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January, 2006 Tax Tip

Use an LLC For Your Rental Property

While I believe the primary reason a person should not own appreciating assets such as real estate in his or her individual name is its exposure to creditor claims, tax advantages are also very important.  Therefore, it is necessary to look to a business structure that will offer the best marriage of asset protection and tax-savings advantages.  A C corporation is not advisable as it is a separately taxed entity thereby creating the potential for double taxation on its profits – once when the corporation operates or sells the asset and realizes a profit, and again when that profit is taken out of the corporation as salary, dividend, etc.

In most cases I recommend that an LLC be used as the preferred entity to hold and operate the asset.  This structure offers the desired combination of tax savings and legal protection.  Because an LLC isn’t taxed at the corporate level (although an election can be made to do so), you will only wind up paying taxes on the operation or sale of assets once – at the personal level on the 1040.  It also is great from an asset protection standpoint because most state laws provide that your ownership interests in an LLC can’t be seized by creditors.   Therefore, if you should be sued and have a judgment entered against you, all of the assets held in your LLC would be safe from judgment creditors.   It would indeed be disastrous to lose your valuable (likely nest egg) assets in a lawsuit judgment against you. 

Would an S corporation serve just as well as the vehicle to hold real estate and other appreciating assets?   After all, it offers pretty much the same tax benefits and asset protection as does an LLC.   From a protection standpoint, “pretty much the same” is not “the same”.   While your ownership interest in an LLC can be protected from a creditor, that is not the case for your ownership shares in either a C or an S Corporation.  Your shares in either of these entities can be seized by a judgment creditor, meaning that if you can’t otherwise pay off a judgment against you a creditor can seize your shares – and through them, get to all of the assets owned by the C or S Corporation.   That is why it is rarely recommended that corporations hold real estate and other appreciating assets.

In this litigious society one never knows when or where the next lawsuit may come from so, if you haven’t already done so, get your valuable assets into LLC’s.  If you have more than one rental property, I strongly advise you to use a separate LLC for each property.  Otherwise you are assuming more risk than necessary.  If a creditor should sue and obtain a judgment against your LLC, he can seize all assets owned by that LLC to satisfy the judgment.





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