As a rental property owner, you are exposed to some potential hazards and liabilities. Through no fault of your own, a tenant could be injured at one of your properties and they may decide to litigate. Or a massive weather event could damage your property and you might need expensive repairs. So how would you protect yourself?
In the example of a tenant who tries to sue you, the most important thing you should do to protect yourself and your assets is to put your property under the ownership of an LLC, or limited liability corporation. If you are involved in any litigation, your home, personal savings and any other privately owned property or assets of yours are protected.
Forming an LLC is pretty straightforward. While the requirements and procedures vary from state to state, the process usually involves selecting a name for your LLC that no one else is using. Then you’ll file your articles of organization, which generally requires information about the company principals, which would be you and any of your partners. Some, but not all states will require an operating contract, which is essentially an agreement amongst the LLC members about the breakdown of responsibilities, obligations, and how profits and losses are distributed. The final thing you need to do to start your LLC is to obtain the business licenses and permits necessary for your industry. When you file your LLC documents, I recommend using a website that ends in “.gov” versus a “.com” site. .Gov sites are less expensive and there’s no real advantage to the .com sites.
Beyond the liability advantages, there are strong tax advantages to operating as an LLC. A real estate LLC can save you thousands of dollars. An LLC allows for pass-through taxation, which means that the business won’t be directly taxed. Instead, investors report their LLC’s profits or losses on their personal tax returns. In most cases, this will result in a lower rate for business owners and avoids double taxation.
One thing you should know is that if you finance your rental property, the borrower is the LLC, not you personally. This can be an obstacle, as lenders will be less inclined to rent to a new LLC as the borrower. Generally, lenders will want to see that this is a stable and solvent enterprise. In that case, you’ll need to establish your LLC and eventually transfer the ownership of your property to the LLC once it has established creditworthiness. This can take up to two years, so in the meantime you’ll need to protect yourself with insurance policies.
Insurance will be your one safeguard until you’re able to transfer the ownership to your LLC, so when you’re working with an insurance agent, make sure that they’re aware of this. You also want to talk to your insurance agent about insurance for fire, flood, or other natural disasters. We have seen catastrophic weather events with increasing regularity, so you don’t want to have your livelihood ruined by underestimating how much coverage you’ll need. Another safeguard is that I require my tenants to have renters’ insurance. In the event that their property is stolen or damaged, they can process claims through their own insurance.
