"I own a personal residence and a rental property. I was told to put the rental property into an LLC to protect my personal residence from the liability of the rental property. Is this a good idea?”
This is probably good advice. There are benefits and drawbacks to LLCs (limited-liability companies), but if you are planning to put your rental property into a limited-liability entity to protect your other personal assets, an LLC is usually the best choice. There are other entities that offer limited liability, such as C-corporations and S-corporations, but the tax consequences of putting real estate into a corporate entity like those can be disastrous.
When you contribute real property into an LLC, the liabilities associated with that real property and its business activities are cut off from the personal assets of the owners (called “members”) of the LLC. People who have multiple properties or other assets (for example, investment accounts or ownership of a business) can benefit greatly from separating their rental properties from their other assets by use of LLCs.
Of course, the property within the LLC is still subject to the liabilities of the LLC. If there is a lawsuit related to the property held in the LLC, the property itself can still be subject to any judgment associated with that lawsuit.
While the principles of liability protection by an LLC are appealing, they aren’t without limitations. Individuals can always be held responsible for their own acts of negligence, so keeping property in an LLC is does not always protect the members from their own bad or negligent actions. Additionally, much of the financial protection that LLCs offer can be accomplished through insurance.
Not only will lenders require minimum insurance coverage, but in the event of a lawsuit or claim, it is better to have cash paid out of an insurance policy than be forced to sell the property to pay for money damages.
A problem with relying solely on insurance as a protection from liabilities is that insurance policies have limits in the amount of damages they cover, and exceptions and limitations on the types of damages that are covered. Best practices call for property owners to both hold the property in an LLC, and to carry adequate insurance.
There are other drawbacks to an LLC. One of those drawbacks is the annual minimum Franchise Tax that the state of California assesses against LLCs and other corporate entities, which is currently $800 per year. For some, the Franchise Tax may make the LLC not worth the cost. Additionally, many lenders won’t lend to an LLC directly and at minimum will require LLC members to personally guarantee the debt.
Alex Myers is an attorney with Myers & Associates in Napa, and can be reached at alex@myers-associates.com or at 707-257-1185. The information provided in this column is not intended as legal advice, nor does it create an attorney-client relationship. The information is not a comprehensive analysis of the law — if you need legal advice you should contact an attorney.
This column originally ran in the Napa Valley Register on March 3rd, 2015. You can read it on the Register's website here: http://napavalleyregister.com/business/should-i-create-llc-for-rental-property/article_21e4c0ce-5cf3-5875-a9e8-7e3477beea82.html
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