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- As the entity name implies, choosing an LLC for your rental activities protects your personal and other business assets from business and judgment creditors of the LLC. For example, if you contribute a residential rental property to the LLC upon formation, this contribution represents the maximum loss you can incur. This is because all debts that the LLC incurs are not the responsibility of the individual owners or members of the LLC. In the event the LLC has insufficient funds to pay a creditor or a lawsuit judgment, the creditor can place liens on the rental residence, but not on your personal assets, such as your home and bank accounts.
- An LLC is also a good business entity choice if you ever want to admit new owners as a way to raise capital. Suppose you start your LLC with one rental residence and some years down the road you decide to seek out investors. By admitting new investors as members of the LLC, you can raise capital without having to borrow funds from a bank and paying interest. The flexibility of the LLC structure allows you to admit new members quickly and easily. However, once the LLC has more than one member, all owners must agree to admit future investors or draft an operating agreement that provides the procedures for doing so. The end result is that you can grow your LLC from operating one rental residence to being a real estate conglomerate.
- Immediately after you create an LLC for the rental residence, the IRS designates it as a partnership for tax purposes unless you are the sole owner. If you are the sole owner, the automatic designation is a sole proprietorship. In both cases, the LLC is subject to pass-through taxation. This principle requires the owners to report all of the LLC's taxable income and deductions on their personal tax returns in proportion to their ownership interest. For example, if you are the sole owner, you will report 100 percent of the LLC's income and deductions on a Schedule C attachment to your personal return. And if the LLC uses partnership taxation, the LLC gives each partner a Schedule K-1, which reports their share of income and deductions, which you must report on a Schedule E attachment to your return.
- As an alternative, you can elect to treat the LLC as a corporation for tax purposes by making the election on Form 8832. When you do, the IRS will treat the LLC as a completely separate taxpayer that reports and pays tax apart from its owners. The LLC must then file an annual tax return on Form 1120 or 1120A each year, regardless of whether it earns income.
Limitations on Liability
Expanding Rental Business
Pass-Through Taxation
Corporate Taxation
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