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How to Form an LLC to Hold Your Rental Properties

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One of the most important activities of being a landlord is managing risk.  This is critical whether you have 2 rental properties or 20.  Obviously one part of this equation is having good landlord insurance that encompasses building, liability and umbrella insurance.  But the other part, which is less understood, is putting your properties into a legal entity to shield your personal assets.  And for most real estate investors, a single-person LLC (limited liability company) is the best legal entity for this purpose.

I won’t go into the nitty-gritty details of what an LLC is because you can find tons of information about this on my site and about 1 million others.  But it essentially provides the same level of protection as a ‘regular’ corporation but is easier to manage because your taxable income or loss flows through your personal tax return.  A good rule of thumb is to put up to 5 properties into a single LLC.  If you acquire more than 5 properties, it’s time to create a second LLC.

The process of actually creating an LLC is straightforward.  Either hire an attorney or do it yourself on, and in either case it’ll cost roughly $200-$300 for the initial setup plus a nominal annual corporation fee. Also, keep in mind that you can form your LLC in any state; you are not limited to incorporating in your home state.  I have my properties in a Delaware LLC even though I am based in NJ because the state of Delaware offers many tax advantages for businesses.  That said, you’ll probably want to do a little research to figure out the best state of incorporation for your own specific situation.

The process to actually place your properties into the LLC is a little less straightforward.  Simply put, unless you are investing in true commercial property, you will not be able to purchase a property in the name of an LLC.  Lenders will not put the mortgage in the name of your LLC even if you attach a personal guarantee.  As such, at the time of acquisition, your personal name will need to be on the title since that is what will be on the mortgage.

So what you will need to do is transfer the property’s title into your LLC a few months after closing (you’ll need to wait a few months to ensure the original title has been recorded with the local municipality).  This requires the filing of a quitclaim deed, and any attorney can do this for you for a nominal fee.  This will make the LLC the legal property owner.  Even though the mortgage will still be in your personal name, it doesn’t matter; what matters in terms of limiting your liability is that the LLC is the owner of record according to the deed.

One last piece of advice is to avoid using an escrow account with your mortgage lender to pay property taxes and insurance.  The reason is that this might clue the lender in to what you’re doing, and in rare circumstances the lender might have a problem with the transfer.  So, avoid the potential for headaches and do not use a mortgage escrow.

In the final analysis, aside from buying good, below market rental properties, the next most critical thing you’ll need to do is manage risk.  Just get the most insurance coverage you can afford, and hold your property titles in the name of your LLC, and you’ll effectively shield your personal assets. Good luck!

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