Owning your rental Property in an LLC can be a smart decision as a property owner. An LLC can help reduce your overall personal liability, but with anything, it’s important to understand the benefits and drawbacks for your investment purposes.

What is an LLC?

A limited liability company (LLC) is a type of business structure. It combines the reduced liability of a corporation with the flexibility and relaxed format provided from a partnership or sole proprietorship.

An LLC can be created by a group or individual. When you own one, you are considered a “member” of that LLC.

Benefits of Creating an LLC for Your Rental Property

Limits Personal Liability - If your rental property is an LLC and someone files a lawsuit against you, then only your rental property is at stake, not your personal property or assets. In contrast, If you’re sued as an individual owner, then your personal assets could be at risk as well.

Individual Protection for Multiple Rentals - If you own multiple rentals, then you can set up a separate LLC for each one. This insulates each property from liability claims. For example, if one of your rental properties is sued, but each of your properties are set up under a different LLC, then only the one property being sued is at risk.

Pass-Through Taxation - Normally, a corporation is taxed directly on its profits and the owner is taxed again on their individual income, but with an LLC in most states, the company’s income will “pass-through” to you as the business owner. This means all income made from your rental property (LLC) will flow through to your individual tax return. It’s important to note that in Illinois there is a separate state tax directly on LLCs called a personal property replacement tax. Although there is an additional tax, the income percentage taxed on LLCs is less than the corporation tax percentage.

Easy Separation of Business and Personal Expenses - You’ll want to create a separate bank account for your LLC to make a clear distinction between your business and personal expenses. This makes it easier to claim business expenses for taxes because you’ll have separate bank statements.

When to Create an LLC

You can create an LLC before or after you purchase your rental property, but it’s less work if you do so before purchasing. If you already have a rental property and would like to convert it to an LLC, then below are some steps you should take.

Notify your mortgage lender that you’re transferring your title to the LLC. It might be hard to change your property to an LLC with an outstanding mortgage. Your lender may choose to close your existing loan and create a new one, possibly with an increased interest rate. In some cases, you might not qualify for a mortgage.
Notify your tenants the property is now owned by an LLC, and update your rental lease.

LLC Fees to Consider

When setting up an LLC, there is usually a small registration fee. You’re also required to fill out an annual report for your LLC. In Illinois, it costs $75 to submit annually.

Additionally, Illinois taxes your LLC directly. This tax is called a personal property replacement tax.

If you convert your rental to an LLC after the property is purchased, it might trigger additional taxes like a Title Transfer Tax as well.

Will an Umbrella Policy Offer the Same Protections as an LLC?

An umbrella insurance policy will help cover additional costs not covered by standard landlord insurance. For example, if you’re sued for $1 million, and your standard landlord insurance only covers $200,000, then umbrella insurance will help cover the remaining balance. This provides additional protection for you personally.

However, umbrella insurance still has a limit. If the lawsuit exceeds your umbrella policy’s coverage, then your personal assets will be at risk. With an LLC, your personal assets will never be vulnerable during a lawsuit against your LLC.

If you’re interested in owning your rental property in an LLC, here is a step-by-step guide for creating an LLC in Illinois by Nolo.com.

For more information about managing your rental property in the Chicagoland Area - give us a call! We’re happy to help with any of your rental property needs.