Should I own my property in an LLC? I’ve received countless emails asking this question. While attending local meetups, many have also asked me if I own my properties in an LLC. In fact, I was also asked this question during a panel discussion at FinCon earlier this year.
So, should I own my rental property in an LLC?
Owning rental property in an LLC
There are pros and cons to owning a property or properties in an LLC. We will start by discussing the pros. Then we will walk through the cons. Lastly, I will share my view and approach.
Benefits of owning a rental property in an LLC
Property records are public information. This means anyone can look up the owner of a property. So, when you buy real estate in your name the whole world may know.
Owning a property in an LLC provides an extra layer of privacy. Let’s say you bought property 123 Main Street in your name. The deed of record would show Jane or John Doe as the owner.
Now, if you bought the property in an LLC the deed would state the LLC entity as the owner. A quick search of the public property records may show that “XYZ, LLC, “Generic Name, LLC” or “Get your hands off my assets, LLC” owns the property.
It’s easy to find Jane or John Doe. Finding the owner of an LLC is more time-consuming.
A Limited Liability Company, or an LLC for short, is one of the least complicated business structures available. The structure provided by an LLC protects the owner’s personal assets. This business entity limits the owner’s risk to only assets owned by the LLC.
The LLC structure is appealing to some real estate investors because it limits their downside. Hence the name ‘limited liability’.
Essentially, a well-structured LLC will protect the owner’s personal assets. In the worst case scenario, the owner’s personal assets (primary residence, savings, stocks, bonds, retirement accounts) would not be at risk. At most, the owner would risk losing the property held by the LLC.
LLCs provide a ‘pass-through entity’. The recent changes to the tax laws favor this structure. I will not pretend to be a tax expert, nor am I a CPA. However, Marketwatch put together a good analysis that you can check out here.
Disadvantages of owning a rental property in an LLC
If you own real estate with debt, your lender will require you to have insurance. You should have insurance even if your property is debt free.
Increased insurance costs is one of the downsides of owning a property in an LLC. It’s more expensive to purchase insurance for a business than an individual. So, insurance for a property in an LLC is more expensive than if you owned the property in your name.
Owning or transferring a property may trigger the Due-on-Sale Clause in your loan agreement. This clause in your deed or loan agreement may require you to pay your loan back in full in cash or refinance the property if you transfer ownership. Seek written approval from your lender prior to transferring ownership of your property. Failing to do so may lead to the bank foreclosing on your property. This is a costly mistake that can easily be avoided.
Buying or refinancing a residential property (single family, duplex, triplex or quad) owned by an LLC may be more challenging. Since the property is owned by the LLC and not an individual, banks will often look to the business’ income and cash flows to support the loan. Often, the LLC will not qualify for the mortgage.
Commercial real estate properties are different than residential properties (4 units or less). It’s commonplace for commercial buildings (5 units or more) to be owned by an LLC. In fact, most commercial lenders expect (though not require) a commercial property to be held by an LLC. Commercial mortgages have different underwriting metrics than residential mortgages. A commercial lender cares most about the property’s cash flows and income. Second, a commercial lender considers the financial strength of the individual buying the property. Next, the lender looks to the borrower’s experience and capability to manage the property successfully.
In general, using an LLC increases costs. First, there is the actual cost of forming the LLC. You will have attornies fees and filing fees with the state. Additionally, there will be ongoing fees associated with keeping the LLC registered.
Second, insurance costs will increase when operating as a limited liability company. Accounting costs also increase if you operate as an LLC. LLCs are required to file their own tax return. This will lead to higher recurring costs during tax season.
In general, LLCs will increase costs. Some individuals are ok with increased cost because of benefits associated. Personally, I am not a fan of owning my properties in an LLC. The additional expenses and the associated returns are not justified to me. I’ve found a different approach for asset protection, limiting liability, and protecting myself.
Alternative to owning a rental property in an LLC
As I mentioned earlier, you should have insurance on all of your properties. Each insurance policy will have a liability coverage for that property. My individual policies provide between $250,000 and $500,000 in liability coverage. This means in the event of a lawsuit or judgment, my policies will provide between $250,000 and $500,000 in protection. I could be sued for $500,000 and not pay a cent out of my own pocket.
But what if something catastrophic happens? Or I am exposed to a larger lawsuit or judgment?
I also have an umbrella policy in addition to all of my individual policies. An umbrella policy provides additional protection above and beyond the limits of individual policies. My umbrella policy provides $2 million in additional liability coverage and also covers me for auto accidents.
So, why do I like the umbrella policy approach?
Simple, it’s very affordable and offers great protection. As a landlord, I may be exposed to liabilities or potential lawsuits by tenants. Depending on where the incident occurred my individual policy would cover the first $250,000 or $500,000. That is a lot of protection. Then, add in $2 million from my umbrella policy – I am now covered for $2,250,000 to $2,500,000. I sleep well at night knowing I have up to $2.5 million in coverage before I would need to come out of pocket.
So, how much does an umbrella policy cost? That is a great question.
I called my insurance broker earlier this week for quotes. For my situation (4 properties and 1 car) a $1 million umbrella policy would cost $260/year or $ $21.67/month. A $2 million policy would cost $323/year or $26.91/month.
Both of these options cost way less than having individual LLCs for each property. The umbrella policy also offers a great level of liability coverage. If desired, you can also obtain a larger umbrella policy for a few extra bucks a month.
When LLCs make sense
- a commercial property
- when you have a ton of assets to protect
- when you have a partnership or are investing with multiple people (other than a spouse)
- If you have extreme anxiety and worry about the risk
When LLCs don’t make sense
- on a residential property
- when you own only a few properties
- when you own the property on your own without partners or investors
- when you do not have a ton of assets
So, I own 7 doors through four properties. I have two single family homes, a duplex, and a triplex. I own each property in my name. Each property also has an insurance policy. Each property’s insurance policy provide $250,000 to $500,000 in protection. This protects me from any lawsuit or claim filed against me up to that dollar amount.
Additionally, I have an umbrella policy for $2 million. This means that my insurance provider will cover any claim against me for up to $2.5m in a year before I have to pay a penny. Given that my net worth and assets are well below this level, and that it’s very unlikely any type of suit would exceed $2.5million, I am well protected. The cost of this policy is significantly cheaper than the LLCs. Am I exposed to more risk by not owning my properties in an LLC? Yes, I am – but that is a risk I am willing to take.
What is your approach to asset protection? Do you own your properties in an LLC or your own name? What is your reasoning for doing so? Have you considered an umbrella policy for additional protection? Or, do you use a method that was not discussed in this article?