LLC vs. Trust for Real Estate: Which Is Right for You?

Selecting the right legal structure for your real estate investments has significant implications for your business. Two popular options for real estate investors are forming a limited liability company (LLC) or establishing a trust.

Both LLCs and trusts offer distinct advantages and disadvantages, and the right choice depends on your specific goals, long-term plans, and risk tolerance. Key decision factors you should consider include asset protection, tax minimization, and ease of management.

In this article, we'll take a closer look at LLCs and trusts, examining their characteristics, benefits, and drawbacks. Once you have the details of each structure, you can make decisions that match your investment strategy and objectives.

Creating an LLC for your rental property

An LLC (limited liability company) is a separate business formed under the law of the state in which your rental property resides.

When you create an LLC for your rental property, the LLC becomes the legal owner of that property instead of you personally. This separation between your personal assets and your business assets is a key benefit of an LLC structure.

Two main types of LLCs for rental property include:

• Single-member LLCs: Have only one owner, also known as a member. This is a common choice for individual real estate investors.
• Multi-member LLCs: Two or more members form this LLC. This structure is suitable for partnerships or groups of investors who want to own rental properties together.

Before deciding to use an LLC for your investment properties, consider both the pros and cons. An LLC offers benefits like personal asset protection and flexible ownership, but it also has potential drawbacks that you should be aware of.

Advantages of an LLC

• Separate legal entity: Provides a shield between personal assets and potential liabilities related to the rental business.
• Flexible ownership structure: Allows for single or multiple owners, including individuals, corporations, and other entities, and is adaptable for various investment strategies.
• Pass-through taxation: Avoids double taxation and lets members report income and losses on their personal tax returns.
• Transferable ownership: Enables members to buy and sell ownership shares without necessarily selling the rental properties, providing flexibility in managing investments.
• Capital contribution options: Permits members to contribute equity capital or provide debt financing through loans to the business.
• Limited personal liability: Protects members' personal assets from potential legal liability related to the rental business, provided necessary formalities are followed.

Disadvantages of an LLC

• Compliance obligations: State requirements for annual filings, meetings, record keeping, and fees can be burdensome.
• Additional self-employment taxes: Members must pay a 15.3% self-employment tax on rental income in addition to regular income taxes.
• Potential loss of liability protection: Participating in illegal activities can result in the removal of personal asset protection.
• Ownership transfer complications: Some states require dissolving and re-forming the LLC when membership changes occur.
• Limited capital raising options: LLCs may face challenges in raising substantial outside capital compared to corporations that can sell public stock.

Establishing a real estate trust for your investment property

A real estate trust is a legal arrangement set up at the state level to hold rental property assets. It's different from an LLC, because it's not a business entity.

People commonly use trusts for estate planning purposes to avoid estate taxes, keep rental properties within the family, and to bypass the probate process.

There are two main types of trusts you can use for rental property:

1. Revocable trust: This type of trust lets the original property owner (grantor) make changes, control and manage the trust assets directly, and end the trust during their lifetime. After the grantor's death, it becomes irrevocable.
2. Irrevocable trust: In this arrangement, the grantor transfers ownership of rental properties into the trust, which a trustee manages according to the trust instructions. The grantor gives up control over the assets.

Before choosing a real estate trust for your rental properties, consider the advantages and disadvantages to determine if it's the right fit for your needs.

Advantages of a real estate trust

• No recurring fees: Unlike LLCs, which require annual fees and filings, trusts don't have ongoing costs once set up.
• Estate planning: Helps rental property investors avoid estate taxes, smoothly transfer business assets to heirs, and avoid probate.
• Multiple owners: Trusts offer a way for multiple owners of a rental property to document and manage their ownership interests.
• Asset separation: A trust does not consider assets as part of the grantor's personal holdings, which reduces individual tax liability.
• Privacy: Provides more privacy than publicly-recorded LLC ownership details. However, new government regulations are making this harder.

Disadvantages of a real estate trust

• Limited liability protection: A trust doesn't inherently shield the trustee or beneficiaries from liabilities related to the rental business.
• Upfront complexity: Setting up a trust can be more complex and costly than an LLC, so legal assistance is often necessary.
• Rigid structure: It's more difficult to make changes to a trust's structure compared to an LLC's operating agreement.
• Separate estate planning required: Even with a rental property trust, you'll likely still need a will or other estate documents for assets not held in the trust.

Factors to consider when deciding between options

Now that you understand the basics of LLCs and trusts for rental properties, it's time to determine which structure best aligns with your goals and needs. Consider the following factors to guide your decision-making process:

Assess your asset protection needs

• How much risk are you willing to take on?
• Do you have significant personal assets to protect?
• Consider the potential liabilities associated with your rental property.

Evaluate your estate planning goals

• Do you want to pass your rental properties to heirs efficiently?
• Are you looking to minimize estate taxes?
• Consider how you want your assets managed after your death.

Determine the current and future scale of your rental portfolio

• Are you planning to acquire more properties over time?
• Do you need flexibility in managing ownership interests?
• Consider the complexity of your investment strategy.

Assess the potential benefits of combining an LLC and a trust

• Would you benefit from the liability protection of an LLC and the estate planning advantages of a trust?
• Consider the added complexity and costs of maintaining both structures.
• Evaluate if using both an LLC and a trust aligns with your long-term goals.

Real estate trust vs LLC: Making the right choice

Choosing between an LLC or a trust for your real estate investments requires consideration of your specific goals, willingness to take risks, and investment approach.

While LLCs offer strong protection from liabilities and flexibility in operations, trusts can provide additional safeguards for your assets, benefits for estate planning, and potential tax advantages.

The best structure will depend on your unique situation and priorities. Ask for advice from a legal, tax, or financial advisor who can assess your situation and provide guidance to help you make the best decision.

Should rental property be in an LLC or a trust? FAQs

What is the best type of trust for real estate?

For real estate ownership, a revocable living trust is often considered the best option. It lets you keep control of the property while you're alive and passes ownership to your beneficiaries after you die without needing probate.

What type of entity is a trust?

A trust is a legal arrangement, not a separate business entity.

What is the difference between a trust and a sole proprietorship?

A trust is a legal setup where a trustee manages assets for the beneficiaries' benefit. A sole proprietorship is a business structure where one person owns and runs the business, with no legal separation between them and the business.