situation befalls. In such a case, your rental property will be the only asset at stake and not your personal property.
2. Keep Your Rental Properties Immune to Each Other
Forming a separate limited liability company for each of your rental properties will help keep your assets immune to one another at the time of lawsuits.
Suppose someone files a lawsuit against one of your rental properties under a distinct LLC. In that case, the rest of the rental properties under your other LLCs will not get affected by the case.
3. Scale Your Business to Your Heart’s Content
If you plan to roll up your sleeves and get into the depths of the real estate business, forming LLCs will allow you to scale up your efforts.
With LLC, you can add other co-owners to your buy-and-rent business when it grows. Of course, you can do so with a partnership agreement, but the ownership proportions will always be blurrier than with an LLC.
4. Pass-Through Taxation
By setting up an LLC, you benefit from the company’s income “passing through.”
Essentially, all income made by your LLC (your rental property) will only be taxed once on the owner or shareholder’s tax return.
In short, you and your shareholders will get to keep more of the LLC’s income.
The best thing you can do before setting up your LLC is to discuss your situation with a tax professional. They will help you determine the best way to minimize your tax burden.
Forming an LLC to buy rental property may not benefit small real estate investors. According to the Washington Post, small real estate investors may be unable to get around some of the problems with LLCs, which are easier for those with more extensive portfolios.
For example, you might not be able to find a lender who will finance your properties if you hold them in LLCs. You might also be unable to get the best rates with the lowest fees.
Another thing that makes LLCs less beneficial for small investors is the attached cost. The protection of an LLC comes at a price—typically several hundred dollars to get started, as well as an annual fee to keep your business running.
The 5 Steps to Set up an LLC
Before getting into the steps, here’s an important thing to keep in mind – keep your business and personal expenses separate.
Creating a separate business bank account for LLC will make it easier to claim rental property operating expenses when it comes time to do your taxes.
According to Forbes, it will also help you avoid mixing all your expenses, piercing the corporate veil, and losing the protection of your assets.
Now, let’s get into the steps.
LLCs are regulated at the state level, so the company formation laws and the process may differ by state. The following steps are an overview of the process.
1. Reserve a Name For Your LLC
If you have some LLC name ideas, check your state’s business directory to ensure that the name you want is unique and not already taken by another LLC.
In the state where you are filing, your company can’t have the same name as an LLC that already exists there.
2. Hire a Registered Agent
The next step is to hire a Registered Agent (RA). This person will receive and correspond to all of your company’s legal and tax documents.
When choosing an RA, keep in mind that they must be a resident of the United States or a corporation that is allowed to do business in the United States.
3. File a Certificate of Incorporation
After hiring the agency, you must file a certificate of incorporation for your LLC with your state’s Division of Corporations.
You can submit this form and pay the necessary fees online, by mail, or in person.
The filing fees vary between states, so here’s a resource to find out the cost of filing an LLC in your state.
Your company will be officially incorporated once the documents get filed and accepted by the Division of Corporations.
4. Make an LLC Operating Agreement
An Operating Agreement is a legal document that contains the terms and guidelines for LLC ownership and management.
If your company consists of more than one member, this document will help you lower the chances of internal disputes in the future. When LLC members sign an operating agreement, it becomes legally binding.
5. Get an LLC EIN
EIN for “Employer Identification Number.” This is a nine-digit number that the Internal Revenue Service (IRS) assigns to businesses.
An EIN is like a Social Security Number for businesses, and is needed to open a business bank account, file and manage Federal and State taxes, and hire employees.
To apply for EIN, visit this IRS page.
The Bottom Line
If you want to get serious about investing in real estate, you should set up an LLC – it will protect you from liability much better than working as an individual or sole proprietor.
LLC is relatively easy to set up, but it does require a few extra steps and costs to give you more protection from liability.
So, make sure you always weigh the pros and cons on your own to make the best choice.
About The Author: Lyle Solomon has extensive legal experience, in-depth knowledge, and experience in consumer finance and writing. He has been a member of the California State Bar since 2003. He graduated from the University of the Pacific’s McGeorge School of Law in Sacramento, California, in 1998 and currently works for the Oak View Law Group in California as a principal attorney.
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