From the period of June 2020 to June 2021, property values reportedly increased by over 30%, according to real estate marketplace website Zillow. With those kinds of returns, some have decided to try their fortunes investing in single and multi-family home properties. While investing in real estate has its positives and negatives (the discussion of which we will leave for another day), for those that have determined that investing in property is the right choice for them, many then ask: should I form an LLC for my rental property?

Why an LLC?

The most common entities filed with the Texas Secretary of State are limited liability companies, commonly referred to as LLC’s. LLCs are relatively straightforward, offer liability protection to the members, and offer certain flexibility in terms of taxes. As they relate to investment properties, forming an LLC and running your rental property business through the entity has its benefits. Having an LLC for the rental property insulates the members of the LLC from personal liability, so for example, if someone slips and falls or suffers some other form of injury on the property, the personal assets of the members would be protected in a lawsuit. In short, a limited liability company insulates the member(s) from the liabilities of the company. That being said, the LLC should always maintain adequate liability insurance for the property.

In terms of taxes, an LLC allows you the flexibility to elect the classification with which it will be taxed, be it as a corporation, a partnership, or a disregarded entity. If pass-through taxation is elected, the company does not have to file a separate tax return, as profits and losses will be reported on the owner(s) personal income taxes, thus eliminating double taxation. Depending on your financial plans, we highly recommend consulting with a CPA as to which election would be most beneficial/appropriate for your situation.

So What’s the Catch?

While there are advantages to establishing an LLC for your rental property, there are important considerations that must be taken into account when determining if this is the right course of action.

There are costs associated with the formation of an LLC including a filing fee with the Secretary of State as well as yearly administrative tasks and filings that must be timely submitted in order to maintain LLC’s active status.

Additionally, in order to maintain the liability protection afforded by an LLC, it is essential that the LLC have its own bank account, and all leases/contracts be in the name of the LLC and any and all transactions take place with the entity acting demonstrably separate from its member(s) in order to maintain the corporate veil. What this means practically is a bit more work from the member’s perspective, and a bit more paperwork to ensure the company is being run appropriately.

Also worth noting is that while an LLC may apply for a loan, unless the company has a long financial track record, more than likely the loan will have to be personally guaranteed. Some banks may offer higher interest rates if the loan will be made to a company instead of an individual. While it is possible to purchase the property and then deed it to the LLC, it is important to review the loan documents and ensure that doing so would not constitute a default and be cause for the acceleration of the loan. Additionally, it is important to make sure that the formation and governance documents of the LLC are tailored to the ownership and leasing of rental properties. Some cookie-cutter online formation services often times use generic documents that may not coincide with how one intends to run their business, or may even require the signatures of all members for even the most mundane transactions.

Can I have multiple rental properties in a single LLC?

While the number of properties owned by an LLC are unlimited, it is typically not advisable to have more than a single property per LLC, the reason being that you do not want your property at 123 Avenue B to be subject to liability for a slip and fall or unpaid contractor at 321 Number Street. In the event that multiple rental properties are in your budget, it is recommended to form multiple LLCs for the peace of mind. Of course, each LLC then comes with its own paperwork, bank account, etc.

Ultimately, the decision of whether or not to form a limited liability company is one that must be considered carefully. While the liability protections are very advantageous, someone unwilling or unable to complete the additional administrative tasks and properly run the business as its own separate unit from the owner may end up paying extra money only to still have the same exposure as though the LLC did not exist. Apart from this, there are other risks to consider, from loan acceleration and breaches of contract to taxes. Because of this, it is recommended that you consult with an attorney and tax professional before entering the rental property business. We here at Rapp & Krock are happy to answer any questions and provide guidance from start-up and property acquisition to any other business law needs your company may need moving forward.