Lately, my husband and I have been evaluating our investment strategies and making some changes to where we invest our money. I previously wrote about buying our rental property, you can check out that post here.
Well, we recently sold our rental property (it was a really hard decision for me!) in order to invest in land. We also have had the pleasure of dealing with prior tenants who aren’t as pleasant as one would wish.
Basically, the tenants left the property a mess, and as a result we did not give them their security deposit back. Instead, our property manager sent them an itemized list of where that money actually went. They feel entitled to their security deposit, so they decided to sue us for the return of their deposit.
As bad as it sounds, we aren’t worried or stressing at all. First, because it is the price you sometimes pay for investing and having a business. And second, because we have an LLC that protects us personally from anything that might happen with our rentals.
This got me thinking, why do some people choose not to have an LLC? I hope it’s not because they don’t understand the benefits that the LLC can provide them! And just in case it is, I want to share the benefits that an LLC provides.
Please note: I am not a Lawyer and am not trained to give legal advice. I simply have personal experience and my own research. Always consult an attorney with questions.
An LLC protects you personally
This is my #1 reason that I formed an LLC before purchasing my rental property.
Let’s look at an example of how the LLC could protect you in case of a lawsuit…
You own a property that is valued at $150,000. You have a loan on the property for $100,000, leaving $50,000 in equity. You have a weak board on your deck stairs, and your tenant falls and breaks his leg. He sues you, and is awared a $250,000 judgement.
You lose the $50,000 of equity you have in your property, as you have to sell your property and all money goes towards paying the judgement. Your $5,000 checking account balance is also taken. This leaves $95,000, zero of which you are liable to pay.
The LLC is now bankrupt, and there is nothing more they can get from it. Since your other assets (your house, car, boat, etc) are owned in your personal name, they cannot claim judgement on them.
Now let’s take that same example, but this time you own the rental property in your personal name…
This time, after the property is sold and the checking account drained, they come after you for the remaining $95,000. You now have to sell the boat and refinance your house in order to pay the balance.
The second scenario definately sucks!
Protect yourself by investing through your LLC.
An LLC gives you more privacy
I am a firm beliver that tenants do not need to know your personal business. It is not their right to know who is in the LLC, where you live, or who your family is.
And with an LLC, they never need to know! You have an email address for the LLC, and a seperate PO Box. Any rent checks are sent to the PO Box, and any correspondence is sent to the email.
In the unfortunate chance that your tenants become angry, you will have no fear that they will come after you personally. They don’t know what kind of army is hiding behind the LLC.
Another way to look at this is negotiation power. If the person on the other end of the conversation thinks there are others who help to make the final decision, you can have the upper hand. It also gives you more confidence to say no to things that don’t benefit you, without coming off as the bad guy.
If a tenant wants to rent a property for $100 under the list price, you can take it back to everyone and discuss. This may mean that you are simply going to sleep on the idea! They don’t know. You can then come back a day or 2 later and say that unfortunately, that number was not accepted. However, you are prepared to offer them a free month with a 2 year lease.
Chances are, they are going to be a lot more accepting of this then if you alone were to do this. They would also expect an answer from you immediently, since you are the sole decision maker.
An LLC ensures protection from co-investors
This one only applies to LLC’s that have more than one member. Since my LLC is owned by my husband and I, this isn’t a big deal for me either. However, it is still one to mention.
I have been looking into this one more lately, as I am considering forming an LLC with another individual. Basically, if you owned the property with another person not in an LLC and something were to happen to them, it could be a mess.
If you owned it in an LLC, then
An LLC has tax benefits for the investors
First, please note that I am not an accoutant. You will need to consult an accountant before making a decision based on the tax benefits. I always recommend having an account on your payroll anyway. You would be surprised some of the questions that come up during the year, and I’m always thankful I have someone to call or email to get professional advice and information!
If you and a partner want to invest in real estate, then it is probably because you want to make money, right?
So what happens when tax time comes around? How do you deal with the profits, expenses, depreciation, and everything else with the property. Well, you likely will file a tax return for the LLC.
That LLC will act as a pass-through, meaning the money earned will pass through to the individuals and will not be treated as business income. You won’t need to worry about double taxation. It is subject only to capital gains rates on the ownership shares of the member, and not to corporate capital gains taxes.
If you own the LLC individually, then you don’t even need to file a seperate tax return. You can include it on your individual, personal tax return.
There are a lot of reasons that forming an LLC is a benefit to you.
Some people argue with me, pointing out the cons of having an LLC. While an LLC does cost money to create and run, and financing may not always be as appealing, the pros of the LLC outweigh the cons 10:1. Before you decide to start investing in real estate, or before you continue investing, take the time to do your own research about LLC’s. And as always, I recommend you find a good real estate attorney to add to your payroll. Remember that the team you have is a large contributing factor to your success.
Now it’s your turn: Do you have an LLC? Why did you form your LLC, and have you seen any of these benefits?