When investing in a short term rental (STR), deciding how to take title is crucial. One popular option is to purchase the property in the name of a Limited Liability Company (LLC). While this structure offers several benefits, it also comes with certain challenges and costs. Before making this decision, it’s important to weigh the pros and cons carefully.
Disclaimer
The author is neither an attorney nor a CPA. This blog post is intended for informational purposes only, and readers should consult with proper professionals before deciding how to take title to a property.
Benefits of Purchasing a Short Term Rental in an LLC
Liability Protection One of the primary reasons investors choose to purchase property through an LLC is the protection it offers from personal liability. If someone were to file a lawsuit related to your rental property, having it owned by an LLC can shield your personal assets from being at risk. This means that, in most cases, your personal savings, home, and other investments will remain protected.
Professional Image Owning a rental property through an LLC can give you a more professional image. This is especially useful if you plan to expand your real estate portfolio or work with vendors and other industry professionals. An LLC can make your business seem more credible and organized. It's also imperative if you have multiple unrelated co-owners.
DSCR Loan Eligibility Most DSCR lenders require that the property be owned in the name of an LLC. Common practice among many of my clients is to write the offer in the name of the owner and or assignees. This allows us to change the name on the contract to a newly named LLC between the time it goes under-contract and closing.
Pass-Through Taxation LLCs often enjoy pass-through taxation, meaning that the profits and losses of the business are reported on the owners' personal tax returns. This can simplify the tax process and potentially offer tax savings, depending on your specific situation.
Pitfalls of Purchasing a Short Term Rental in an LLC
Piercing the Corporate Veil While an LLC offers liability protection, there is a concept known as "piercing the corporate veil." This occurs when a court determines that the LLC's owners should be held personally liable for the business's actions or debts. This typically happens if the owners fail to maintain the LLC as a separate entity from their personal affairs. For example, commingling personal and business finances or failing to properly document business activities could lead to the veil being pierced, putting your personal assets at risk.
Challenges in Obtaining Financing Financing a property through an LLC can be more challenging than obtaining a loan in your personal name. Many traditional lenders are hesitant to lend to LLCs, especially if the business is newly formed or lacks a financial track record. If you do find a lender willing to work with your LLC, you may face higher interest rates or stricter terms compared to personal loans.
Formation and Maintenance Costs Starting and maintaining an LLC involves costs and administrative tasks. You'll need to pay state filing fees, which vary depending on your location, and possibly annual maintenance fees to keep the LLC in good standing. Additionally, there may be costs associated with hiring professionals to help set up the LLC, such as attorneys or accountants. These expenses can add up, particularly if you are managing multiple properties.
Ongoing Compliance Requirements Operating an LLC requires ongoing compliance with state regulations. This might include filing annual reports, keeping accurate records, and adhering to tax obligations. Failure to meet these requirements could result in penalties or the dissolution of your LLC.
The Bottom Line
Purchasing a short term rental in the name of an LLC can offer significant benefits, particularly when it comes to liability protection and tax advantages. However, it's not without its challenges, most notably, difficulties securing financing, and ongoing costs and compliance requirements.
Before deciding to take title to a property in an LLC, it's essential to consult with a qualified attorney and CPA to understand the specific implications for your situation. By doing so, you can make an informed decision that aligns with your financial goals and risk tolerance.
