This is a very common question for owners of rental properties. Of course, like most things in life, there are advantages and disadvantages to consider when deciding whether to form a limited liability company (LLC) to hold your rental property. While I cannot possibly list all of the advantages and disadvantages in this blog post, I will include several of the key considerations.
Most importantly, LLCs provide limited liability for the owner of rental property. In other words, the LLC helps to shield the owner’s personal assets (e.g., other rental properties, primary residence, etc.) from any liability that may arise from the ownership of the rental property. Of course, liability insurance will provide the owner protection to a certain extent; however, the protection an LLC provides is much more comprehensive. For example, liability insurance policies often have certain limitations and exceptions which may expose the owner’s assets to potential liability should the policy not fully cover the liability. In contrast, an LLC does not have any limits or exceptions. Assuming corporate formalities are observed (e.g., personal and business assets are not co-mingled, etc.), an LLC provides strong liability protection for the owner’s other assets; however, it is important to note that the property itself may still be subject to future judgments.
When real estate investors own multiple rental properties, each property is often owned in individual LLCs so the potential liabilities can be limited to the specific asset. By way of example, if the investor owned three rental properties (Property A, Property B, and Property C), it would likely be advantageous to hold each in its own limited liability company. If all three properties were owned by the same LLC and a lawsuit arose relating to Property A, the plaintiff may be able to enforce a judgment on Property B and Property C (assuming it exceeded the insurance policy limitations). In contrast, if Property A was owned by its own LLC, the judgment would only be enforceable against Property A. As you can imagine, this difference can be quite advantageous to the investor if a large liability were to arise.
On the other hand, the use of individual LLCs for rental properties may not be ideal in all situations. Instead, it will require a case-by-case determination due to the potential cash flow of the rental properties. The formation costs for multiple LLCs are not especially high; however, the annual minimum tax in California is currently $800 per year which may bring the financial viability of using individual LLCs into question. As I indicated above, if the rental properties generate a significant amount of revenue, the use of multiple LLCs for limited liability protection is likely a good idea.
If you own rental properties and would like a more comprehensive analysis relating to the use of an LLC or multiple LLCs to hold your investment properties, give one of our experienced real estate attorneys a call today!
Ariel Bedell is an experienced attorney at The Loftin Firm. For questions relating to this blog post or any other California real estate, corporate governance, land use, or estate planning issue, contact Ms. Bedell at 760-814-9649.