Should You Put Your Rental Property Into An LLC?
dan • April 4, 2022
If you own rental real estate, you may be wondering whether you should be holding that property in your name, or whether you should transfer it into a limited liability company (a.k.a. an LLC). There are a number of factors to consider. Even if you have decided that titling your rental property to an LLC is the way to go, there are often many more decisions to make concerning the structure and location of that LLC.
What is the purpose of an lLC?
The reason to set up an LLC is to silo off the risks associated with different assets from one another. Or to put different assets under different umbrellas, if you prefer that metaphor.
The most common concern that landlords have, after not receiving rent on time and having to make major unexpected repairs to the property, is that someone is going to be injured on the property, and that injured person is going to sue. If that happens, having the property in an LLC at least gives the landlord the argument that any resulting damages award should be entered against the LLC, not the landlord personally. Whether that argument prevails or not depends on a number of factors (Google " piercing the corporate veil " to learn about why your LLC might not stand up to judicial scrutiny). But if you have managed your LLC correctly, the purpose of this arrangement is that you should not have to pay any judgment entered against the LLC from assets or insurance outside the LLC.
What I just described is known as "inside-out risk" -- i.e. , risk arising from inside the LLC and potentially reaching assets outside the LLC. It can, however, go the other way too. If you get sued as a result of an event in your personal life ( e.g. , a car accident), you don't want the plaintiff in that lawsuit to be able to attach a lien against your rental property. An LLC might help you accomplish that.
LLCs give you the opportunity to separate business assets from personal assets, or even separate some business assets from other business assets, and potentially contain the risk associated with one asset from affecting other assets. If you own multiple rental properties, you could, for example, put them all into one LLC. Doing so would at least separate the risks associated with those rental properties from the risks associated with your personal life.
You may, however, want to consider putting each property into separate LLCs. The drawback to splitting properties up this way is the added administrative hassle of managing multiple LLCs. Even for single-member LLCs, this can get exhausting at some point, and many people fail to maintain the discipline necessary to maintain multiple bank accounts, multiple leases, multiple books, etc.
The most common concern that landlords have, after not receiving rent on time and having to make major unexpected repairs to the property, is that someone is going to be injured on the property, and that injured person is going to sue. If that happens, having the property in an LLC at least gives the landlord the argument that any resulting damages award should be entered against the LLC, not the landlord personally. Whether that argument prevails or not depends on a number of factors (Google " piercing the corporate veil " to learn about why your LLC might not stand up to judicial scrutiny). But if you have managed your LLC correctly, the purpose of this arrangement is that you should not have to pay any judgment entered against the LLC from assets or insurance outside the LLC.
What I just described is known as "inside-out risk" -- i.e. , risk arising from inside the LLC and potentially reaching assets outside the LLC. It can, however, go the other way too. If you get sued as a result of an event in your personal life ( e.g. , a car accident), you don't want the plaintiff in that lawsuit to be able to attach a lien against your rental property. An LLC might help you accomplish that.
LLCs give you the opportunity to separate business assets from personal assets, or even separate some business assets from other business assets, and potentially contain the risk associated with one asset from affecting other assets. If you own multiple rental properties, you could, for example, put them all into one LLC. Doing so would at least separate the risks associated with those rental properties from the risks associated with your personal life.
You may, however, want to consider putting each property into separate LLCs. The drawback to splitting properties up this way is the added administrative hassle of managing multiple LLCs. Even for single-member LLCs, this can get exhausting at some point, and many people fail to maintain the discipline necessary to maintain multiple bank accounts, multiple leases, multiple books, etc.
What kind of LLC should I set up?
If you are a sole operator, meaning that you are the only owner of the property and the only recipient of its income, the answer is probably straightforward. You would form a single-member LLC (in the world of LLCs, owners are referred to as "members"). The nice thing about single-member LLCs is that they do not have their own tax return. The IRS treats them as "disregarded entities," and the LLC's income is simply reported on Schedule C of your personal tax return. Also, because you don't have a business partner, having your property inside an LLC likely won't feel any different from having the property in your name.
The drawback to such LLCs is that, because there is so little administrative hassle involved, it can be difficult to argue that this truly is a business entity, separate from you and worthy of allowing you to shield your personal assets from the LLC's debts. If you have a single member LLC, it is especially important that you go out of your way to handle the LLC's assets separately from your personal assets. When it's just you, it can be easy to use the LLC's bank account for personal expenditures, and vice versa. You must not blur these lines! It may feel silly sometimes, but the optics matter greatly. If, some day, you find yourself asking a judge to honor the LLC and not authorize the collection of its debts from your personal assets, that judge will wonder why he or she should treat the LLC's assets as separate from your own if you have not done so yourself.
If you do have a business partner, the answer is also probably straightforward. You would set up a multi-member LLC. Running a multi-member LLC is usually significantly more complicated than a single-member LLC. As you may have deduced, unlike a single-member LLC, a multi-member LLC does file its own tax return. Moreover, it is strongly recommended that multi-member LLCs have operating agreements, detailing the roles, obligations, and contributions of the members. That operating agreement should probably also have detailed "buy-sell" provisions, specifying what happens if one of the members wants to exit the business (something that is a certainty to happen some day). While it may seem like this will be easy to figure out when the time comes, it usually is not. The benefit of all this hassle is that, in the event of a lawsuit, it will likely be considerably easier to prove that the LLC really is separate from its owners than it is for the owner of a single-member LLC.
A more difficult question can arise if your business partner is your spouse. Even if your business partner is your spouse, the IRS still considers that to be a multi-member LLC, and taxes that entity as a partnership, with its own separate tax return. The need for a sophisticated operating agreement, however, is probably less than when the partnership is between unrelated parties, because, unlike unrelated partners, in the worst-case scenario, married couples do have the divorce process to help them figure out who gets what.
I recently made the following video with Ryan Nguyen of Nguyen & Associates , discussing factors for married couples to consider when deciding how to structure their rental property ownership.
The drawback to such LLCs is that, because there is so little administrative hassle involved, it can be difficult to argue that this truly is a business entity, separate from you and worthy of allowing you to shield your personal assets from the LLC's debts. If you have a single member LLC, it is especially important that you go out of your way to handle the LLC's assets separately from your personal assets. When it's just you, it can be easy to use the LLC's bank account for personal expenditures, and vice versa. You must not blur these lines! It may feel silly sometimes, but the optics matter greatly. If, some day, you find yourself asking a judge to honor the LLC and not authorize the collection of its debts from your personal assets, that judge will wonder why he or she should treat the LLC's assets as separate from your own if you have not done so yourself.
If you do have a business partner, the answer is also probably straightforward. You would set up a multi-member LLC. Running a multi-member LLC is usually significantly more complicated than a single-member LLC. As you may have deduced, unlike a single-member LLC, a multi-member LLC does file its own tax return. Moreover, it is strongly recommended that multi-member LLCs have operating agreements, detailing the roles, obligations, and contributions of the members. That operating agreement should probably also have detailed "buy-sell" provisions, specifying what happens if one of the members wants to exit the business (something that is a certainty to happen some day). While it may seem like this will be easy to figure out when the time comes, it usually is not. The benefit of all this hassle is that, in the event of a lawsuit, it will likely be considerably easier to prove that the LLC really is separate from its owners than it is for the owner of a single-member LLC.
A more difficult question can arise if your business partner is your spouse. Even if your business partner is your spouse, the IRS still considers that to be a multi-member LLC, and taxes that entity as a partnership, with its own separate tax return. The need for a sophisticated operating agreement, however, is probably less than when the partnership is between unrelated parties, because, unlike unrelated partners, in the worst-case scenario, married couples do have the divorce process to help them figure out who gets what.
I recently made the following video with Ryan Nguyen of Nguyen & Associates , discussing factors for married couples to consider when deciding how to structure their rental property ownership.
What Next?
If you think it might be time to think through your rental property structure, you can:
- Give us a call at 720-821-7604 to schedule a "Discovery Session" at which we can determine whether our firm would be a good fit for your needs. Or fill out our contact form to have us call you.
- Visit our small business page to learn more about how proactively thinking through your rental property structure can help protect your assets and give you peace of mind.
- Learn more by reading our blog or watching our videos .
I recently had the pleasure of sitting down with Tasha Beckman and Nicole Robalado on the Empowered Elder Podcast to talk about one of the topics I care most about: helping families protect themselves before a crisis forces their hand.  You can watch the full episode below. But I also wanted to highlight a few of the key points we covered, because they come up in our office week after week.
If you've been putting off estate planning — or think you already have it handled — there's a good chance one of these common misconceptions is part of the reason. Earlier this year, I had the privilege of speaking at an event hosted by Jim Smith , a Golden real estate professional who regularly brings together valuable resources for his clients and community. He recently published a summary of that presentation on his blog, and you can read it here and watch the full video here . I wanted to expand on a few of those key points for our own readers.
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