Limited Liability Company Protection for Landlords

For protection of personal assets, forming a limited liability company (or LLC) can be a wise move for a landlord to make. An LLC can be like "having the best of both worlds" because it can provide the personal protection of a corporation, but without all the complexities and tax complications of a corporation. In this regard, an LLC is like a cross between a corporation and a basic sole proprietorship or partnership.

The rationale behind creating an LLC is to protect and shield from creditors the personal assets of its owners, who are commonly referred to as "members". If the business affairs of the LLC are conducted correctly and without fraud, then the members will not be liable for the debts of the company. Their only liability would be equal to their individual investments in the LLC. The exception to this would be if they personally guarantee the debts of the limited liability company.

LLCs are created with a document called the "articles of organization" which is specified publicly by the state where the limited liability company is formed. Also, members of the limited liability company commonly specify and adopt an "operating agreement" for running the company.

Individual landlords who act as "sole proprietors" or "partnerships" are essentially operating in "naked form" without limited liability protection. Now that all states allow one-member LLCs, it creates the perfect opportunity for a small landlord to become an LLC and gain the protection of a corporation while still being treated (for tax purposes) like a sole proprietor. This is because the IRS, in this situation, basically ignores the existence of the LLC by treating its income as being earned as a sole proprietorship.

This is a huge advantage because it provides corporate-like liability protection without the tax formalities that are associated with regular corporations. A one-member LLC that passively invests in rental property would report its income and expenses directly on the owner's (or member's) Schedule E federal income tax form of their tax return.

Basic Advantages of LLCs

• LLCs can have one owner (member) or an unlimited number of owners (members),
• An annual general meeting of owners is not required,
• LLC members are protected from liability for the acts and debts of the LLC,
• By "default tax classification", profits are passed through and taxed at the member's personal tax level, not at the LLC level,
• Far less record keeping and administrative paperwork involved,
• LLCs offer "check-the-box" options for taxation. They can elect to be taxed as a sole proprietor, partnership or corporation, and
• LLCs can have "pass-through" taxation. This prevents double taxation unless the LLC chooses to be taxed as a corporation using IRS Form 8832.

General Disadvantages of LLCs

• Many states levy an annual "franchise tax" or capital values tax on LLCs,
• Members who operate their LLCs without an "operating agreement" may run into problems if the liability protection provided by the LLC is challenged,
• It may be confusing to determine which LLC member has the authority to execute a contract on behalf of the LLC,
• Investors may be uncomfortable with investing in LLCs rather than their "more familiar" corporate counterparts. Corporations can conduct "IPOs" by issuing stocks to the public - LLCs do not offer this benefit,
• Income produced by the LLC which is received by members is taxed at ordinary income tax rates and is subject to FICA tax, and
• Unlike an S-corporation, earnings from an LLC are subject to self-employment tax.

Because limited liability companies are formed at the state level, their rules can vary for each state. Before deciding to form an LLC, you should seek professional advice from your accountant or tax professional.

For more in-depth information about limited liability company protection, please visit The Landlord's Library book collection. It's a terrific, one-stop source for practical, comprehensive information on the entire subject of residential landlording.

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