Complete Guide to Forming an LLC For Your Rental Property

Whether you own one rental property or 10, setting up a Limited Liability Company (LLC) is a wise move. Not only will doing so give you legal protection and tax benefits, but it will also reduce your workload if and when you ever decide to sell your rental properties.

Keep reading to learn about the benefits of forming an LLC for rental properties and how to set one up correctly.

What is an LLC for a rental property?

An LLC is a business structure that provides legal protection from personal liability. What does that mean? If a tenant or contractor tries to sue you for anything related to your rental properties, your personal assets would be off-limits.

This liability shielding is the key difference between an LLC and a sole proprietorship, which offers no legal safeguards. Not to mention, when compared to corporations, LLCs are much easier to set up and manage.

You should establish your rental property LLC in the state where you do business. Because LLC regulations vary by state, it’s essential to understand your state’s specific laws and requirements.

What are the best ways to use an LLC for a rental property?

Setting up an LLC for a rental property has several advantages for your business, which include:

• Tax benefits: As a real estate investor, your tax situation will become slightly more complicated than with typical employment. Despite the added complexity, when you set up an LLC for a rental property, you’ll enjoy numerous tax benefits that work in your favor.
• Business separation: Setting up an LLC will allow you to separate all rental property activities from your personal finances. To do so, you’ll need to open a business bank account to ensure business income and expenses never flow through your personal accounts. You’ll also conduct all business under your LLC’s name, with your property insurance listing the LLC as the insured party instead of yourself.
• Asset protection: An LLC creates a legal separation between your business and personal finances, ensuring that your personal assets will remain protected if someone sues your business.
• Flexibility in ownership: An LLC is helpful if you own a rental property with others, as it lets you define how profits will be distributed among members.

Steps to Setting Up Your Rental Property After Registering as an LLC

Once you establish a rental property LLC, take these steps to ensure everything is set up correctly:

• Transfer the property title: After forming your LLC, transfer the rental property’s title from your name to the LLC.
• Update insurance policies: Update your property insurance to reflect the LLC as the insured party. You may need to switch from a personal to a rental policy, which could affect your rates.
• Revise your lease agreement: Update all lease agreements to list the LLC as the new landlord.
• Open a business bank account: Use an LLC account for rental income and expenses to separate personal and business finances.
• Contact your lender: If you have a mortgage, notify your lender of the pending title transfer and ask them about any additional requirements for the transfer process.
• Create an operating agreement: If you haven’t created an operating agreement that outlines profit distribution and business responsibilities, do so as soon as possible.
• Maintain thorough records: Keeping accurate and thorough records for your rental property will help keep your business compliant and ensure your legal protections remain intact.

How Rental Income is Taxed as an LLC

For tax purposes, LLCs function as pass-through entities, meaning they don’t pay taxes themselves. Instead, income passes to LLC members, who report and pay taxes on their personal returns, which helps businesses avoid double taxation.

How you report rental income on your taxes will depend on how your LLC is structured. Here’s a brief review of the different structures to consider:

• Single-member LLCs: All single-member LLCs will report rental income on Schedule E of Form 1040.
• Multiple-member LLCs: Any multi-member LLC will report rental income on Form 8825 as part of Form 1065.
• LLCs Designated as an S-Corp: All LLCs designated as S-Corps will report rental income on Form 8825, filed along with Form 1120S.

Rental properties operate like any other business, allowing you to deduct most expenses from your taxable income. Common deductible expenses include:

• Mortgage interest
• Property taxes
• Maintenance costs
• Insurance
• Property management costs
• Legal fees
• Tax preparation fees

What You Should Know About Taxes & LLC Rental Property Income

Setting up rental properties under an LLC can also be beneficial thanks to the Tax Cuts and Jobs Act, a 2017 law that introduced significant tax reforms, including lower corporate tax rates and deductions for pass-through businesses.

Qualified Business Income (QBI) Deduction 

Thanks to the Qualified Business Income (QBI) deduction, LLCs have been able to deduct 20% of their net business income since 2018. This deduction applies to individuals earning less than $157,500 as single filers or $315,000 for those married filing jointly.

However, LLCs must meet several conditions to qualify for the QBI deduction, including:

• You must set up your LLC as a disregarded entity or an LLC where the income passes through.
• You must not have both commercial and residential real estate investments.
• You must have separate books for each real estate enterprise.
• Perform at least 250 hours of real estate rentals annually.

Important Note: The Qualified Business Income deduction will expire on December 31, 2025, unless Congress decides to extend the benefit.

1031 Exchange

When you sell a rental property and reinvest the proceeds into a similar one, you can defer capital gains taxes through a 1031 Exchange.

This exchange comes with strict timing requirements. You must identify a replacement property within 45 days of selling the original rental and close on the new property within 180 days.

Given the complexity of rental property taxes, consulting a qualified tax advisor is always a smart move.

Best Practices for Managing an LLC for Rental Property

If you’re setting up an LLC for your rental property, following best practices will help ensure it runs smoothly.

Open a Separate Business Bank Account and Credit Card

Opening a business bank account and credit card helps separate personal and business expenses. Doing so is essential for maintaining your LLC’s liability protection and preventing confusion over business expenses when tax season comes around.

Review Your Operating Agreement Periodically

Having a clearly defined operating agreement is important, but regularly reviewing it is just as essential. Laws change over time, and consistently updating your agreement could help prevent potential legal issues down the road.

Maintain Compliance

Stay informed about changes in local laws and regulations, including changes to required licenses and landlord-tenant laws in your state.

Consider Using a Property Management Platform

If you want to adopt a more automated approach to your rental property operation, consider hiring a property management company. TurboTenant, for example, handles rental advertising, rent collection, maintenance coordination, and more.

Make a Tax Advisor Part of Your Team

Running a business will inevitably make your tax situation more complex than with traditional employment. Hiring a tax advisor can minimize your tax liability and ensure you file your returns accurately and on time every year.

How to Form an LLC for Your Rental Property

Forming an LLC for your rental property is an intelligent way to protect your personal assets from business liability. If you’re ready to set one up, follow these steps:

1. Determine your LLC name: Choose a name that complies with state laws and includes “LLC” or “Limited Liability Company.” Always check your state’s Secretary of State website to ensure the name is available.
2. Submit your Articles of Organization: File this document with your state’s business office to officially establish your LLC. Your Articles of Organization should include your LLC’s name, business address, registered agent, and business officers. Filing fees vary by state and typically range from $50 to $500.
3. Get your Employer Identification Number (EIN): Apply for a free EIN through the IRS website, which is mandatory for filing taxes and opening business bank accounts.
4. Create the operating agreement: While not always required, having an operating agreement is almost always beneficial, especially for multi-member LLCs. This document should outline how profits and responsibilities are divided among owners and help prevent potential disputes.
5. Open a business bank account: Before collecting rental income or paying expenses, set up a business bank account to keep personal and business transactions separate.
6. Transfer the property title: Update the title for each rental property you own to reflect your LLC’s name instead of your personal name.
7. Update insurance: Ensure all policies list your LLC as the policy owner instead of your name. Also, make sure premiums are paid from your business bank account rather than an escrow account.
8. Revise lease agreements: Revise existing lease agreements to reflect your rental property LLC as the landlord. All future leases should also include the LLC’s name.
9. Register for permits and taxes: Secure any required rental property permits to ensure compliance with local laws. If required, register for local property taxes as well.

When should I consider creating an LLC for rental property?

You can create an LLC for a rental property anytime, but doing so before purchasing simplifies the process. Buying the property under the LLC’s name eliminates the need to update titles, insurance policies, and leases later. Doing so may also help you avoid paying additional change fees that some lenders or states charge.

Should I put my rental property in an LLC?

Having an LLC for a rental property is a wise choice in most cases, as it protects liability if something goes wrong. For example, if someone slips and falls on the sidewalk in front of your rental property, they could sue. But, instead of going after your personal assets, their lawsuit would be limited only to your business’ assets.

If you plan to grow your rental property business, an LLC can also make expansion and investor partnerships easier. It can help simplify selling the business as well; rather than transferring the deed for each property, you’ll be able to transfer your LLC membership interest to the buyer.

Another key reason to consider an LLC is tax flexibility. As a disregarded entity, the LLC passes income directly to members’ personal tax returns, helping them avoid double taxation. If your income is high enough, electing an S-corporation tax status could further optimize your tax situation.

Can I put my house in an LLC and rent it to myself?

Technically, you can transfer your personal residence into an LLC and rent it to yourself, but this comes with challenges. First, you must always correctly report taxable income to avoid jeopardizing your liability protection. Next, balancing personal and business interests can also be tricky, as many decisions may blur ethical or legal boundaries.

Pros and Cons of Creating an LLC for a Rental Property

Before moving forward with an LLC for your rental property, consider the following pros and cons:

Pros

• Liability protection: LLCs shield your personal assets from business liabilities.
• Pass-through taxation: Single-member and multi-member LLCs pass income directly to members, avoiding double taxation (since the business itself doesn’t pay income taxes).
• Flexibility: While LLCs use pass-through taxation, members can structure the operating agreement to allocate expenses strategically. For example, a member in a higher tax bracket might claim a larger share of expenses to reduce their taxable income.
• Asset separations: An LLC requires a separate business bank account, which keeps business and personal finances apart and simplifies tax reporting.

Cons

• Setup costs: Not only does it cost money to form an LLC, but most states also charge an annual fee to maintain one, which can end up being several hundred dollars or more.
• Additional paperwork: Establishing a rental property LLC requires extra documentation and ongoing compliance filings.
• More challenging tax situation: While income passes through to members’ tax returns, LLCs may have additional tax forms to file, depending on their structure.
• Financing can be complex: Some lenders are hesitant to work with LLCs and those that do often charge higher interest rates.

How TurboTenant Helps Landlords Manage LLC-Owned Properties

TurboTenant is a free property management software that helps landlords manage LLC-owned properties. It helps rental property owners streamline tenant screening, send and receive rental applications, collect rent, and more. Additionally, TurboTenant integrates with REI Hub to offer advanced accounting and bookkeeping solutions.

Sign up for a free account today to see how TurboTenant can simplify your property management operation.

FAQ: Common Questions About Forming an LLC for Rental Property