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Should A Rental Property Be Put In An LLC?

Real Estate Attorneys for Landlords and Property Owners

This article summarizes the benefits and disadvantages to placing rental properties in a Limited Liability Company in the State of Illinois. A Limited Liability Company, or otherwise known as an “LLC”, is a hybrid between a partnership and a corporation. In Illinois, LLCs have increasingly become the favorite business entity for property owners.

What are the Benefits of an LLC?

There are three (3) major benefits on an Illinois Limited Liability Company or otherwise known as an “Illinois LLC” or “LLC”. The following is the first major benefit of an LLC:

1. Limited Liability Protection

The major benefit for rental property owners is limited liability protection. Simply put, this means that the business and the property owners are separate and distinct from one another. The basis of the LLC is to provide asset protection for the rental property owners.  A major concern for property owners is liability issues that may threaten the financial viability of a person or family. For example, lawsuits that typically deal with an LLC are limited to the business aspects of the corporation, rather than impacting a family’s assets such as other rental properties.

In 2008, we witnessed several multi-millionaires that were financially destroyed due to one negative mortgage or lawsuit that threatened their whole portfolio of rental properties. For instance, our firm represented an individual who was a multi-millionaire who decided to put the legal title of all his properties under his personal name, rather than the LLC. This decision ultimately puts this client at risk for liability and asset issues.

The benefit of creating separate LLCs for each rental property is autonomy from lawsuits. Lawsuits that threaten the financial viability of a particular rental property are limited to that specific rental property, rather than interfering with an entire real estate portfolio. When properties are legally titled under an individual’s name or a husband and wife’s name, one lawsuit and judgment will apply to all of the properties. This can be detrimental because one judgment will automatically attach to all of the properties and one cannot refinance or sale a property without paying off a lien.

Furthermore, the value of separate LLCs for each property is the ability to strategically default on one property if the loan or mortgage becomes unaffordable. Strategic defaulting on a mortgage is a last resort, but the COVID-19 crisis of 2020 has left  many rental property owners considering their financial best interests. Rental property owners will create different business bank accounts for each LLC, and then each LLC must be organized and run as separate business enterprises. In Illinois, a series LLC should be considered to simplify the annual report process and decrease the financial costs of owning and operating multiple LLCs.

2. Pass-Through Entity

An LLC is a pass-through entity, which means that for tax purposes the LLC is disregarded.  Disregarded for tax purposes means that the LLC is similar to a sole proprietorship. For tax purposes, a rental property owner will pay taxation based upon their individual tax return. Then, a Schedule E is filled out for property owners on their own individual or family tax return.

Unlike a corporation, the LLC does not have two separate taxes, which impact the profits of a corporation owner. With an LLC, all of the rental property income will flow through to the individual or family tax return of the rental property owners.

Rental property owners should consider using holding companies and subsidiary companies.  Put simply, there should be a parent LLC that owns child LLCs for each rental property under the parent company’s LLC.  Again, one of the benefits of separate LLCs is the ability to create different business deals with different investor or partners.

3. Flexibility and Management

A significant advantage of an LLC is its’ flexibility.  An LLC is a mix between a corporation and a partnership. A corporation has specific structure restraints, which limit one’s options such as management structure.  For instance, an S corporation has a limit on only one type of stock. In contrast, an LLC may develop multiple ownership options for active and passive investors.  An LLC is similar to a partnership because a partnership is solely restricted by its’ owner’s ingenuity.

For example, one of the major benefits of an LLC is the ability for a husband and wife to own an LLC without the liability concerns of both spouses owning the rental property. Often, we discourage spouses from owning properties together because it is simply an additional liability concern.  By operation of Illinois law, a husband and wife automatically have an ownership interests in each other’s rental properties.  Therefore, making one spouse a manager versus an owner has significant advantages without the liability risks.  We often organize the LLC into a safe spouse and high-risk spouse.  A safe spouse may have a W2 job where in case of liability concerns, their income must be protected from wage garnishment. In contrast, one spouse may have significant liability concerns while another spouse is a safe spouse with limited liability concerns.

 

Importance of an LLC Operating Agreement

An LLC Operating Agreement is a written agreement which describes the responsibilities and duties of Members and Managers.  In Illinois, an LLC is presumed to be a manager LLC. A manager LLC is operated and run by the managers of the LLC. A Member is essentially a business owner or a shareholder. A Manager is a person or entity that is elected by the Members to operate the day-to-day affairs of the rental property.

Our firm consults title companies with regards to their title insurance and legal risks involving LLCs and rental properties.  We review LLC Operating Agreements and organizational structures when rental property owners aim to refinance their properties or sale their properties.  In most instances, rental property owners fail to have a written LLC Operating Agreement, which details the ownership and management responsibilities of their property rental business.

An LLC Operating Agreement is vital because it minimizes liability concerns and details the ownership and management responsibilities of members and managers. Proper legal guidance is crucial because operating without an LLC Operating Agreement maximizes the liability exposure of property owners.

First, most LLC Operating Agreements fail to designate property distributions upon a death or incapacity.  This is problematic because probate concerns are significant if one member or manager is deceased.  Probate is the process in the State of Illinois of identifying the rightful owners and heirs of property interests.

Second, LLC Operating Agreements limit disputes among members and managers.  Often, a husband and wife will operate rental property, which significant liability exposure in case of lawsuits or insolvency. Bankruptcies and lawsuits threaten the family wealth of rental property owners. Utilizing the benefits of the LLC flexibility is structure is an important asset protection tool.

Third, an LLC Operating Agreement and proper resolutions make it easier to sell property and refinance mortgages swiftly. The LLC Operating Agreement and LLC Resolutions inform title companies and mortgage companies of the Members, Managers, and the powers of Members and Managers to sale property and refinance properties.

Annual Report for Limited Liability Companies

At least annually, LLC owners must file annual reports with the Illinois Secretary of State.  The filing fee is $150, which is a yearly maintenance cost. This cost may be deducted from one’s taxes, which minimizes one’s tax-related concerns. Generally, the filing fees for creating an LLC is $150 to $154 (with credit card fees). The charge to expedite an LLC filing is about $100.  An expedited filing means that the Secretary of State will recognize the LLC within one to two business days.

Use of Illinois Land Trust Coupled with LLCs

An Illinois Land Trust is an asset protection strategy to minimize one’s liability concerns.  An Illinois Land Trust protect one’s beneficial interests in a property by limiting liens and judgments being attached to rental property. An Illinois Land Trust has three major advantages for rental property owners.

The first benefit of an Illinois Land Trust is the ability to create a beneficiary upon a death.  A Land Trust operates similar to a life insurance policy where one may designate a beneficiary or beneficiaries of their rental property.

The second benefit of an Illinois Land Trust is the ability for the land trust to own the legal title of rental property.  With land trust, there are two distinct features, which are the legal title and beneficiary ownership interests. The legal title holder is generally Chicago Title Land Trust, which operates as the Trustee. As the Trustee, Chicago Title Land Trust is bound to follow the directions of the beneficial owners. Thus, the beneficiary of the Land Trust is truly the owner of the rental property. Therefore, the benefit of Chicago Title owning your legal property is increased asset protection. The Land Trust is distinct from your LLC or your individual (or joint names). Thus, liens and judgments against an individual or entity will find it more difficult to place a lien or judgment against a property.

The beneficiary of the Land Trust is usually an LLC or an individual’s name. The beneficiary of the land trust enjoys the usual benefits of property ownership.  The beneficiary instructs the legal owner of the property and the legal owner must comply with the wishes of the beneficial interest holders. The beneficial owners create the ability to sell the property or refinance the property similar to the property being in their individual or joint names.

The Land Trust and the LLC combined strategy is an effective asset protection mechanism for rental property owners. This strategy minimizes liability concerns by preventing liens and judgments from attaching to rental properties. Second, privacy and property ownership is private and difficult to ascertain under the right circumstances. Privacy is a crucial benefit of land trust.  However, privacy alone is just one feature of the land trust.

Real Estate Attorneys Throughout the Chicagoland Areas

Sean Robertson and Gateville Law Firm concentrate in real estate law throughout the Chicagoland areas. Our law firm operates virtually and does significant real estate business in the suburbs of Chicago. Our real estate and estate planning attorneys work collectively to maximize the profitability and asset protection of our rental property owners. Our real estate lawyers also assist rental property owners with their closing and eviction needs.

 

Contact Sean Robertson at 630-780-1034 to discuss your real estate needs.

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