Renting out a house is simultaneously one of most conservative and the most worrying risks you can take. This is especially true if it’s your first time doing so. Everybody needs a place to live whether the stock market is skyrocketing or it’s plunging downward. But that doesn’t mean they’ll rent your house at your set price; and an empty house is an expensive monthly expense.
Renting out properties has other risks besides the worry about whether you’ll always have tenants or not. Those risks range from small expenses to large lawsuits, which is why many real estate investors recommend forming an LLC for your rental business. Unless you form an LLC, or limited liability company, you are considered a sole proprietor almost by default; and that means your personal assets will be tied up in any problems.
Here are five reasons why an LLC should be high on your priority list once you start buying and renting out residences.
1. Protect your personal assets from economic downswings.
Whether it’s just a temporary downswing or the economy tips into a recession, that will impact your business. If your properties have variable rate mortgages, those interest rates might go up. Your current tenants might lose their jobs and your houses may sit empty for a few months. Eventually, extra expenses and low revenue could mean you can’t pay the mortgage, any loans for repair, and other outstanding debts from your rental business.
The bank may start by foreclosing on the house. But if that’s not enough and you have a sole proprietorship, creditors can come after your personal assets. You might go from renting your house out to renting an apartment!
2. Limit your personal liability due to lawsuits.
Real estate investors are also vulnerable to legal action. If you’re new to the business, you’re going to make mistakes. That could range from having a deck not up to code to accidentally violating fair housing laws when choosing tenants. The US is a litigious country, and suing for both real and imagined infractions is a common course of action.
While having an LLC doesn’t prevent tenants from suing you personally, it creates an official barrier that limits your liability. Using a combination of an LLC and an umbrella coverage policy should stop suits and claims from impacting your personal finances.
3. You want peace of mind.
Once you’ve heard one horror story about a tenant suing someone you know, there might always be a small trace of worry in the back of your mind. If the thought of potential lawsuits is giving you anxiety, don’t give up on the idea of real estate investment. Finding established ways of protecting yourself and your business can give you the peace of mind you need to keep going.
4. Consider multiple LLCs if you have lots of houses to rent.
An LLC is a great tool for separating your personal assets from your business assets, especially as your business grows from having one house to rent out to several. But once you start buying up tens of residences or buy your first multi-family property, consider splitting up your properties into multiple LLCs. This is also a good way to organize your investments if you start having properties in different regions. Just like you originally needed an LLC to protect your personal assets from potential losses from your business, you can separate the risks of one set of properties from another.
5. Make everything official when you have partners.
Working with partners is always complicated, even when the benefits outweigh the downsides. If you have strictly business relationships with your partners, an LLC should be your first go-to move to establish trust and transparency. If you’re going in on a house with a friend or a family member, an LLC is even more important. Nothing can sour a relationship faster than miscommunications about money and responsibilities.
Once you decide an LLC is the right next step for your business, make sure you do it right. Contact our team at Dungan & LeFevre. Our legal professionals can walk you through the process to make sure everything is filed correctly and your burgeoning company is ready to grow.
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