When you have valuable assets, significant costs or debt, or the possibility of someone getting hurt, a limited liability company (LLC) could help shield you from liability. Additionally, it can also help you with your taxes. For property owners, this business structure is commonly used to organize rental properties into separate LLCs with the goals of protecting personal assets.
A financial advisor could help you decide if an LLC is beneficial for tax and liability purposes, choose a tax classification and integrate it into your overall financial strategy.
What Is An LLC?
An LLC is a business structure governed by state law. This means that the specific details differ across jurisdictions, although most (if not all) states share the same general principals. Along with S-Corps and partnerships, the LLC is a common business structure option for individual property owners or small group owners.
As with other business structures, an LLC allows you to operate a business as a legal entity independent of the owners and operators. The company can hold its own bank accounts, own its own assets and is independently responsible for any debts and liabilities. This allows owners to operate a business without being personally exposed to the associated risks and costs, as long as they keep their business and personal assets strictly separated.
A limited liability company is relatively easy to form. Among other reasons, this makes it popular for landlords and rental property owners. In fact, it’s common for owners to form a separate LLC for each individual property, allowing them to separate the costs, debts and taxes of each unit while centralizing the profits. This creates a relatively efficient overall business structure that allows you to collectively operate a series of businesses without burdening the entire organization with an outlier’s poor performance.
What Are the Tax Benefits of an LLC For Rental Properties?
Generally, an LLC is taxed on what’s called a pass-through basis. This means that the company itself does not pay any taxes (LLCs that choose to be taxed as C corporations do pay their own taxes.) Instead, the business owner reports any income or losses on their personal tax returns and pays income taxes accordingly.
For an LLC with multiple members, the company does need to file an informational tax return with the IRS. This tells the tax agency how the LLC has divided its earnings among its members, to make sure that all income is reported accurately.
If you own a rental property, this tax structure allows you to access the liability protections of a small business while keeping the profits entirely as personal income. This can eliminate several (potentially costly) steps involved with other business structures.
For example, depending on the nature of your business, a C corporation might have to pay income taxes before passing along the remaining after-tax profits. This is known as the double taxation risk, in which first the company then you pay taxes on the same money, and is only associated with LLCs taxed as C corporations.
If your LLC gets taxed as a C or S corporation, you have to issue yourself formal paychecks. These can be subject to additional forms of income and payroll taxes. Members of LLCs not taxed as corporations may have to pay self-employment taxes on the business earnings. These payroll taxes may not be associated with the proceeds of rental property, however.
When you pay your taxes, you first reduce all of the property’s income by all of its associated expenses. For example, say your property brought in $2,500 in a month and you spent $750 on maintenance. You would claim $1,750 of taxable income.
Bottom Line
If you operate a rental property, it’s smart to form an LLC. This can protect you from potential liability associated with having third parties on your property. An LLC also separates personal and business assets, reducing personal financial risk. Additionally, it can offer flexibility in how rental income is taxed, depending on the chosen tax classification.
Real Estate Investment Tips
- A financial advisor can help you identify investment options and manage risk for your real estate portfolio. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- If you want to know how much you could pay in taxes for the sale on an investment, SmartAsset’s capital gains calculator can help you get an estimate.
Photo credit: ©iStock.com/miniseries, ©iStock.com/fizkes
The post What Are the Tax Benefits of an LLC for Rental Properties? appeared first on SmartReads by SmartAsset.