April 11, 2023

Do I Need An LLC for My Rental Property? Top Factors to Consider

While there are benefits and downsides, forming an LLC for your rental properties can be a powerful way to protect your personal assets.

Do I Need An LLC for My Rental Property? Top Factors to Consider

As a rental property owner, you may wonder: Do I need an LLC for my real estate business? 

Of course, the answer will depend on your specific circumstances — but on the whole, having an LLC can be a powerful form of legal and financial protection for landlords. 

Whether you own one rental property or many, real estate investors may want to consider forming an LLC. Read on to discover who should form an LLC, as well as some of the entity’s key advantages and important factors to consider.

What is an LLC?

By definition, a limited liability corporation (LLC) is a separate and distinct legal entity — meaning your personal assets are separated and protected from potential lawsuits. LLCs were first introduced in 1977 and have become increasingly popular since then.

Since LLCs are regulated at the state level, the process for creating an LLC will differ depending on your location. However, a few considerations apply to every landlord, regardless of geography. 

Who should create an LLC?

There are a few key scenarios in which creating an LLC may be beneficial when it comes to owning rental properties. As mentioned earlier, if you own one or more rental properties, an LLC will provide a layer of protection between your personal assets and any potential lawsuits or liabilities related to your rentals.

Additionally, if you have business partners or investors involved in your rental property business, forming an LLC can help establish clear roles and responsibilities and provide a structured way to distribute profits and losses.

Finally, if you plan to use your rental properties as a long-term investment strategy, creating an LLC can help you manage and grow your portfolio in a more organized and streamlined way.

Ultimately, the decision to create an LLC will depend on your unique circumstances and goals. It may be helpful to seek advice from a lawyer or financial advisor to determine the best action for your situation.

Benefits of LLCs for real estate investors

By forming a landlord LLC, real estate investors get significant protections and advantages — including personal asset protection and built-in tax benefits. 

1. Personal asset protection

Operating a rental property business as a sole proprietor comes with inherent risk. If you don't have an LLC, there's no separation between your rental and personal income. That means if the property is in your name and a tenant, vendor, or other entity decides to sue you, they can go after your personal assets. 

An LLC mitigates this risk by making your real estate business a separate and distinct entity. Your personal assets are much more protected if you run into a legal issue and your rental business is under your LLC. 

2. Built-in tax benefits

Legal provider Nolo notes that an LLC is not a separate tax entity like a corporation; instead, it is what the IRS calls a "pass-through entity." Your rental income and losses "pass-through" the business to the LLC owners, who report that information on their personal tax returns. According to FortuneBuilders, this structure often results in lower tax rates for the rental property and business owner. But while LLCs are not taxed directly at a federal level, some states do require annual LLC taxes.

3. Establishing a business profile

By creating an LLC for their rental property business, you can build a business profile and credit history separate from your personal profile. As your business grows, this will help you qualify for non-recourse lending (i.e., a loan secured by collateral, but you're not personally liable), which allows you to minimize risk to your personal assets and finances. 

4. Flexibility in management

An LLC allows for greater flexibility in management, as it can be managed by its members or a designated manager. This can benefit rental property owners who want to maintain control over their business but also want to delegate responsibilities to others. Additionally, an LLC can have unlimited members, which provides more options for ownership and investment.

5. Transferability of ownership

An LLC provides greater flexibility in transferring ownership of the rental property. Ownership interests in an LLC can be sold or transferred to others without requiring the LLC to dissolve or restructure. This can be advantageous for rental property owners who want to sell or transfer ownership to others without disrupting the rental business' operations or requiring a complicated legal process.

Potential downsides of forming an LLC

Now that you know the benefits, here are a couple of important factors to consider when evaluating whether to form a landlord LLC for your rental properties.

1. Increased paperwork and administrative tasks

Setting up an LLC requires filing paperwork with the state, obtaining an Employer Identification Number (EIN), and creating an operating agreement. LLC owners must also keep detailed records of finances and business activities, including property expenses and rental income. This can be time-consuming and may require hiring a professional to handle the paperwork and ongoing administrative tasks, adding to the cost of forming and maintaining an LLC.

2. It can be costly depending on your location

On average, the annual LLC tax is $91. But that amount and the filing fees vary vastly depending on where you operate your business. For example, forming an LLC in California costs only a one-time $70 fee, but California LLCs that make $250,000 or less must pay an annual tax of $800 — and California LLCs that make more than $250,000 must pay additional fees ranging from $900 to $11,790 per year (depending on the LLC’s annual income).

On the other end of the spectrum, Arizona LLCs have no annual tax and, depending on the method you choose to initially file it, range from $50-$80.

When considering LLC formation, research your state's tax policies to see which rules and fees apply to your rental business. 

3. Commingling has serious consequences

As a real estate investor, it's essential to keep your personal income and expenses separate from your LLC income and expenses — otherwise, you could risk losing the liability protection entirely. 

Each LLC requires a separate business bank account to avoid commingling, so you’ll need to make sure you’re not depositing rental income into your personal account or using business assets to pay for personal expenses. To that end, Azibo makes it easy to open a separate bank account for your rental business, with features designed for landlords and a 1% cash-back debit card to allow you to easily manage your real estate finances and avoid commingling.

4. LLCs require ongoing maintenance

Once you form your LLC, your work is not done. Most states require periodic renewals, fees, and maintenance to keep your property management entity in good standing and continue your personal liability protection. These tasks are not usually complicated — for example, California LLC owners must file a statement of information form every other year, and pay a franchise tax annually. LLC owners must also keep up-to-date records of key documents their state requires, including Articles of Organization, Statement of Information, or Operating Agreements. 

While these tasks are not usually complicated, forgetting to stay on top of them has serious consequences — from late fees and penalties to suspension of your LLC, which eliminates your protection. 

5. Limited flexibility in tax classification

While LLCs offer pass-through taxation, they may not be the best option for all rental property owners. Depending on the number of owners and other factors, an LLC may be required to file taxes as a corporation rather than a pass-through entity. This can result in higher tax rates and more complicated tax filing requirements.

Additionally, LLCs may not be eligible for certain tax benefits available to other business structures, such as S-corporations or partnerships.

How to set up a landlord LLC

If you’re interested in forming a landlord LLC, there are a few different ways to get started.

On the one hand, you can take a DIY approach and form an LLC through Rocket Lawyer or LawDepot — a relatively affordable option for landlords with simple real estate portfolios who don't mind doing some of the work themselves. 

Alternatively, you could hire a lawyer to handle the LLC formation from beginning to end. Of course, this option will be a bit more costly — while LLC setup software may cost a couple of hundred dollars, business lawyers are estimated to charge between $1,000 and $1,500 for LLC formation services.

Get additional protection from landlord insurance

Outside of LLCs, there are other ways to help limit your personal liability as a rental property owner. 

One strategy is landlord insurance, which is often required by mortgage lenders and specifically designed to protect your rental property owners — this way, you won't have to pay out of pocket if something bad happens, such as property damage or injury. Umbrella insurance policies also add an extra layer of protection, covering a range of liabilities, including fire damage, flooding, and vandalism. Not sure which insurance carrier to contact? Get a free quote from top carriers through Azibo Insurance Services

It's important to note that landlord insurance and umbrella policies may not always be enough to protect your assets. Insurers can lower coverage, deny claims, or cancel policies — so forming an LLC and taking out a landlord insurance policy is still a good idea.

Grow your rental property business with Azibo

Whether you’re already operating as an LLC or exploring the steps for incorporation, Azibo is here to help you manage your rental property finances and grow your portfolio. Sign up for our free, all-in-one property management platform today to access tools for rent collection, accounting, tenant screening, insurance policies, and more.

You can sign up for Azibo as a sole proprietorship, single-owner LLC, or single-member corporation. Landlords operating under an LLC can select whether to invite tenants using their legal name or LLC name. 

Looking for more ways to improve your rental business operations? Check out the “Protecting Your Real Estate Assets” chapter in our free Real Estate Investor's Guide for actionable tips from industry and legal experts. 

LLC for rental properties FAQs

Do I need a separate LLC for each rental property?

One common question is whether landlords must set up a separate LLC for each property versus one for their entire portfolio. 

There's no wrong answer here — but your decision will depend on your risk tolerance. Setting up one entity per property offers the highest level of protection because when you bundle properties together into one LLC, you're exposing one property's profits to another's potential liabilities. 

That said, each LLC comes with costs, so work with your CPA and potentially a real estate lawyer to figure out what makes sense for your business.

How to report income from an LLC

Reporting income for a landlord LLC involves following specific tax rules and regulations.

Generally, rental income generated by the LLC is reported on the owner's individual tax return using Schedule E. The LLC does not pay taxes on rental income, as it is considered a pass-through entity where the profits and losses flow through to the owners' personal tax returns.

However, the LLC must still file an annual tax return with the IRS, which reports the LLC's income and expenses. It is essential to keep clear and accurate records of all income and expenses related to the rental property and to maintain a separate bank account for the LLC to facilitate tax reporting and compliance.

Additionally, state and local tax rules may vary, so it is advisable to seek advice from a tax professional for guidance on reporting income.

Adding properties to an LLC after the fact

Adding properties to an LLC after it was created is common for landlords expanding their rental property portfolio.

The process of adding a property to an existing LLC typically involves amending the operating agreement and filing the appropriate paperwork with the state. It's important to note that adding properties after it has been formed does not change the tax classification of the LLC. If the LLC is a single member, the owner must report the income and expenses of the new property on their personal tax return.

If the LLC is a multi-member LLC, the members' income and expenses must be allocated according to their ownership percentages. Additionally, adding properties to an LLC may impact liability insurance coverage, so reviewing and updating the insurance policy is important.

What are the main differences between an LLC and an S corporation?

An LLC is a business structure different from an S Corporation, which is a tax classification available to small businesses.

Unlike S Corporations, LLCs have more flexibility when it comes to choosing their shareholders or owners. S Corporations are more restrictive in this aspect. Another key difference is that S Corporations must pay a salary to owners who own more than 2% of the company and work for it, while LLCs are not obligated to pay their members or owners a salary.

Streamline Your Rental Business with Azibo Accounting!

Get real-time insights, painless transaction management, and effortless tax prep.

Click 'Request a Demo' to experience compliant accounting built for landlords.

Request a demo