Should I form an LLC for my first rental property?

Question

Hello All,

My name is Charquis and I am in the process of purchasing a new home and turning my current home into my "first rental property." I have been told that I should form an LLC before gaining a renter? I am not sure if this is the best option for me financially. I don't make a lot of money, so real estate is my way of trying to secure my future and present. Should I form an LLC (in Baltimore, MD) for my first rental property?

Thanks in advance!

Alan Rohrer · Answer

@Charquis M. and @Tyler Work

Forming an LLC is an asset-protection strategy rather than a tax strategy. Some get liability protection by putting 1 property per LLC (a little excessive depending on their value- just my opinion... but if it helps you sleep better at night, some do it). Some have a limit like $1 million of assets per LLC. Others keep in their personal name and have liability insurance like @Mike S. has mentioned.

Depending on your personal situation, one (or a combo) of these might make sense for you. You will want to talk with an attorney in your city that can answer that question for you.

A few tips:

-Be careful if you ever transfer the home from your name to the LLC (or vice versa), as many mortgages have a due on sale clause that will cause the entire principal to be due upon transfer of the house.

-Do not flip houses in the same entity as you hold/rent. Not only is it not best for liability purposes, but they have significantly different tax treatments and usually benefit from different structures.

-Because an LLC is an asset-protection strategy and not a tax strategy, you won't be able to deduct any more or less expenses. (technically you can deduct the costs of forming the LLC- but that would be the only additional expense you could deduct)

-And finally to @Tyler Work - Your client likely had that issue because they weren't personally guaranteeing the mortgage.

Tyler Work · Answer

All, just curious what the tax benefits from having the home in an LLC are?  I'm guessing there are more expenses you can write off?

I had a client/colleague who recently went to sell their property in Tennessee to buy in Denver.  The property was in an LLC and they wanted to do a 1031 exchange.  They ended up having to get a commercial loan at a higher interest rate than a regular mortgage.  I'm sure there are ways around it but having the home in an LLC created huge problems for this couple when they went to do a 1031.

Mike S. · Answer

Totally unnecessary.  A good insurance policy plus umbrella coverage will more than suffice.

Peter Stewart · Answer

As already stated, first step is to speak with an attorney since there are many legal ramifications for putting your home into an LLC.

You'll find the consensus divided on LLCs for rental properties. And, for those who do them, some do each property as a separate LLC and some group them together or hold them all under one. There are many ways to approach it. Again, this is where you rely on the advice from a local attorney and balance that with your personal situation (ie how risk tolerant are you, what are your goals, etc).

Personally, I put all my properties into individual LLC's. Yes, I am taking a risk for violating the due on sale clause for the ones with mortgages, but it's a calculated risk I'm willing to take. I like keeping everything totally separate/insulated, and I don't want to rely on an insurance policy to save me if something goes wrong.

In IN the fees were super cheap to get it set up. About $100 or so to form the LLC and then under $200 for the title company do to the quitclaim.

Not sure how much the timing matters on when to form the LLC. On a few of mine I transferred them to LLC's after having tenants in place. Again, I'll defer to attorney advice here.

Account Closed · Answer

You need to talk to an attorney or an escrow company on that one. When you put a property into an LLC you are generally violating the Due on Sale clause. That may be a big deal or it may be nothing at all. I happen to think that it is a very small item in the grand scheme of things. You may regard it differently, I don't know. However, putting it into an LLC changes title and you have to ask escrow if that will cause a transfer tax which is very substantial in Maryland.

Raymond King · Answer

@Charquis M. - Thanks for asking this question, it's one that's been weighing on my mind.

@Alan Rohrer - Your post makes perfect sense and really appreciate the time you took to write/explain things. Looks like I'll opt for the insurance when I finally purchase my first property but keep LLC in mind for down the road.

Jojo Olaseha · Answer

HI,

Do you owe a mortgage on the property you want to rent? You may have some difficult putting it in a LLC is the mortgage is currently in your name. If you don't owe a mortgage then you should put it in an LLC. You may h=not have a lot of money but if someone sues you and comes after your personal and business assets you will lose ALOT!!! Contact a title company asap. I suggest Stephen from the Law Office of Matthew J Parr.

Charquis M. · Answer

@Alan Rohrer Thank you so much for your concise and thorough answer! You answered my question exactly!

I am curious as to why is there a liability issue for flipping and buy/hold under the same name?

@Raymond King you are welcome! Glad to know I am not alone in having many questions and concerns. I am going with Liability insurance as well.

Anyone have any recommendations for liability insurers? I have Geico homeowners now, but if there’s better please let me know.

@Dennis M. Thanks for your advice. If the llc will not save me more COCROI the  it’s not worth it to me.

Larry S. · Answer

@Charquis M.The reason that buy and hold properties should be held in a different LLC from a flip is due to taxes on the income received from each type of property.  Income from a buy and hold property is rental income, which has different tax treatment from ordinary income.  Income from a flip (aka your profit) is considered ordinary income and taxed as such.

Should I form an LLC for my first rental property?

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