This biweekly sponsored column is written by the experts at Gordon James Realty, a local property management firm that specializes in residential real estate, commercial real estate and homeowner associations. Please submit any questions in the comments section or via email.
The formation of a Limited Liability Company (LLC) entity can be extremely useful if you are a rental property owner. It allows you to protect your assets, gain tax benefits for your rental property, and manage any property ownership transfers in a more convenient way. This article explores the legal, tax and property transfer benefits of holding your property in an LLC, rather than keeping it under your name.
If you elect to form an LLC and transfer your rental property to the LLC, any judgment against the property will extend only to the LLC and not to your personal assets. In essence, the LLC offers you liability protection against a lawsuit or against creditors who might seek to make claims on your assets. It is also generally recommended that you place each rental property you own in a separate LLC. This provides additional assurance that any judgment against one property will not affect the other properties. Moreover, in many states, creditors can seize a property if it is owned in your name. If it is in an LLC, however, creditors may be limited to placing a lien on your property. Although types of liens vary, a lien may allow a creditor to claim any cash distributions from the LLC to its owners, and may also entitle the creditor to have the right to any proceeds from the sale of the property. In D.C., for example, a judgment lien can be attached to your rental property for up to 12 years. Other liens, which may be attached to the property, will impact a creditor’s ability to collect funds under a judgment lien. Creditor-debtor laws do vary by jurisdiction, and you should research your state’s regulations to understand the rights and obligations that debtors and creditors have under the law.
You can further protect yourself by adding a liability insurance policy for each property, as well as purchasing an umbrella policy to provide additional liability coverage beyond the limits of your primary insurance policies. Placing your rental properties in an LLC and buying additional insurance for them offers you a double layer of protection in the event of a lawsuit.
An LLC can be taxed as a sole proprietorship, a partnership, a C corporation or an S corporation. For rental property ownership purposes, it is best that an LLC is taxed as a sole proprietorship or a partnership. This is because any income will flow through to the individual members of the LLC and it will be reflected on their tax returns. In this case, the company will not have to pay any federal income tax and its owners can take advantage of tax deductions for the rental properties held in the LLC. You would be eligible for the real estate depreciation deduction, but will also have to pay capital gains taxes when you sell the property. However, there are options to defer capital gains taxes, such as a 1031 exchange, if you sell one property and reinvest the sale proceeds into another property of like-kind within a specified time period.
Property Ownership Transfer Benefits
When you transfer your rental property into an LLC, you can create units of ownership with a specific value and allocate them to any other members of the LLC. This offers an easy way for you to designate ownership in the property to other family members, rather than updating property deeds to reflect changing ownership interests. Ownership interests can also qualify for several valuation discounts, depending on the structure of the LLC, the terms of its operating agreement, and the division of ownership interests among its members. Since these valuation discounts can reduce the overall value at which ownership interests are valued, they can have a significant impact on gift taxes and estate taxes when interests in the property are transferred between LLC members.
For more information about the benefits of placing your property in an LLC, see the following: