Owning rental real estate can be a great investment. If you have a mortgage on the property, you can use the rental payments you receive to pay your mortgage. Your tenant is essentially paying your mortgage off while you build equity in the property.
However, owning rental property comes with risks. There are tenants who slip and fall, guests who claim injuries, and plumbing that causes water damage. The list goes on and on. Having enough insurance coverage is a top priority, but you should also own the property in a way that will limit your liability and sync with your estate plan.
How you hold title to the real estate is important. If you own the property in your name alone, you can personally be held liable for any damages or injuries that occur there. That means all your other assets (i.e., your home and savings) could be at risk, not just the rental real estate.
Placing the real estate in a trust offers you some privacy (assuming you are not named as the trustee). It may take an injured party a little more effort to identity you; however, if the trust is revocable (meaning you can change or amend it whenever you want), a court will most likely find that you are the owner of the property, and your personal assets will most likely be reached as part of a lawsuit if you are found liable.
Consider holding the property in a limited liability company (LLC) which, when structured properly, allows you to manage the property while protecting your personal assets if you are sued. It can also maximize your estate plan by avoiding probate and allowing for continuity of control if you are incapacitated. Here are 10 important considerations for owning the property in an LLC.
· The LLC is a type of corporate entity. You will need to create the LLC at your secretary of state’s office. The rental property will then need to be deeded into the LLC. In the event that the LLC is sued, the LLC’s liability is limited to its assets which will most likely consist of the rental property and a checking account.
• You can be the manager of the LLC, meaning that you will run and manage the day-to-day operations of the LLC. The owner of the LLC is called the member (it’s similar to a stockholder). You can be the sole member of the LLC, or you and your spouse can both be members, each owning a 50% membership interest.
· If you and your spouse have established revocable trusts as part of your estate planning, each of your trusts should hold a 50% membership interest. This is important as it will avoid probate of the LLC interest in the event of your death. It also allows the successor trustee to take any required action on behalf of your membership interest if you are incapacitated.
· Once the LLC is established, you will need to obtain a tax identification number and open a checking account in the name of the LLC.
· Your rental agreement with your tenant will run between the tenant and the LLC. The tenant will make the rent checks payable to the LLC and you will need to deposit them in the LLC’s checking account.
· You will also need to update your property and casualty insurance carrier as to the transfer since the property will have a new owner.
· If you own title insurance on the property, you will need to let the title company know about the transfer so that a title insurance endorsement can be prepared.
· If you have a mortgage on the property, you will need to speak with your lender as some lenders will not let you hold title in an LLC, or they may charge you a higher interest rate on your mortgage.
· Make sure your accountant knows about your LLC so the necessary tax filings can be prepared at tax time.
· Don’t forget to file annual reports for the LLC or your entity will be dissolved. This can usually be done by you, your attorney or your accountant.