The suitable business structure for your rental property is dependent on the direction of your business and your goals. Using an LLC for your rental property could be lucrative, but there is a downside to it.
Once you have prioritized your preferences as a property owner, this article will enable you to weigh the options by clearly elaborating the cons of using an LLC.
Learn –> How to Invest in Real Estate, Make More Money and Retire Early
Some of the reasons as to why you may not want to use an LLC are:
#1 Financing bank Loan Difficulty
An LLC will have a hard time getting loans from banks due to liability shield. Banks have reservations about approving loans due to the limited liability clause. Lenders want someone to be personally liable. Due to this, financing property as an LLC is a bit challenging.
Another reason for frustration in financing bank loans is that banks give loans at a higher interest rate to LLCs than individuals. Moreover, you may need to take a commercial loan with less favorable terms—for example, a much more prominent down payment and a shorter time.
#2 Setup Costs
There is a cost to creating and maintaining the entity you establish. The fee may vary depending on how you decide to start the company. You may choose to make it on your own, use a lawyer or an online company.
You will need to pay charges for filing, enlisting a lawyer, hiring a registered agent, among other miscellaneous costs.
Resources:
- Real Estate Investing School: How to Retire on Passive Income
- How to Increase Your Income and Master Your Money (Saving, Investing, Taxes)
#3 Limitation to the Limited Liability
Limited liability primarily applies when there is a lawsuit against the LLC and you have not separated business and personal records. The judge may rule that the business structure does not protect your assets.
It is good to make sure that the LLC as an operating entity is different from the LLC members. Otherwise, investors will suffer the loss of protection the LLC gives.
#4 Member Turnover Question
In case of the death of one of the owners, LLC continuity stipulates that there will be a transfer of the property to other partners. If you were a sole owner, the company might have to dissolve, leaving LLC debts and accounts to be dealt with by your next of kin.
Bankruptcy or the death of one of the members can cause the dissolution of the LLC structure for real estate. It can also be dissolved if one of the members decides to leave.
Learn –> How to Invest in Real Estate, Make More Money and Retire Early
#5 Difficulty in Raising Capital
Owners of LLCs are not allowed to sell, buy or trade equity. Investors hesitate to invest in this business structure. It is challenging to attract investors with this business structure. You are responsible for the resources required to maintain or purchase rental properties.
Procuring equity and debts is usually tricky for LLCs. S-Corp and C-Corp provide more opportunities to raise funds compared to LLC.
#6 Tax Responsibilities
Depending on the state you register your LLC in, you may need to pay excise or franchise taxes or both. A sole member LLC faces similar tax obligations as a sole proprietor or as an organization.
You may benefit from a similar gain as a partnership or sole proprietor. However, you are still required to do a different tax filing for the business, which is not usually necessary in other structures. There are also self-employment taxes to pay.
#7 Maintenance Fee
There are financial implications of running an LLC. You need to pay annual real estate LLC fees, renewal fees, business taxes, and other local fees.
Governing agencies usually demand that operational LLCs files an annual renewal notice as a constituent of administrative maintenance responsibilities.
#8 No perpetual Existence
Most states in the US need members of the LLC to establish a limit for the company’s existence. This business structure has strict regulations on the transfer of ownership stake in case a partner pulls out.
This means that a Limited Liability Company may cease to exist even in the absence of such a clause.
#9 Confusion across States
Various states have different regulations for setting up an LLC. Various business structures are registered with States and not Federal agencies, and therefore, there could be confusion due to differences in local laws and regulations.
If you do business in different states, it might be hard to understand and follow the requirements for the various forms of business structures.
#10 You Require Different LLCs for each State You Own Property.
If you own rental properties in different states, you have to file for a limited liability company formation in each state you intend to protect yourself. This is because LLCs are registered with the state.
If you do not do multiple filings, anyone from other than your state of residence may access your assets and finances if they become a creditor.
Overall, it would be best to evaluate whether using an LLC for your property is the right move for you. It is good to make an informed decision about your investment.
Take a Course On Money & Investing
- Real Estate Investing School: How to Retire on Passive Income
- How to Increase Your Income and Master Your Money (Saving, Investing, Taxes)
Or sign up for my weekly email newsletter to get tips and lessons sent to your inbox.
