Introduction
Incorporating a business as a Limited Liability Company (LLC) has also gained immense popularity among real estate investors as it offers more flexibility and legal shield. However, in the case of rental properties, LLCs are not the best choice of business structure. In this article, the disadvantages of LLC for rental property will be discussed in detail. Also the reasons for choosing other formations will be elaborated.
Disadvantages of LLC for Rental Property
Self-Employment Taxes
The members of an LLC are treated as independent contractors and are therefore required to pay taxes on their share of the LLC profits which are self-employment taxes. This may lead to a situation where tax rates are higher than other forms of organization structure.
Limited Access to Capital
It is also important to note that LLCs are pass through entities. This means that some investors will be discouraged from investing in a rental property LLC due to the lack of personal asset protection.
Complexity in Ownership Transfer
It is important to note that transferring ownership in an LLC can be a convoluted process. This may necessitate the consent of every member and can cause disagreements and morbidity.
Ensuring Rental Income: The Amount of Protection Offered is Limited
While LLCs are an effective way to shelter profits from rental property. But they are not ironclad and can leave rental income vulnerable to creditors.
Chances of Piercing the Corporate Shield
If the LLC is not properly managed and its existence is not backed up. The courts can pierce the LLC’s shield and hold the members accountable for the organization’s obligations.
Limited Tax Benefits
It does not have some of the tax advantages that are found in other types of entities such as depreciation and interest deductions.
Chances of Developing a Conflict among the Members of the Organization.
As the LLCs are managed by the members, it may sometimes cause problems such as the members’ disagreement with certain decisions.
Conclusion
However, LLCs are beneficial for rental property owners because of the limited liability protection and the flexibility they afford. However, there are disadvantages to the formation of LLCs. There are other types of business entities that can stand as alternatives to the above structures in the rental property business and these include S Corporations and Limited Partnerships among others. These structures have better tax shelters, and the process of transferring ownership is more manageable and efficient, besides, the income from rental business is well protected. It is best that real estate investors assess the risks and opportunities and consult with experts regarding the choice of legal entity that will house their rental property investments.
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