Limited liability company (“LLC”)
With an LLC, some of the advantages over an umbrella insurance policy include:
- Limited liability – This is the main reason people choose to own their rental in an LLC. Your personal assets will be protected from liability and only the LLC’s assets will be at risk unless the corporate veil is pierced.
- Avoid probate – LLC can be set up to avoid probate in Florida by including a transfer on death provision in the Operating Agreement.
- 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 avoid transfer taxes if there is a mortgage on the property and avoid mortgage penalties for transferring property.
- Reliability – An LLC can be more reliable than an umbrella insurance policy because an insurance policy can drop you.
Some of the disadvantages of an LLC include:
- 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.
- Court representation – An LLC needs to hire an attorney to represent the LLC in court since an LLC cannot represent itself.
- Tax – 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.
Umbrella insurance policy
With an umbrella insurance policy, some of the advantages over an LLC include:
- No piercing the corporate veil issues – Protection from whatever your umbrella insurance policy covers up to a dollar amount identified in your policy. You do not have to be worried about your assets being at risk if the corporate veil of an LLC is pierced.
- Value – An umbrella insurance policy could exceed the value of the property.
Some of the disadvantages of an umbrella insurance include:
- Policy limitations – You are limited to what your umbrella insurance policy covers.
- Exceptions – There may be exceptions in your policy that cause the policy not to cover you when you end up needing it.
- Amendments – The policy might be amended and the amendments could convolute the insurance coverage.
Overall, I generally recommend LLCs over umbrella insurance policies if a client must choose one or the other because LLCs are more reliable. There is not as much fine print with an LLC, and your liability is limited if you are not behaving in a way that can cause the corporate veil to be pierced. However, you can purchase both an LLC and umbrella insurance if you want extra protection. Depending on your situation, it might make sense to have both.