Should I Put My Rental Property In An LLC?

When you have assets such as rental property that are going to need to provide you with cash flow throughout your retirement years, you'll want to look into some level of asset protection at some point. And when it comes to rental real estate, the limited liability company or LLC might be worth considering. However, the methods and strategies that you use will depend on what you have at risk and certain risks that you might be creating yourself.

[00:00:54]:
Hello, everyone, and welcome back to Retired-ish. I'm your host, Cameron Valadez. In today's episode, we are talking about protecting the assets you've accumulated so far over your lifetime, more specifically, rental real estate. One of the most common ways to add a layer of protection to your investment or rental properties is by using what is called an LLC, otherwise known as a limited liability company. This might sound complicated, but bear with me. It's really not once you understand what an LLC is and what it may or may not do for you. As well as the different uses because not only can we use it for things like rental real estate, but you can use LLCs for operating businesses as well. And so you're using them in a different capacity.

[00:01:45]:
First, I think it's important to back up even further and have an understanding of what asset protection is and its overall purpose. Since at the end of the day, that is what the LLC is doing for us. It's helping us protect our assets from certain liability. And just a quick disclaimer here before we dive into this: I am not an attorney and do not provide legal advice. Please consult your own legal counsel when implementing any sort of asset protection strategy or legal entity creation.

My goal is to educate you on the asset protection strategies and LLCs in general, as well as when and why you might consider reaching out to a legal professional to take it to the next level. Far too many people rush out to set up an LLC because it seems like the right thing to do once you either start a business or purchase a rental property and start operating one or multiple properties. And while the LLC is a fantastic entity for certain reasons, it isn't absolutely necessary when you own rental properties. Sometimes, putting properties in one or multiple LLCs can actually be premature and can also have some significant drawbacks. So, we'll also go over some of those today.

But let's set the stage by going over some of the basics of asset protection. Asset protection is essentially a set of strategies and or techniques that you can use to protect the various assets that you own from a lawsuit or maybe a creditor and other potential threats. And you yourself can be one of those threats, which we will talk about in a minute.

[00:03:33]:
And you don't want to lose a lifetime of hard work and savings to one potential mishap or event that ends up wiping you out financially. Before you consider any kind of asset protection strategy, you have to determine what you have that could be at risk. What assets do you own, and how significant are they compared to your overall net worth, at least as of right now. Just because you might have some assets doesn't necessarily mean you need any significant level of asset protection strategy yet, and you can probably get away with some basic types of insurance or just be extra careful in the way you do things and go about life. There are different levels of asset protection. Your in-laws might have what I would call a level three asset protection strategy. Well, you might only need a level-one strategy. It's not one size fits all.

So once you determine exactly what you might have at risk, then you have to ask yourself what are the potential risks that you might have to deal with down the road, or what risks are you potentially creating yourself? So, in other words, do you operate dangerous machinery every day or conduct surgeries in your day job? Do you have a 16-year-old driving a car with your name on the title with a phone where they might be texting and driving occasionally? Or do you sell custom crafts on Etsy in your basement in your underwear? Right?

These are totally different levels of risk. If I have six rental properties with, say, 50% equity in each, and I perform multiple surgeries every week, I would have quite a bit of assets at risk since I have substantial equity and have a more risky occupation. So, generally speaking, the riskier your business or lifestyle and the more assets that are at risk, the higher level of asset protection you would want to consider.

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One other thing I want to throw out there is that there are no silver bullets, no matter how complicated or sexy any asset protection strategy sounds. Any strategy or legal entity, such as an LLC, which we will get into in a second, isn't necessarily going to stop a lawsuit from happening. However, depending on the level of planning and asset protection that you have in place, you might create enough barriers so that you deter someone from suing you due to how expensive and pain in the butt it might be to do so and or you facilitate some sort of settlement.
There are many ways that you can structure your affairs for privacy and different levels of liability protection, but for the rest of the episode, I want to focus mainly on the basic LLC for rental property and when you might consider it.

Okay, so let's dive into the limited liability company, the LLC. What is a basic LLC? What are some of the potential benefits? And what does an LLC not do for me? Believe it or not, there are actually a lot of people out there that have LLCs for the wrong reasons. They think it's doing something and it actually doesn't do that at all. So good thing you're listening to this episode because hopefully, by the end of it, you'll know exactly what an LLC can do for you and what it won't do for you. So, in a nutshell, a limited liability company is a business structure that is separate from you as the owner. They are allowed by specific state statutes and different states have different regulations on LLCs in their state. And in general, an LLC can offer limited liability protection for the owner. So, limited liability is in the title of that legal entity itself. Right? Limited liability company.

[00:07:36]:
Some of the benefits of an LLC for rental property purposes only are personal liability protection, which would be the biggest one, from the operations of the business or the rental. So, remember I mentioned earlier, very briefly, LLCs can be used in different ways. And if you have an operational business like a small business, you might have that in an LLC. And that would be slightly different than using an LLC to own your rental property. Even though either one can actually be looked at as a business. But again, the biggest benefit is there is the ability to have personal liability protection from the operations of the business or the rental. This is the biggest benefit of why someone would even consider an LLC in the first place, and we'll dive a little bit deeper into what this means in a minute.

Another big benefit is to help document the relationship in a partnership, the LLC operating agreement. So what I mean by this is sometimes people own rental property, maybe even you, in a partnership, which means they own a property with somebody else. A lot of times, you might have groups of people that work at the same place, or you know, groups of doctors that might go in on a vacation home, and you've got 3 or 4 owners, you know, and it's up in the mountains so they can go skiing in the winter and go to the lake in the summer. Usually, those are owned in a partnership, and so when you have an LLC, you get to have this operating agreement, which has very specific language in it that says what can and can't happen, and the rules of that partnership. And without that, things can get really messy down the road. So that's another big benefit. Although the LLC is a separate legal entity for tax purposes, unless elected otherwise, it is what is called a pass-through entity. Again, for tax purposes, it's a pass-through entity. This means that for tax purposes the income and expenses pass through to you personally.

[00:09:47]:
Therefore, you generally don't even have to file a separate tax return when you have an LLC, which is nice. But again, that would depend on how you elect for your LLC to be taxed, which is usually done when you're operating a business in an LLC, typically not when you have an LLC just holding rental property. In that case, it's just there to hold it, and the taxes just flow right through to you on your individual tax return. No extra documents to do. However, with most things, there can be caveats to this. And one common one is that if you own a rental property with another owner or multiple, kind of like what I just talked about, technically, it's a partnership, and you'll likely need to then file a partnership tax return in addition to your personal tax return.

Now that we understand some of the main benefits and main reasons one might consider an LLC to hold their rental property, let's look at some of the potential drawbacks and have an understanding of what an LLC does not do for you as a landlord. And the first one is that many states have additional operational costs and or high filing fees or taxes when you have an LLC in their state.

For example, California has an LLC minimum tax or minimum tax of $800 a year. Tennessee has an excise tax for capital gains in an LLC, to name a few. All the states are relatively different and have different costs and different types of taxes when it comes to these LLCs. Some states cost a lot more, and this sometimes keeps people from exploring an LLC further. Or, you know, they think, oh, you know, I've got these risks, and I've got all these assets I want to protect. But then they hear about the cost of an LLC or multiple LLCs in their state, and they go, never mind, I don't want to pay that. However, you should always weigh the cost versus the protection you're getting. In other words, do you have a significant amount of assets to protect that are outside of the LLC itself that would make the annual costs worth it?

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And one of the next drawbacks is that contrary to popular belief, an LLC does not save taxes in any way, shape, or form. This is probably one of the biggest misconceptions when you hear somebody talking about LLCs or the reasons why someone goes and gets an LLC. They do not save you taxes. And lastly, don't think that you should just get an LLC in a state that has more favorable laws or a lower cost to maintain that LLC. Don't try to cut corners. Whatever state you are doing business in as a landlord is generally where you will set up the LLC in order to get asset protection, unless you file it foreign in another state, which is a little bit more complex topic. In any case, always consult your attorney first on what is best. But again, consider setting up your entity in the state where your property is actually located and follow your state's laws.

If you like a certain state's specific laws, like, I don't know, Wyoming or Delaware or something like that, and you like their regulations around LLCs and you like their privacy laws, and you want an LLC in that state, then maybe go shop for rental properties in that state. Simple as that. Don't try to cut corners and buy your property in California, and go put it in a Nevada LLC because you're going to, you know, save some money or think you're going to get some additional benefits. It's likely that you're not going to get the asset protection you're looking for because you're not doing it correctly.

Before we go any further, I want to back up a bit and dive a little bit deeper into something I mentioned earlier, which was when we talked about the main benefit of having an LLC and that liability protection. What I said was that the LLC might be able to protect your assets that are outside of the LLC itself. Before we go any further, I want to explain more of what I mean by this and go over what I call inside and outside liability.

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And after speaking with many property owners over the years, I find that many of them get mixed up with this concept and how an LLC can actually work when it comes to asset protection. So again, that's why I want to go over this and kind of nail this down.

So, let's begin with what I call inside liability. So hypothetically speaking, if you have, say, a rental property that is in an LLC and the tenant gets hurt on the property, that is a liability that was created, or that happened inside the LLC. And generally speaking, the tenant can get at anything that the LLC owns. Let's say they were to sue you. In this case, if it was one rental property, they would be able to go after the equity in that rental property. And also if you have your rental in an LLC, you should have a separate bank account for that LLC. So, if you had any cash in that bank account, maybe that would also be another piece of the list of assets they could go after.

The other question then becomes, but can they go after your other assets that are outside of the LLC? And the answer is typically no. So, in this hypothetical scenario, you can't necessarily protect the rental property or the equity in the rental property, but you're trying to protect everything else outside of it. You're trying to make sure they can't get through the LLC. You're trying to contain that liability exposure so they can't get to you personally. Remember? Because we're saying that the LLC, the entity, is separate from you personally. There are no silver bullets, but this would be better than nothing. Now, let's flip the script here.

[00:16:07]:
Let's say someone sues you after a car accident that you caused, and they got hurt. Think of this as an outside liability since it happened outside of your LLC with the rental property in it. Can someone come after the equity and other money that's in your LLC in this case? In most states, they actually can, so it depends. Just know that even with an LLC, you might not be protecting the rental from you. So remember, by using that LLC in my examples, you protected yourself personally from the rental that's inside the LLC, but you're not necessarily protecting the rental from you. And I think many people believe that if you place an investment property in an LLC, that you are protecting that particular asset since that's the asset you're actually moving into the legal entity. And that's where the confusion sets in. Instead, I encourage you to think about inside liability and outside liability.

And just because you have an LLC doesn't mean you can just leave it at that. So if you went online and did a do-it-yourself LLC and you've got like one or two pieces of paper that you printed out and you signed and submitted to the state, that's not enough. To get the asset protection that you're seeking, you also have to respect the rules of the LLC. Such as having a separate bank account transferring the title of the property that you're putting into the LLC to the LLC. That's actually how you put it in the LLC. It just doesn't magically get in there. You want to have your rental agreements in the name of the LLC. That's really important.

[00:17:52]:
I've seen many times where someone has a property in an LLC, but whenever they get a new tenant, that agreement is between the landlord personally and the tenant. Well, you're not really respecting the LLC, and you might not get the asset protection you're looking for if something happens. Another is documenting your annual minutes and meetings. So, this is a concept for business entities that respect what we call the corporate veil. But essentially, you need to have annual meetings about your business. And in those meetings, you need to have certain notes about things that you talked about. And those are called minutes. Remember, the LLC is a legal entity, and your attorney should teach you how to operate and respect that entity properly in order to help you get the asset protection you're looking for.

If you don't play by the rules, you may open up your liability and ruin the protection it might have otherwise provided you. And this is where some people get in trouble because they have never heard of some of these concepts such as annual meetings and noting minutes, because they go online and create these LLCs by themselves without any proper legal guidance from an attorney. If you're going to cut corners and try to save some money, make sure you know what you're getting into. That one or two pieces of paper that you got from that online do-it-yourself company six years ago buried in your drawer might not be enough.
When might you consider putting rental property in an LLC? Well, this of course, is going to depend, just like with most things in life, and it depends on your exact situation and the varying state's laws where your property or properties are located. But in general, you'll want to consider an LLC for your property if you have a significant level of assets outside of the rental property or properties themselves or you want to mitigate the risk between your various properties. And when I say a significant level of assets, that is relative. It's not a black-and-white dollar amount.

[00:19:58]:
For example, a common situation I see is when someone invests in multiple rentals, and none of them are in LLCs. They might have one that they've owned for 20 years, and it's got $300,000 to $400,000 of equity in it, and they have three others with maybe $60 to $80,000 of equity. Now, in this hypothetical scenario, if the tenant's dog at the $60,000 equity property attacks the neighbor's child, and they sue you, they might be able to go after the equity of the 20-year-old property with 300 to 400,000 in equity, along with all the others and the equity in their personal home. So, in this scenario, even if they didn't have all of the properties in LLCs and just had that one property with the dog in an LLC, they might have been able to limit the exposure to the $60,000 in equity in that one property rather than 100’s of 1,000’s of dollars and their entire net worth. You have to look at your situation and see if adding a layer of protection with an LLC is worth it to you. And the more rental properties you have, the more expensive it might be to maintain several LLCs, depending on where the different properties are located. For example, if we go back to that last scenario, let's say all four rental properties are located in California. You might be inclined to put them all in one LLC to save $800 a year on the other three properties and pay for one LLC.

[00:21:34]:
What would you have done there? You would have just lumped the equity of all of those properties into one. You would have just contained them all in one bubble or one box. And now an issue in property number one can still expose the equity in properties two, three, and four since they are all in the same LLC. So this may not be the best idea.

Or you may have, let's say, short-term rentals that have a higher risk due to constantly having different renters that you don't know too much about since they're all short-term, and they might invite other people over to the house that are not the ones renting it from you. You might compare that to your long-term rentals, where you might have a really good long-term tenant that you know very well. So, you might decide to have these different types of rental properties in different LLCs. Now there are some states that have what are called series LLCs that can allow you to mitigate the headache of having multiple LLCs and still maintain some protection when you have multiple properties.

[00:22:42]:
You essentially have one parent LLC, we call it and can have a bunch of little subs underneath the parent LLC. And those subs hold different properties if needed. For tax purposes, all of those sub-series LLCs flow up to the main LLC or parent LLC, and then that parent LLC's total income and expenses flow through to you on your personal tax return. It actually can be very simple even though it sounds complicated, and there are more moving pieces.

In any case, get with your attorney to see if a Series LLC might make sense for your situation or if you have multiple properties in states that offer Series LLCs. Again, there are many states that do not even offer these Series LLCs. And here's a pro tip for you. One important thing that you'll want to consider if you do have rental properties in an LLC or you decide to do so at some point down the road in the future is that you'll want to consider putting that LLC in your revocable living trust for estate planning purposes or basically have the revocable living trust be the member of that LLC or the owner.

This can be especially helpful if you have rental properties in states other than the state where you reside. Right? Where your domicile is, where you live. The reason for this is that each state will have its own probate and procedures after your death. So, to help avoid probate on a property held in an LLC in another state, if you put that LLC in your trust, it may help that asset avoid probate in that state, preserve more of your money for your beneficiaries, and keep your matters private. In addition, in some cases, if you own rental property jointly with a spouse, you still might have to file a partnership tax return depending on your circumstances, like I mentioned earlier. However, if instead you and your spouse own the LLC through your trust, you can avoid having to file that partnership tax return, which is pretty cool and can save you some money. Because again, those partnership tax returns, they're not so easy to do. They're actually one of the more complicated ones, so it can be dangerous when trying to do them on your own.

[00:25:05]:
And if you need a professional to help you do them, it's going to cost you some extra money. Okay, the last thing I want to mention about all this LLC stuff and the big takeaway here is that just because you have a rental property doesn't necessarily mean that you need an LLC to put it in. As I discussed earlier, make sure you are already implementing the basic asset protection techniques, such as getting your name off the title to your 18-year-old's vehicle, etcetera. Or, for example, when reviewing applications from tenants, conduct more thorough reviews and look for any glaring risks that an applicant may be bringing to the table such as, you know, large dogs, etcetera.

Or if you're going to rent your property on a short-term basis as an Airbnb or VRBO, for example, understand what most renters are going to be using that property in that location for and the risks associated with that. In addition, you can make sure that your homeowner's policy coverage is updated with a higher level of liability protection. This, of course, on top of making sure your tenants have adequate renters insurance, that can help as well. Then you may also consider adding umbrella insurance on top of that. However, don't make the mistake of thinking that a few $1,000,000 of umbrella coverage through umbrella insurance replaces an LLC.

It does not. They do different things, and umbrella insurance is also, in my mind, a last line of defense. That is, it's still important to consider, but I wouldn't rely too heavily on it. There's a reason you can get a couple of $1,000,000 additional coverage in umbrella insurance for less than $1,000 a year or so. These insurance companies will put you through the wringer before ever paying anything out.

That's all for today's topic. Hopefully, I was able to provide you with some clarity around asset protection and some clarity about how LLCs work, especially with rental properties, and how this might apply to your situation. And if you find the information and strategies I provide on this show actionable, insightful, and valuable, please subscribe to or follow the show on your podcast app.

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While you're at it, do yourself a favor and sign up for the Retired-ish newsletter to get more useful and easy-to-digest information on retirement planning, investments, and taxes once a month straight to your inbox, no spam. Of course, if you want to learn more about the topics I went over in today's show, or you want to start getting serious about your family's financial planning and maybe asset protection, you can find links to the resources we have provided in the show notes right there on your podcast app, or you can visit us at retiredishpodcast.com/52. Thanks again for tuning in and following along. See you next time on Retired-ish.

Disclosure [00:28:27]:
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