Forming a limited liability company (LLC) is an easy and inexpensive way to structure your sole proprietorship. It’s a business structure that provides a business with limited liability, similar to that of a corporation, but the structure is easier to establish and maintain.
Before forming an LLC, you need to consider if it’s the best decision for you and your rental property. There are some very compelling reasons to form an LLC. There isn’t one answer that applies to all property owners, which is why you need to do your research to see if it’s the best fit for you.
Consulting with a financial advisor, accountant or attorney would be a helpful step to not only better understand the process, but also to determine if it is the right decision for you.
LLCs gain popularity due to the fact that it protects personal assets. This is the most obvious advantage to forming an LLC. It limits the liability to the resources of the business itself. In most cases, the LLC will protect your personal assets from claims against the business.
Important Tax Information
An LLC is considered a “pass-through entity”, also known as a flow-through entity, meaning that the LLC itself doesn’t pay any taxes. It pays taxes through individual income tax code, rather than through corporate.
Assuming that you’re the sole proprietor/owner of the LLC, you would report your taxes the same way you do now. That simply means that you own rental property but are not a legal entity. If your LLC has more than one owner, such as you and your spouse, the LLC files a separate tax return. This could cost you extra money if you use a professional to do your taxes.
While an LLC offers many benefits, remember not to overlook the possible personal liability risks. LLC rules vary by state, so be sure to research your area. Consult with your attorney and financial expert to create strategies, if any, that would protect both your LLC and your personal assets.
Common LLC Tax Deductions
Rental expense. LLCs can deduct any rent it has paid for property that it does not own, such as office or retail spaces.
Charitable giving. Doing good can also be for tax purposes. An LLC can deduct charitable donations of up to 10 percent of its taxable income
Insurance. Most insurance that is necessary is also deductible as a business expense. However, how and in what amounts insurance premiums are deductible will vary depending on the type of insurance.
Tangible property. Property that is purchased for the LLCs use can be deducted from taxes for the year of the purchase.
Professional expenses. Expenses incurred in maintaining professional licenses, engaging in professional development, or paying for professional resources such as industry journals are deductible.
Meals. Up to 50 percent of meal and beverage costs can be deducted as a business expense. This applies if the meals are “ordinary and necessary” and incurred in the course of business.
Independent contractors. Amounts paid to independent contractors can be deductible. However, if the amount paid to the contractor is above a certain threshold, the LLC must also report the amounts paid to the contractor.
Although LLCs are not free, they can be relatively inexpensive. The amount of fees required to register your LLC will depend upon the state where you live. You can set up an LLC with your local State Corporation Commission and pay as little as $100 in some states, or up to several hundred dollars in others. The cost could go up if you have an attorney set one up for you
Existing Mortgage Property
If you already own a house that you rent out and carry a mortgage on, it could be difficult to move that property to an LLC. The reason being is that a lender could perceive this as a sale and they might call in your mortgage, called a due-on-sale clause. A due-on-sale clause is a provision in a mortgage contract that requires the mortgage to be paid in full.
If that happens, you could lose out on your low-interest rate, or you might not qualify for a mortgage anymore, depending on the circumstances.
Keep Your Money Separate
If you decide to set up an LLC, make sure to never merge your LLC money with your personal money. If this happens, you could lose your protection!
If you head to the mall and use money from your LLC account to buy something, or if you use your personal money to pay for a new garbage disposal for your rental property, this could be seen as a merge of money between the LLC and your personal money. A person suing you could claim that your LLC isn’t a separate entity. Once again, if this happens, this could lead to you losing your protection.
Now that you know more about LLCs, you probably better understand that each landlord’s situation differs, which means that you need to do your research and consult with someone to determine the best course of action. Discuss your options with a financial advisor, CPA/EA, or your attorney to find out whether an LLC is the best option for you. George Sleeman, EA is an excellent place to start. You can find out more about his services at westsidetaxservice.com or by phone at (719) 646-2999. You can also reach out to Sellstate Alliance for all of your property management needs www.springsrentalhomes.com or feel free to call us at (719) 377-8600.