For tax purposes, an LLC can be treated as a sole proprietorship, a corporation or a partnership. While the LLC does not pay taxes, its members do. The Internal Revenue Service disregards, or ignores, unincorporated single-member LLC’s. The member pays taxes exactly the same as before. If two spouses are the sole members of an LLC, it may be treated as a partnership. However, when the only asset is real estate, tax reporting remains the same. Those with high incomes (above $150,000 Adjusted Gross Income) still cannot deduct a loss on real estate income even with an LLC. As a general rule of thumb, unless you are investing with multiple partners in a corporation, creating an LLC will not provide tax advantages.
Protection for Multiple Properties
Because all assets inside an LLC are at risk, a wise real estate investor will place only one property in each LLC. Should a “slip and fall” injury occur at one rental, the LLC limits liability to only that investment. Although losing a single property to a lawsuit might be devastating, losing multiple properties at once because they are inside a single LLC, is an even worse scenario.
Costs of creating an LLC vary by state, but it is generally less expensive than incorporating. For example, Massachusetts charges a $500 filing fee. In addition, they require an LLC to file an annual report for an additional $500 fee each year.
Other costs include consulting with an attorney and a tax professional. To comply with state and federal regulations, LLC members may need ongoing professional assistance with record-keeping and accounting.
Better than insurance
"Umbrella liability insurance" is another way to protect yourself from liability. This kind of high-deductible insurance only pays when other insurances have reached their limits, usually after the first $300,000 has been paid out on a claim. Relatively inexpensive, $1 million in coverage costs about $300 per year.
However, an investor can be sued for more than his insurance will cover. For example, if she purchases $2 million in umbrella insurance, but is found liable for $20 million in damages, she is left to make up the $18 million with her own personal assets. But with an LLC, only the investment property is at risk.
If a single rental property represents the majority of an individual’s wealth, the LLC may provide little additional protection. In this case, “umbrella liability insurance” may be all that's needed. All high net worth individuals should protect their personal assets with umbrella liability insurance, even with an LLC.
- real estate image by Andrei Merkulov from Fotolia.com