A Limited Liability Company (LLC) is a type of business entity that limits the personal liability of the owners. When clients own rental property in their individual name, or are considering purchasing rental property, we advise them to create an LLC to own the property instead. An LLC does exactly what its name suggests, it limits the client’s liability to the asset owned by the LLC. An LLC acts to separate the assets owned by the LLC from the client’s other assets.
To illustrate: If someone injures themself on your rental property, that person can sue you for amounts above your liability insurance coverage, putting your personal assets, including your home, in jeopardy. But, if the property is in an LLC, your liability is limited to the assets owned by the LLC, insulating your personal assets from lawsuits.
If you own more than one rental property, it is beneficial to have separate LLCs for each property, limiting the liability for each property. It is important to follow all formalities to avoid an attack of the LLC in a future lawsuit. Any lease should name the LLC as the Lessor, rent should be payable to the LLC, and a separate bank account maintained.
Besides limiting personal liability, an LLC is the simplest business structure to form and maintain. The owners of an LLC are called members. An LLC in New York State can contain several members or only a single member. The LLC can managed by the members or appoint managers to take care of the day to day business. While an LLC is easy to create, there are initial fees for the creation that can be significant – especially the notice of publication. New York State also requires LLCs to have an operating agreement. An operating agreement should be prepared by an attorney and executed by the members, especially when there is more than one LLC member.
A major benefit of an LLC is that it is a pass-through entity for purposes of income taxation. This means that any income or loss gets reported on the individual members’ personal income tax returns. The LLC elects to be a sole proprietorship or a partnership. Either method is less complex and time consuming than maintaining a corporation. Moreover, an LLC avoids the corporation pitfalls of double taxation.
Another consideration when placing real estate in an LLC is whether there is a mortgage. If you own the property outright and wish to transfer it to an LLC, a deed transfer is all that is necessary. However, if you need financing to buy the rental property, the lender may have additional requirements to place the property in an LLC. Likewise, you will want to check with your lender if you want to transfer your existing mortgaged property to an LLC.
As always, it is best to discuss the creation of an LLC with an experienced attorney. An attorney is not only invaluable in helping you choose the right choice of entity to hold your income producing property, but can put together a solid business succession plan.