How to Transfer a Rental Property to an LLC

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Potential Cost Triggers

Transferring real estate to an LLC may trigger potential costs associated with the property technically changing hands from you (the individual) to you (the LLC member).

Transferring property to an LLC may trigger capital gains tax if the property’s value has appreciated since acquisition. And if you have claimed depreciation deductions on the property, transferring it to an LLC may result in recapturing some of those deductions.

If you plan to do a 1031 exchange in the future, transferring the property to an LLC may impact your eligibility for this strategy. Put simply, the law excludes LLC ownership interests from eligibility for 1031 exchanges.

If you’ve used other tax-saving strategies with the property in the past or you think you might want to in the future—you guessed it—consult a real estate attorney or tax professional in your state to help you fully understand the implications of moving the property into an LLC.

 

Deducting Business Expenses

The news isn’t all bad, though. Owning your rental property and conducting your business through an LLC allows you to deduct property expenses and ordinary business expenses from your taxable income.

It’s hard to overstate the power of being able to write off business expenses as tax deductions, especially when your business periodically involves five-figure repairs to your property. These deductions can make a huge impact on the amount of taxable income you report, and thus the taxes you owe.

For example, if you earn $50,000 of income from your rental property but have to pay $20,000 to replace a roof, your taxable income from the business for the year becomes $30,000—and your tax bill drops by thousands of dollars.

 

Pros and Cons of Holding Property in an LLC

Transferring rental property to an LLC has its pluses and minuses. Many real estate investors find that the benefits outweigh the headaches for them, but your mileage may vary, especially depending on your state’s tax laws.

 

Pros of Transferring Rental Property to an LLC

1. Personal Liability Protection: Transferring rental property to an LLC can safeguard your personal assets from potential lawsuits and claims related to the property. You never know what can happen, so holding your rental property in an LLC limits the amount of damage a potential lawsuit could do to you and the assets you’ve worked your whole life to accrue.

2. Tax Flexibility and Pass-through Taxation: LLCs offer pass-through taxation, allowing you to avoid double taxation and report rental income and expenses directly on your personal tax return. You’ll typically enjoy a more favorable tax rate on business income and have the option to deduct many everyday business expenses, lowering your overall tax burden.

3. Simplified Ownership Structure: LLCs allow for multiple owners and facilitates transfers of ownership interests if you work with co-owners or wish to sell shares of your rental business. It’s also helpful if you decide to bring on employees, such as a property manager, because the LLC can pay them rather than you paying them personally.

 

Cons of Transferring Rental Property to an LLC

Despite these advantages, transferring property to an LLC carries a few trade-offs and considerations worth noting before you pull the trigger.

1. Initial Costs and Taxes: Setting up an LLC involves formation costs, including state filing fees and legal expenses. The cost to file an LLC with the state is often negligible, but plan to also engage the services of a real estate attorney or accountant to help you execute a property transfer correctly. Additionally, many states charge taxes in one form or another whenever you transfer property.

2. May Invalidate Your Current Loan and Insurance Policies: Transferring your property to an LLC can invalidate the mortgage loan and owner’s title insurance policy you signed in your name. Many mortgages include a “due on sale” clause that can force you to pay the full mortgage amount immediately if you transfer the property incorrectly, so make sure you involve your lender in the process before you initiate the transfer. You’ll also need a new insurance policy in the LLC’s name. And because your brand new LLC doesn’t have the credit history you do, you may not be offered the same rates on new loans or insurance.

3. Difficulty Refinancing: Fannie Mae and Freddie Mac, the federally backed mortgage institutions, only guarantee loans issued to individuals, not to business entities. That discourages most residential mortgage lenders from working with you. You have options for financing LLC-owned rental properties, including refinancing with a commercial or portfolio lender, but these providers tend to offer less favorable rates and shorter terms lengths compared to residential mortgage lenders. Additionally, lenders may require a personal guarantee, which puts you personally on the hook to repay the loan in case of a default.

 

How Many Rental Properties Should I Put in 1 LLC?

There’s no one right answer to that question. You have to find a balance between liability protection versus cost and inconvenience.

You could create a new LLC for every single rental property. But those costs add up quickly, and you have to open separate bank accounts for each LLC, complete tax returns for each LLC, and so forth.

On the opposite extreme, you could create just one LLC to hold a dozen or more properties.

To strike a balance, I’ve known some real estate investors to put two to four properties in each LLC. That segments the risk to small portfolios — if you get hit with a nasty lawsuit, theoretically you contain the risk to just that small portfolio of properties. 

How many properties you put into a single LLC also depends on the size of the property. If you buy inexpensive single-family rental properties, you might put a handful into a single LLC. If you buy a 20-unit apartment building, you probably want a separate LLC for it. 

Find your own balance between protection, hassle, and cost.



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