If you own rental property or are considering investing in real estate, choosing the right business structure is an important decision. Many small businesses choose to operate as a limited liability company (LLC), but is this the right structure for you? Keep reading to learn what a real estate LLC is, how to form one, the benefits, and how it’s taxed.
What is a real estate LLC for rental property?
A limited liability company, or LLC, is a business structure that can help small business owners reduce liability by separating personal assets from business finances. When a small business chooses to operate as a real estate LLC, the rental property is owned by the business rather than the individual owners.
Why do real estate investors use LLCs instead of other business structures?
One of the main reasons real estate investors use LLCs instead of other business structures is because of liability protection. If you’re a small business owner, you know how important it is to protect your personal assets, and an LLC can do exactly that. As we mentioned above, when you choose to operate as a rental real estate LLC, the rental property or properties are owned by the business, instead of directly by you. This creates a separation between your personal assets and the rental property.
Legal issues can happen, and in the case that a tenant sues you, you’ll want your personal assets, like your bank account, home, and vehicle, protected from liability. With an LLC, your assets may be protected if any legal actions are taken against you. However, you should keep in mind that an LLC provides limited liability protection, meaning protection isn’t necessarily guaranteed.
Benefits of an LLC for rental property
Aside from personal liability protection, LLCs offer several other benefits, including:
Business credibility
Operating as an LLC can make your small business appear more legitimate to potential tenants, contractors, lenders, and partners.
Separation of finances
As mentioned above, a real estate LLC will separate your personal finances from your business finances. This separation can make tracking your income and expenses easier, as well as your tax reporting.
Flexible tax treatment
Rental income earned through an LLC is typically taxed as pass-through income. We’ll explain this further later.
How to form a real estate LLC for rental properties
Forming a real estate LLC for rental properties is a relatively simple process. The exact steps vary by state, and it’s important that you check your state’s website for its specific requirements.
These are some of the common steps to forming a real estate LLC:
Choose a business name. Aside from choosing a business name that fits your brand, you’ll need to ensure it’s available and legally compliant with your state’s registry.
File articles of organization. This document includes basic identifying information about you, your partners, and your registered agent, as well as the name of the LLC and other key details about the business. You may have to pay a filing fee.
Create an operating agreement (required for some states). This document includes more granular details about the LLC, such as funding, investor information, profit distribution, management plans, and more. This is required by California, New York, Delaware, Maine, and Missouri.
Apply for an Employer Identification Number (EIN). You can do this online via IRS.gov or by mail via Form SS-4, the Application for Employer Identification Number.
Choose a tax classification (optional). The IRS will default your tax classification based on the number of members you have, but you can choose your classification by filing Form 8832, Entity Classification Election.
Open a separate business bank account. You’ll need to keep your personal bank account separate from your business account.
How are LLCs taxed for real estate property income?
LLCs are typically considered pass-through entities, meaning profits and losses pass through to the owners, who pay taxes on their individual tax returns.
Single-member LLCs are generally treated as disregarded entities for federal income tax purposes and report on Schedule E for Form 1040, while multi-member LLCs file as partnerships on Form 1065, and file Schedule K-1s for each partner to report on their individual tax returns.
The IRS automatically declares these tax classifications based on the number of members in the LLC. As mentioned above, you can also choose your tax classification by filing Form 8832.
If choosing a tax classification, a single-member or multi-member LLC can elect to be treated as a corporation. Corporations file Form 1120, U.S. Corporation Income Tax Return. However, becoming a C corp can subject the LLC to double taxation, as it would lose its pass-through status. To maintain pass-through status, the LLC can elect to be treated as an S corporation. Similar to partnerships, S corporations file Form 1120-S and distribute Schedule K-1s to their shareholders. The LLC must file Form 2553, Election as a Small Business Corporation, to become an S corp.
Can an LLC help reduce taxes on rental income?
There are a few ways owning rental property through an LLC can help reduce taxes on rental income, depending on your situation and how the LLC is structured.
Pass-through taxation. Most LLCs are considered pass-through entities for federal tax purposes. This means the LLC itself doesn’t pay entity-level tax, but the owners still pay federal income tax on rental income. This setup can simplify taxes and help avoid an extra layer of taxation.
No double taxation. Unless electing to be a C corporation, LLCs generally aren’t subject to double taxation. With a C corporation, income can be taxed once at the business level and again when distributed to owners as dividends. An LLC typically avoids this because profits are taxed only once, which is on the owner’s personal tax return.
Business deductions for rental expenses. Rental property owners operating through an LLC can deduct many ordinary and necessary business expenses, which may reduce taxable rental income. Common deductions include mortgage interest, property taxes, repairs and maintenance, property management fees, and more.
FAQs
The bottom line
Choosing to open an LLC for rental property can be a great business structure for rental business owners. LLCs can help reduce liability exposure, potentially lower taxes on rental income, and build credibility for businesses, while keeping your personal assets separate from your business finances.
Whether you’re self-employed, a partnership, or an S corp, you can easily file your business returns and distribute Schedule K-1s with TaxAct®.
File your return with TaxAct so you can report your entity’s income and expenses with confidence.
This article is for informational purposes only and not legal or financial advice.
All TaxAct offers, products and services are subject to applicable terms and conditions.
