Helping You Make Informed Choices for Your Real Estate
What is an LLC?
LLC is a business term short for Limited Liability Corporation, which is one of the business structures that protect owners from losing their personal assets to lawsuits and debts. An LLC combines the peculiarities of a partnership and a corporation. Registering a business as an LLC is one of the easiest routes in the United States.
People may prefer registering their businesses as LLCs because of flexible taxation, limited liability, fewer compliance regulations, etc. There are some essential disadvantages for real estate investors, corporations, and other categories of people who want to register their rental properties as LLCs. Here are some reasons why using an LLC for rental properties might not be a great choice.
Disadvantages of using LLC for Rental Property
While using an LLC might be beneficial for rental properties, it is crucial to consider some of its disadvantages.
Purchasing and registering your rental property as an LLC real estate can be challenging financially, making it a vital factor to consider. The cost of creating an LLC can be tough, particularly for sole investors or those with a restricted budget. LLCs need ongoing maintenance, which attracts administrative expenses that can affect the property’s profitability.
When some lenders want to offer financing for rental properties, they might demand higher down payments because of the risks associated with an LLC. One such risk could be when a borrower, in a single-family, defaults on the loan repayment. The lender might find themselves in a difficult situation because the LLC protects the borrower’s personal properties, making it impossible for the lender to seize anything worthwhile.
Transferring an Already-owned Property is Tedious
If you want to transfer your property into an LLC, it might be challenging due to various administrative issues. It might be more difficult if there is an open mortgage on it. When you want to transfer property ownership to an LLC, it is a former transfer, which might reduce your interest rates. It may also attract transfer taxes and reassessment of property taxes.
The transfer process involves legal documentation and paperwork that might consume time and effort, thereby needing professional help, which will incur additional costs.
Keeping Money Together Can Cause Tax Problems
Some property owners are unaware that keeping personal and business money together comes with disadvantages in the long run. Keeping personal and business funds together might weaken the personal liability protection that LLC ownership provides. You might risk losing your personal assets because the LLC wasn’t handled as a distinct legal entity.
Putting business and personal funds together can make monitoring and tracking expenses and income for tax purposes difficult. This can lead to tax complications, making you miss out on benefits custom-made for LLCs.
Uncertain Asset Protection
When there is no clear asset protection, you might risk losing your assets when there is a lawsuit from the rental property. This means that the essence of using an LLC is to protect your wealth from business-related hazards.
Uncertain asset protection can also cause legal disputes because proving that the LLC is a legitimate and dissociated entity will be hard; this can affect relationships with partners, lenders, etc. Maintaining a clear distinction between LLC and personal finances is advisable through proper documentation and following all legal requirements.
Alternatives to consider instead of an LLC for your Rental Property
An LLC is not the only business model option if you want to manage rental properties. Even though there are no alternatives with the same offering as an LLC, you can consider other options that might be more beneficial.
A sole proprietorship is a one-person business without legal distinction between the owner and the business. Setting up a sole proprietorship is less expensive and complex than creating an LLC.
The sole proprietorship formation process involves less paperwork and bureaucracies, which makes it more attractive for small and mid-scale rental property owners. If you don't have much renting, or your insurance caters to liability concerns, a sole proprietorship might be great.
Real Estate Trust
A real estate trust, called a realty trust, enables several owners to invest in the same property. Using this business model instead of an LLC is suitable for passing on your rental prosperties. You can indicate who you want to transfer your properties to. Since several owners have a stake in the same property, a real estate trust can ensure they get the full proportion of what they own.
An S Corporation is a business model that enables businesses to avoid double taxation using the pass-through taxation method. The shareholders in the corporation report the organization’s income on their individual tax returns, preventing the company from being taxed in the federal sphere. This business structure is more suitable for multiple people than an LLC because there is a clear chain of command.
A C corporation is a business entity commonly used by bigger organizations and retailers. They are often subject to double taxation, making them more expensive than other business models. A C corporation is a better alternative than LLC for rental properties because of its reduced audit risk.
Other business models like sole proprietorships and LLCs have a higher audit prospect because they are managed by property owners who have their records. A C corporation also comes with more protection for personal assets than an LLC.
While there are attractive rental property pros when using an LLC, it is important to consider the prospective downsides. If you don’t have access to sufficient funds initially, an LLC might not be the best choice because it is expensive to create and maintain. You can engage the services of a professional to assist with due diligence while considering the alternatives to an LLC.