We have many clients who own residential properties that they rent out. We strongly recommend that these properties not be held as a personal asset. No, those residential properties need to be owned by an LLC.
Why an LLC? First of all, an LLC is a business entity that provides the liability protection of a corporation, without all the difficult task of meeting a series of control and management documents. As a separate legal entity (from yourself), it assures Your personal responsibility is limited- the LLC can be held responsible, which means your other assets are protected. Moreover, the LLC is a pass-through entity- that means the net income flows to your personal tax liability. (You also must maintain separate bank accounts fort the LLC from your personal funds!)
While many states do not obligate the managers of an LLC to have an operating agreement, we so require. The agreement outlines the rights, responsibilities, and relationships among members (if there is more than one). Decision-making profit-sharing, and roles are all clearly defined, precluding arguments among the members.
And, if you won multiple properties, they all should be held in separate LLCs, so no one LLC can jeopardize all your holdings.
Now, if you ready to buy a property- remember that you must first establish the LLC. And, be prepared for higher mortgage rates, since businesses pay higher interest rates than do individual mortgagees. Conventional loans, portfolio lenders, even FHA loans can be obtained. (The FHA will only proceed if this is a single member LLC- and it will probably require you to personally guarantee the loan.)
Your LLC must adhere to record-keeping requirements, file annual reports, and maintain separate financial accounts for both the LLC and personal finances. This entails additional administrative efforts and potential costs.
IF you plan to sell the property, you can just change ownership of the LLC to the new owners. That makes the sale a simple transaction.
Feel free to contact us to help you get (and stay) organized. Enjoy your rental business venture!
Good info – thanks for sharing!
Hope it helps you.
Very interesting topic Roy! We are actually toying with the idea of purchasing a small place in the mountains and I know it’s a good area for renting. Not sure if we’ll go that route, but you gave me some good pointers!
Good luck on your venture, Martha,