If you have considered buying a rental property as an investment, you have probably wondered whether you should keep the property as a personal asset or to put the rental into an LLC or a trust.
The common reasons an investor might choose to hold their real estate investments in an LLC or trust are to protect themselves from personal liability, separate their personal assets from the business assets, potential tax benefits, and for the ease of probate after death. While nothing protects a landlord completely, legally or financially, some property owners think an LLC or trust can minimize some of the potential liability.
Either choice is complex, and it is always best to consult with an advisor to look at your own goals to see what makes sense.
Limited Liability Company (LLC)
A Limited Liability Company (LLC) is a business structure that separates the owner's personal assets from the business assets and limits some legal responsibility. The company exists separately from its owner(s) where they can’t be held personally liable for the company’s debts and they limit their loss exposure to their investment in the LLC.
Pros and Cons
With an LLC, it is more likely that the investors' personal liability is minimized because of the separation between personal and business finances the LLC creates. Property owners can create an LLC for each property they own, creating an additional separation between their investments. There is also the potential for tax benefits because of the pass-through taxation that takes place. The LLC’s earnings pass through to the LLC owner’s personal taxes, which can prevent double taxation.
Setting up an LLC can be expensive. While the initial fees might even out over time, preparing for the initial costs is important when considering an LLC. Also, an LLC doesn’t offer complete separation from the owner and the LLC. The owner can still be held legally and financially liable for the rental property in the LLC for negligence and other offenses.
Trusts
There are two main types of trusts for rental properties.
An irrevocable trust is where the grantor, or owner of the rental property, gives up ownership of the property to the trust and names a beneficiary. Once created, the grantor can’t change an irrevocable trust without the permission of the beneficiary. A trustee manages the trust completely, and the grantor has no control. In this type of trust, the assets associated with the rental property are owned by the trust, which can relieve the grantor of tax liabilities.
In a revocable trust the owner still has control of the rental property and can change the trust at any time. Like an irrevocable trust, there is a grantor, trustee who manages the trust, and a beneficiary.
Pros and Cons
Setting up a trust for a rental property can help avoid probate after the owner’s death, making the process easier for their beneficiaries. It can also eliminate estate taxes in some situations. A trust also allows anonymity because the property is owned by the trust, removing the owner’s name from associated records.
Like an LLC, there are set-up costs for creating a trust. Sometimes it can also increase the cost of liability insurance for the rental property. A trust usually has less legal protections than an LLC.
Choosing to keep a rental as a personal asset, or to set up an LLC or trust depends on your own financial goals. Discussing your options with a professional is an important step in setting up the structure of your rental portfolio.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
