Increasingly, people are considering leasing their homes when they move or purchasing homes to lease specifically for investment purposes. While there are many factors to consider when leasing a piece of real estate that you own, one important consideration is who owns and is leasing the property.
An individual who owns a piece of real estate can rent that real estate out to others as a sole proprietor. This means that they are renting the property that is still in their name and signing the lease personally. This can create significant liability for them if something goes wrong. Anything from a claim of a breach of the lease to a guest of the tenant injuring themselves on the property could create liability for the owner and lessor of the property. If rental property is co-owned, the owners are jointly and severally liable for the acts and omissions of the other owners of the property. Creating an LLC could address the personal joint and several liability of the owners and to provide a mechanism for dispute resolution if the co-owners disagree on how to handle the rental property. This is one reason why it can sense to from a limited liability company (“LLC”) to own and lease the property.
If properly done, forming an LLC to own and lease the property insulates the owner of the LLC and their personal assets from any liabilities that arise from renting the property. This is because a limited liability company is treated as a separate legal entity for state law purposes. Any liabilities that arise from the rental of the property would be enforceable against the limited liability company but not the owner or their personal assets. If you are renting multiple properties, forming multiple LLCs can insulate each of the rental properties that arise from any of the other property.
While forming an LLC would change how you report the rental income, it would not place significant additional burdens on the taxpayer as the owner of the LLC. While each LLC is treated as a separate entity for state law purposes, which is how most liability would arise, for federal tax purposes LLC’s are generally disregarded entities. As a disregarded entity, an LLC with one member would report an income and expenses from the LLC on their individual tax returns on a schedules C, or equivalent form, minimizing the additional expense of operating the LLC.
The reporting and payment of tax for an LLC becomes slightly more complicated if the LLC has multiple members. The default rule is that any multiple member LLC is taxed as a partnership. This means that a separate partnership tax return would need to be filed annually which would affect each member’s tax return. This can be burdensome as most taxpayers are unfamiliar with partnership tax returns and can create additional expenses in getting the returns prepared. However, the LLC can elect to be taxes as an “S Corporation” where the company’s income and expenses would flow through to the each member of the LLC proportionally. While this still requires an additional tax return, it can be more efficient for some taxpayers.
Ultimately, LLC’s can be an effective tool for limiting personal liability for rental property without being overly burdensome to manage from an administrative and tax perspective. If you own property that you are renting out that is still in your name, you may want to consider placing that property into an LLC.