Do I Need Llc For Rental Property – Do it; you have taken all the necessary steps and bought the house you plan to move into. At this point in the process, you may think your work is done, but the reality is that it’s just beginning. With the deed in hand, you will face taxes and other costly challenges. Of course, you’ll start looking for ways to save on those taxes when an LLC may come into existence.
A frequently asked question is “can I put my primary residence in an LLC?” Many people are aware of the benefits of owning real estate in the form of a limited liability company and wonder how to implement it in their own home. Some of these benefits include asset liability protection and significant tax benefits that cannot be overlooked. Why not register your home with an LLC to get all these benefits?
Do I Need Llc For Rental Property
The problem is that an LLC may not be the right choice for the property you currently live in. There are a few caveats to this type of structure that you should be aware of, which is why it’s better to use an LLC for business investment than a primary residence:
Should You Form An Llc For Your Rental Property?
An LLC is one of the easiest ways to organize your business in a way that protects your assets in the event of legal issues. The protection offered by an LLC is similar to that offered by corporations, but it is not really a cooperative entity. An LLC can consist of one person or several people, who are then called the members of the LLC, with management specified in the contract. This LLC can then do business in multiple states, although it must be registered and pay annual registration fees in the state of original registration. Once formed, LLC members can contribute money, property, stock, or services and can borrow money on behalf of the LLC.
There are many reasons why people choose to form an LLC: limited personal liability, less paperwork to oversee, greater management flexibility, and tax benefits, to name a few. In the field of real estate, an LLC can be especially useful. Individual membership LLCs are taxed as sole proprietors, which comes with tax benefits such as lower marginal tax brackets.
Another reason this legal structure is popular with real estate investors is that they can register an LLC for each property they own, preventing mutual liability. Multistate LLC registration is also relatively easy compared to other types of business structures, which is why this structure is used more often by real estate investors. After all, the purpose of an LLC is to legally separate you from your business investments, which doesn’t really apply to your primary residence.
The same characteristics that make an LLC a good idea for real estate investing as a business are the ones that make it bad for your home. There are several good reasons why an LLC is not appropriate for your primary residence. For starters, there are more disadvantages to contend with financially. If your state has a homestead property tax exemption, then putting your home in an LLC will mean you won’t qualify. Currently, the principal residence exemption is $250,000 for an individual and $500,000 for a married couple filing jointly. This exemption only applies if you have lived in the property for two of the last five years.
Forming An Llc For Your Rental Properties
Likewise, forming an LLC around your primary residence can affect the type of financing you’ll be able to get, as well as the amount of down payment you’ll need to put down. If you plan to take out real estate loans under the umbrella of an LLC, you may face difficulties with lenders since this is your primary residence. Because the property is owned by an LLC, you may have to pay higher closing costs on the loan and be responsible for higher interest rates.
The LLC will not only affect your financing in this case, but it will also increase the amount of tax you are liable for. For local property taxes and state income taxes, deductions that would have been available to the sole proprietor are lost. Many local governments do not provide tax relief to corporations and real estate companies. In other words, an LLC does not offer the tax break that most people are looking for when considering placing their personal residence in an LLC.
Additionally, registering an LLC for your home will also increase your insurance costs. That’s because by living in the property, you effectively become a “tenant” of the LLC, which requires you to take out additional insurance or, in the event of an unexpected injury, your property could be at risk.
The tax issues you’ll face when you live in a home owned by an LLC go even further. When your primary residence is subject to an LLC, you lose the capital gains deduction due to changes in property ownership under the IRS.
Setting Up An Llc For Your Small Business/rental Property Is Important And Easy
Perhaps the most serious disadvantage of placing your personal residence in an LLC is related to any loans you may have taken out on the property. Once you register as an LLC and transfer ownership of the property to it, you can trigger the “due on sale” clause found in the loan documents, which will make the entire loan balance immediately payable. Very few investors and property owners have the funds available to settle such a significant balance at once, and this is a real risk if you choose to place your home under this legal structure.
It is also important to note that with home and business assets pooled together under the LLC umbrella, there is no asset protection barrier between them. Any legal issues you face as an LLC will directly affect your home, which is a huge risk to save on taxes.
If the LLC is formed with multiple members, including you, for example if your spouse participated in it and you are not paying rent on your home, this may be self-defense and a breach of fiduciary duty. This leads to the kind of legal liability you cannot afford.
With all this in mind, what is the best thing to use an LLC for? While it is not a good idea to put your personal residence in an LLC, there are certain types of real estate investments that are perfect for this type of legal structure.
Llc Ownership Of Rental Properties: Legal, Tax, And Ownership Transfer Benefits
Limited liability companies are best suited to renovating and flipping properties that have been purchased by investors to renovate and resell for capital gain. These properties were purchased for business purposes only and the investor has no intention of moving into them. This type of legal registration is ideal for flipping homes because the investor’s personal assets are separate from the company’s assets. LLCs are also relatively inexpensive to register and the process can be done online. Another reason this structure is popular is that it is easy to transfer ownership.
Many rental property investors also place their rental properties under the protection of an LLC. Investment property can be a major liability if the owner fails to take the necessary precautions. The benefits of having your investment property covered by LLC liability protection are very similar to the benefits a fix and flip real estate investor can get.
Another alternative with a similar structure is the S Corporation (S-Corp), also used as an asset protection strategy. The main difference between an S-Corp and an LLC lies in the way taxes work: S-Corps are classified differently than LLCs by the IRS. Income generated by an LLC is taxed as personal income, while business expenses in an S-Corps are deductible from the company’s income. An S-Corp can offer the same level of asset protection whether you’re focusing on residential transfers or rental property acquisitions.
If an LLC is not a good option for your home, what can you do to protect it and save on federal taxes?
Should You Create An Llc For Your Rental Property?
A more suitable option for your main residence is to register it with a Qualified Personal Residence Trust (also known as a QPRT). This is a type of trust that removes a personal home from your estate to reduce gift tax when assets are transferred to the trust’s beneficiary. The great thing about this option is that it allows you to stay in the property under the terms of the trust without having to pay rent for it.
By allowing you to remain a resident of the property for a period of time with a ‘retained interest’ in the home, a QPRT reduces your total taxable estate as well as gift liability tax if you choose to leave your home to someone else. You can indicate this in the trust conditions by creating tasks that indicate that the trust conditions have been reached
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