How to reduce your liability as a landlord? Here is the number one thing you can do to protect yourself..
Consider creating an LLC. In fact, you may wish to create not one but TWO LLCs. An asset LLC and a management company LLC. An LLC, or limited liability company, is a business structure that offers various benefits for Orange County rental property owners.
Here’s a summary of its advantages and how to create one:
- Liability Protection: How to reduce your liability as a landlord? By forming an LLC, you shield your personal assets from lawsuits related to your rental property. Only the assets owned by the LLC are at risk.
If you are sued because someone is injured on your rental property, including a guest of the tenant, then your personal assets are not necessarily protected as an individual landlord. Regardless of how small or insignificant the lawsuit may seem, it can be a costly process to defend your assets. If you put your rental properties in an LLC, you will still have to pay for the cost of for an attorney should you be involved in a lawsuit; however, because the LLC is acting as the landlord, your personal assets are protected. The party that is suing may only go after the assets held in the LLC. - Separation of Properties: Creating separate LLCs for each rental property further protects your assets. If one property faces legal issues, the others remain unaffected.
- Tax Benefits: One of the major advantages of using a limited liability company for your rental property is pass-through taxation. This means that the LLC does not pay taxes; the business owner pays the taxes, thus eliminating the double taxation that occurs if you were to form a corporation instead. If you are the sole member of your LLC, you will be taxed similarly to a sole proprietorship while enjoying the additional benefit of liability protection.
- Financial Organization: Establishing an LLC enables clear separation of business and personal expenses, simplifying tax filings. One of the major benefits of having your property owned by an LLC is that you will be able to take certain deductions on your taxes that you otherwise would not be eligible for. Additionally, if you run your company out of a home office, you may even be eligible for other additional deductions, such as utilities, repairs and maintenance, or dwelling insurance costs.
Who Should Consider an LLC to reduce their liability?
Any landlord, regardless of the number of properties owned, can benefit from the liability protection and tax advantages offered by an LLC.
When to Create an LLC for your rental property?
It’s advisable to form an LLC before purchasing a property to avoid complications with mortgages, tenant notifications, and taxes. If you already own property and are looking to add it to an LLC, check with a corporate lawyer to see if and how this might work for you.
Before leasing the property you may wish to consider create a separate LLC or corporation for the management company. This means that the tenant will sign a contract with the management company rather than the asset holding LLC. This might offer an extra layer of protection for your assets. Talk to an attorney about this option!
How to Create an LLC:
- Check with your lender about transferring title to the LLC.
- Choose an available business name and fill out Articles of Organization.
- Work with a corporate attorney to draft an LLC Operating Agreement outlining member rights and responsibilities.
- Fulfill state-specific requirements and register the LLC.
- Transfer property ownership to the LLC using a Quit Claim Deed.
- Set up a separate bank account for the LLC and update rental leases accordingly.
It is highly recommended that you do all of this well before you actually enter escrow. That way you will be ready to make your purchase once you make an offer. If you wait until after you make an offer you will have to rush to incorporate within the standard 17 day assignment period.
Costs of Creating and Maintaining an LLC:
Formation costs vary by state and may include filing fees and publication expenses. Ongoing costs may include annual franchise taxes and state fees. Some decide to create their LLCs in different states for tax reasons. Speak with your corporate attorney and CPA about how the LLC will affect your taxes and annual expenses.
Naming Your LLC
If you would like to own an LLC to reduce your liability as a landlord with this hack, you can choose any available name for your LLC. There are two benefits of naming your LLC this way. For one, it’s easily recognizable to your tenants. Second, it’s likely a unique address in your city or county, meaning you’ll be able to register it without a problem. Naming conventions typically include the property address for easy recognition and uniqueness. However, I have seen clients come with creative names for their LLCs as well.
How to reduce your liability as a landlord with an LLC.. pros and cons:
- Pros: Personal liability protection, property separation, pass-through taxation, and financial clarity.
- Cons: Additional paperwork, potential mortgage complications, and annual filing costs.
Comparison with Umbrella Policies
While umbrella insurance policies offer some protection, they have coverage limits. An LLC provides more comprehensive asset protection during legal proceedings.
Some people may prefer to use liability insurance for their business, rather than an LLC, for protection. While this is a great starting point in protecting your liability as a business owner, it does not provide the same level of protection as an LLC. Liability insurance has some disadvantages and limitations, including, but not limited to, the following:
- Policy limitations
- Exceptions
- Addendums that might convolute the insurance coverage
- Additional insurance which might be required, such as hurricane insurance
In conclusion, despite the added paperwork and costs, forming an LLC can offer significant benefits and protection for landlords, making it a worthwhile consideration for rental property owners. This blog post is not legal advice and is for general educational purposes only. If you would like to reduce your liability as a landlord with this hack, speak with a corporate attorney and accountant before making any decisions.