Owning your rental property in a limited liability company (“LLC”) is usually a good idea. It is often better than owning rental property in your individual name because you can limit your individual liability. The following are some of the major pros and cons to owning rental property in an LLC:
Pros:
Limited liability – The rental property will be in the name of your LLC and not your name. Thus, if someone sues you, they will be suing your LLC and not you. Your personal assets will be protected and only the LLC’s assets will be at risk, unless the corporate veil is pierced.
Pass through taxation – The LLC will not have to file a separate tax return, instead, profits or losses will be reported on the owner’s personal income tax.
Easy to transfer property – You can transfer the property by transferring the membership interest in the LLC to someone. Property will still be in name of LLC, but someone else will own the LLC. This way, you can potentially avoid transfer taxes if there is a mortgage on the property and avoid mortgage penalties for transferring property.
Flexible management – LLCs are easy entities to manage compared to other entities. You can create an Operating Agreement, which is a private document that describes the management of the LLC and it can be changed at any time.
Avoid probate – LLC can be set up to avoid probate in Florida by including a transfer on death provision in the Operating Agreement.
Avoid FIRPTA – If you are a foreigner investing in the US in your individual name, you may be required to send up to 15% of your closing proceeds to the IRS when you sell the investment property. The reason is because foreigners do not typically pay tax to the US each year. To avoid FIRPTA, you can form a multi-member LLC to pay taxes in the US. Note that FIRPTA applies to sole-members LLCs, unless your LLC elected to be treated like a corporation or partnership for tax purposes. It is important to consult with an U.S. accountant if you are foreign and you own real estate in the U.S.
Cons:
Fees – LLCs have startup fees and annual fees. The annual fees are potentially $100 a year for a registered agent, if you need one, and $138.75 for the annual report.
Difficulty obtaining a mortgage – Financing a property that is under an LLC can be more expensive. Lenders are often reluctant to lend to entities, thus the interest rate will be higher and might require a higher down payment.
Representation in court – You will need an attorney to pursue evictions because your LLC will need to be represented by an attorney. You could still file an eviction, but if the tenant responds or a hearing is required, you’ll need to hire an attorney. Entities must be represented by an attorney in court proceedings.
Additional tax filing – Although an LLC is treated as a pass-through entity for tax purposes, the LLC must still file an annual tax return. An LLC files a Form 1065 to report the income and expenses that passed through to each member. An LLC also needs to send a Schedule K-1 to each member of the LLC. Schedule K-1 details the net income to each member of the LLC. LLCs do not need to file the Schedule K-1 with the IRS, but the Form 1065 does need to be filed with the IRS.
Self-employment tax – Self-employment tax is a federal tax levied on a self-employed person. It is not the same as federal income tax. It is a separate additional 15.3% tax (12.4% of the tax is for Social Security and the other 2.9% is for Medicare) that business owners pay. Sole proprietors, LLC members, and general partners that are self-employed need to pay the self-employment tax.
Due on sale clause – If your rental property is not yet in an LLC and there is a mortgage on the property, review your mortgage to find out whether it has a due on sale clause. A due on sale clause in a mortgage is triggered when a property is transferred without the consent of the lender. If the due on sale clause is triggered, the entire balance of the mortgage can become due immediately. If you are transferring your property to your LLC, obtain your lender’s consent whether there is a due on sale clause or not.