DISCLAIMER: This business planning process takes into account many variables and can be both a simple and complex issue - depending on your personal situation. This paper is offered only to provide you with some ideas and options. It is not legal advice. You should always consult with a local and licensed attorney for details and help with your individual situation.
If you’re a vacation rental property owner or considering the purchase of one, you’ve likely asked yourself, “Should I make my vacation rental an LLC?” There are pros and cons, but for most, the answer is NO. With enough liability insurance, your protection against guest liability issues is pretty secure; however, if you really think an LLC is right for you, please read on.
If you own multiple properties, have built-in liability issues like a private pool (indoor or outdoor), or if you have not adequately maintained walkways, stairs, or other areas prone to accidents, an LLC may be the correct option.
Why do small-business owners opt for an LLC vs a Simple Sole Proprietorship?
- As Asset Protection
Having a “business” in an LLC can protect you PERSONALLY from a lawsuit. In the event of a lawsuit related to your LLC, only the assets of that LLC can be at risk - not everything else you might own. In fact, it's hard (not impossible) for you to be personally named as a plaintiff. You can be named as an LLC’s “member,” but again, that is not you personally.
Let’s look at a real example…
Imagine one of your property guests was injured slipping on your walkway from the parking area to the front door. They go to the ER, get X-rays, maybe a cast, and are in pain. They find a personal injury attorney from a TV commercial and call. Next thing you know, you're being sued for a HUGE sum for actual damages and pain and suffering! If your vacation rental was held and titled under an LLC, only the LLC’s assets could be at risk - not anything else you own or are invested in.
- For Anonymity
Generally speaking, you can name your LLC anything you want. As it relates to your vacation rental property, THAT is the name on the tile. In the event someone goes searching for a property on a county or state property search website, the only thing a person can usually see is the LLC as the owner, so it keeps property ownership mostly anonymous!
I say mostlybecause an industrious person can go to the state's (where the LLC is domiciled) Secretary of State website and do a business search by name to find any and all public information about the LLC, including in a lot of instances the LLC members’ names, addresses, and who its Registered Agent is.
A note about Registered Agents:
ALL LLCs are required to have a Registered Agent. This is a person/entity who is open during ALL normal business hours and can accept official government correspondence or accept service of a court or regulatory summons if necessary. Many times the LLC organizer/member names themself as the Registered Agent. As long as physical addresses match (many states do not allow P.O. Boxes) and there is someone at that address every business day, there is no problem. Our advice is to engage the services of a commercial Registered Agent. Their fees are quite affordable and they know what they are doing and usually do a great job!
- To mitigate additional accounting issues and costs
MOST LLCs are set up as a “pass-through” entity, so any income generated from the vacation rental passes to the LLC’s owner or owners. This means that if you’re the sole owner of the vacation rental or you file a joint 1040 form, you’ll more than likely report and pay taxes the same way you do now.
If you’ve never had an LLC, you’ll learn about IRS Forms:
- 1040 (you’re already familiar with this!)
- Schedules C, E, and F
Having a GOOD local CPA can be a huge help for vacation rental property LLC owners for quarterly tax payments and annual tax return filings. Unless you really know what you’re doing, we’d strongly suggest having a licensed local accountant do that for you!
NOTE: If you decide to set your LLC up as a “subchapter S” corporation or a “subchapter C” corporation, this paper will not discuss those types. These are much more complex and are usually reserved for vacation rental property owners who have a large portfolio of properties or have other highly complex personal and business financial issues.
Creating an LLC Costs Money - is this a cost you want to incur?
It costs money to set up an LLC. Most owners use an online service like LegalZoom or engage the services of a local business attorney to help set them up and do the necessary filings. For their fee (between $99 and UP) they will create your Operating Documents, apply for your EIN, and file your docs with the Secretary of State’s office for the state you’ve chosen as your LLC’s State of Domicile. Laws and regulations vary from state to state. Some states are easier than others, so having a good local attorney is a must if you’re in one of those places!
If your rental property resides in another state other than the state you live in, you will need to determine in which state you should file your LLC. If you only have one rental property in another state, you could consider forming your LLC in that state. If you decide to form an LLC in your home state but have a property in another state, you may need to qualify for intrastate business. This means that you may have to pay taxes and meet the laws of the other state. Each situation is unique and may require different guidance.
MISCELLANEOUS TAXES AND FEES
So that you’re not surprised, some states have miscellaneous LLC related fees and taxes, including franchise, intangible property, excise, and annual filing renewal fees. Be sure you consider that when forming your LLC. Check with your accountant on these!
Re-titling from Personal Ownership to an LLC: Can you do it? What are the consequences?
Many people convert the ownership of their vacation rental to an LLC. This can usually be a pretty easy process using a “quit claim” deed; however, there are specific steps you must take, and there could be possible adverse tax and lender consequences.
If you’ve financed the purchase of your vacation rental property, your first call should be to your lender. You may have received preferential underwriting or interest rates - all reserved for personal buyers. With this in mind, though unlikely, your lender may require full repayment of the mortgage. There’s no guarantee that the lender won’t demand full repayment of the loan, which could require paying cash, refinancing, or selling the property.
So before making any decision, speak with your lender about their requirements. Understanding their requirements will help you make an educated decision if you decide to transfer the deed to an LLC.
Other possible adverse re-titling consequences:
Tax Consequences - While there can be certain tax benefits, there can also be certain tax consequences of moving property. You may incur a delayed tax consequence, or if multiple people own the property you could trigger a tax event for someone else. Make sure you speak with a CPA to fully understand how this could help or hurt you from a tax standpoint and consult with any partners to make sure it works for them.
Mortgage Rate Increases - Many owners of rental property will get a good rate on their mortgage by purchasing the property as an individual. If you later transfer the ownership over to a business, then you would likely no longer qualify for the much lower rates your lending institution gives to individuals. You probably have a legal obligation to share this transfer with your lender, but when they find out it could cost you a lot of money by your rate being increased.
Insurance Cost Increases - One thing that many people don’t consider when transferring property to an LLC or corporation is insurance. If the ownership of your property changes to a business, then your insurance carrier could make you change any current personal insurance policy to a commercial policy. We strongly suggest obtaining commercial level property insurance (structure, contents, liability, and loss of income) - something with higher limits - well beyond what a personal policy plan will cover.
Speaking of insurance...
We all know the costs of physical risks and perils to our property: fire, wind, rain, and other acts of nature. We understand theft, vandalism, and the resulting loss of use/income when one of these perils strike. But the biggest peril a vacation rental property owner faces is LIABILITY! All you need to do is watch TV and see all of the ads from attorneys looking for victims of accidents, injuries, and sickness - and those claims aren’t just limited to automobile or industrial mishaps. These happen at vacation rental properties too!
You need sufficient liability coverage to ensure that ANY claims are defended and covered by your insurer. Our suggestion is to have a MINIMUM of $1M of liability coverage. If you have a large lodge or a private pool, $2M is not out of the question. Having this level of coverage should take care of all claims that might arise. Want to learn more about vacation rental pretty insurance? We have a detailed paper on this as well. Just call or email and ask for it!
So, should you make your vacation rental an LLC?
As you can see, forming an LLC can be complex and difficult. If you want to limit your PERSONAL OR OTHER BUSINESS risk exposure, creating an LLC may be the protection you need. On the other hand, having a strong and high limit insurance policy may be all the protection you need. Every vacation rental property owner is different, so It’s always best to ask for guidance from your financial planner, CPA, or attorney to discover if an LLC is right for you and your vacation rental property.
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