Why You Should Put Your Rental Property in an LLC

By Michael Safren, Esq.

Owning rental property is a great way to increase your net worth, increase your monthly income, and provide the valuable service of housing to your community, but it is equally important to protect yourself from the liability that may arise from your rental ownership by using a legally recognized entity structure.  While some have acquired rental property intentionally, others became landlords unintentionally, either through turning former residences into rentals as they move up the property ladder, through an inheritance, or through a marriage where both spouses already owned a property and one now become a rental.  

Regardless of how you came to be a landlord, it’s important to make sure that your rental property is working as hard as it can for you, and that your personal assets are protected from any liability that your investment property might expose you to.  Some examples of liability that landlords may face include: injuries to the tenant and their property that occur on your rental property, damage to surrounding properties resulting from known tenant behavior or landlord negligence, claims by lenders and creditors for money lent to the landlord or for the rental property, and torts that a landlord may commit while operating the rental business.

One of the best solutions to protect your assets, limit your liability to creditors, create clear business boundaries for your rental property business, and assist you in the management of your rental property or properties is to create a limited liability company (an LLC) to own and operate your rental property business. 

What is an LLC?

In Washington State, a Limited Liability Company (LLC) is a business structure that offers liability protection for you as the owner and operator of your business.  The law generally holds that an LLC, properly formed, is a separate entity from its members.  That means that if your business has unpaid debts, obligations, or is sued, your personal assets such as your home, your bank account, and future wages are protected from any liability.

What are some of the benefits to putting your rental property in an LLC?

1.  An LLC Limits your Personal Liability to others such as Injured Tenants, Creditors, and Tortfeasors.  The main function of an LLC is to limit the liability of the owners of the entity.  The last thing you want is for a tenant at your rental property to have an issue and try to claim against your personal assets such as your home, your car, your bank account, and your other investments.

It’s extremely important that if you own multiple properties, each property is kept in a separate LLC.  Just the same as you want to protect your personal assets from the liability of your investment property, you also want to protect each property from the liability of any other property.

2.  An LLC Can Avoid “Double-Taxation”.  While other business entities are “double-taxed” meaning that business pays taxes twice - once on both the business profits and again on any money distributed to the owners - an LLC can function as a  “pass-through” entity and avoid this double taxation.  Single-member LLCs (or LLCs owned by a married couple) can  function as “pass-through” entities by the IRS – that is, any income “passes through” the LLC to the owners for tax purposes, without additional or separate taxes paid by the business.  As a result, income and capital gains from the LLC pass through directly to you as the owner and you only pay taxes on the business profits at your marginal tax rate. 

3.  An LLC can Help You to Ensure Clearer and More Accurate Accounting for Your Rental Business.  An LLC must operate as a business separate from the owner’s personal finances. To operate separately, the LLC should obtain EIN, open a business bank account, and do business under the LLC business name.  This separation from your other income and finances enables easier accounting and clear delineation of the revenues, expenses, and profits for your rental business.  It also allows a clearer determination of exactly which expenses are related to your rental business and thus deductible from your tax obligations.  This will be important at tax time because you can deduct both your rental business expenses such as property repairs, maintenance costs, property insurance, and property management costs along with the depreciation of the property itself.

4.  An LLC Allows for You to Protect Your Privacy as the Property Owner.  Property tax records are public in King County so anyone can look up the legal owner of a property.  If you own your rental property through an LLC, only the limited liability company’s name is visible in the public records and your name is shielded from public view, including from any prospective tenants.

5.  An LLC Can Prevent disputes Between Owners.  If you own a rental property with other people, such your parents or siblings or other investors, a well drafted Operating Agreement can prevent conflict between the owners by enumerating and spelling out the rights and responsibilities of the owners and allowing you to pre-determine the  outcomes or resolutions for various situations that might cause conflict between owners.

Items to consider when forming an LLC for your investment property.

The best time to form your LLC is Before You Acquire the Property.  If you are thinking of becoming a property investor, or acquiring a rental property, it is best to form your LLC before you buy the property because issues such as financing, insurance, accounting, operating, and management systems and expenses, and rental agreements should all consistently reflect the name of the LLC.  Making these changes after you start your rental property business becomes more complicated and takes more effort.

However, if you already own investment properties, it is not to late!  You may need to refinance any mortgage you have when you transfer the title of the property into your LLC.  Many lenders consider that transfer as “sale” and if you have a “due on sale” clause in your mortgage or deed of trust, the lender may require that you repay the entire loan at the time of the transfer.  This is called “acceleration of the note.”

If you are considering moving your property into an LLC, talk to your lender to prior to transferring the property into the LLC to find out whether if they will allow the assignment of the Note and Deed of Trust to the LLC or if your lender will instead accelerate the note.  If your lender will not allow an assignment of the Deed of Trust and Note, do not fear, we have contacts with lenders who are willing to work with and lend to LLCs.

You will also need to re-sign leases with your tenants after you have moved your property to an LLC.  The new lease will list the LLC, not you personally, as the landlord.

The Expenses to Create and Maintain your LLC.  The creation of an LLC can take some time and does come with expenses.  The State of Washington charges a fee to register your LLC with the state and you may also need to register your business with the city or county where your property is located.  You will also need to file yearly reports with the State and other jurisdictions.

Do I Need an Attorney to Form my LLC?  Although you can create an LLC on your own, it is important to consult with an experienced business attorney to make sure all the necessary steps are completed to ensure your LLC will work as intended.  The cost of an attorney before you start is much smaller than the cost of needing an attorney to fix any issues that arise later on.

What about an Insurance Policy?  An insurance policy can help cover costs of claims against you, however liability policies typically have limits, exceptions, and carve-outs.  First and foremost, it is likely that your liability policy does not cover liability arising out of renting the property.  Even if you obtain such coverage, those policies again have limits, exemptions, and carve-outs.  If the LLC did not own and operate the property rental business, then you would still be personally responsible for any claims that exceed the policy limit.  Further, certain types of negligence, and intentional torts are generally not covered by insurance policies.

Estate Planning and your LLC.  If you have already completed your personal estate planning and have a Trust, please consult with us about who should be the member of the new LLCs for your investment properties.  Just as the title holder of your house matters for your Trust, so does the member of your LLC.  At The Law Offices of Jenny Ling, PLLC, we are experienced in both comprehensive estate planning as well as real estate and we can ensure your assets and family are protected the way you want it.

Protecting Your Assets

If you already own investment property, or are thinking of buying some, give our office a call to discuss if an LLC is right for you and how best you can protect all you have worked for.

Michael Safren is a Partner at The Law Offices of Jenny Ling, PLLC.  His practice focuses on business, real estate, probate, and civil litigation.