Published May 27, 2021. Updated July 6, 2023.
Have you incorporated your real estate investment portfolio? There are different business entities that you could choose to protect your rental properties and business. When you invest in Detroit property, incorporating provides legal protection from certain liabilities and offers tax benefits to you as an investor.
Which business entity is best for rental property owners? Your lawyer and an expert property manager can help you choose the best business entity for your needs.
While this article isn't meant as legal, tax, or financial advice, our experts talk a bit about two types of incorporation to consider: an S Corp and the most common for real estate investors—the LLC. Here's what investors need to know about an LLC for rental property investments.
Why Incorporate Your Detroit Rental Properties?
If you currently operate your real estate investment portfolio (or even a single rental property) as a sole proprietor, your rentals, personal income, and assets are at risk.
A sole proprietor entity is a business owned by one person. Many new investors choose this non-incorporated way to operate investment properties because this business entity doesn't have to be legally registered with the state. While it’s simple and free to set up your sole proprietor business, it leaves you without critical protection from a resident lawsuit when you invest in Detroit property.
What many investors don't realize, tho, is that without legal incorporation with the right business entity, they could lose their rental property, investment income, personal income not related to the property, and assets if a lawsuit doesn't turn out in their favor.
However, by incorporating your properties with the right legal entity, investors separate personal income and assets from business income and assets. It's the best way to avoid losing everything when an unhappy renter or vendor wins a lawsuit against you.
What Is an LLC?
A Limited Liability Company (LLC) is a combination of corporation, partnership, and sole proprietorship for tax purposes. However, with an LLC in place, your rental properties and income stay separate from personal assets and income.
Creating an LLC for rental property investments is less complex than creating a corporation, but it offers many benefits that aren't available to other entities. Successful incorporation as an LLC protects you from personal liability regarding your rental property business.
When you invest in Detroit properties, this means that if someone has an accident and is injured on your investment property, they can't sue you personally for medical expenses and damages. They would have to sue your LLC business. So, an LLC protects your personal assets in case of a lawsuit.
Benefits of Creating an LLC for Rental Property Investments
Forming a Limited Liability Company (LLC) for your rental properties offers many advantages, primarily focused on liability protection, tax benefits, and enhanced management flexibility.
Liability Protection: As we mentioned, the most prominent benefit is the separation of personal and business assets. If your rental property incurs debt or faces legal action, your personal assets, like your home or savings, remain insulated. Only the assets within the LLC would be at risk, which can provide significant peace of mind.
Tax Benefits: Operating through an LLC allows you to take advantage of pass-through taxation. Instead of the income from the rental property being taxed at a corporate rate, it "passes through" to your individual tax return, avoiding double taxation. This can often lead to significant tax savings.
Ease of Management: An LLC offers more operational freedom compared to corporations, which are often burdened with extensive regulations and reporting requirements. This makes it easier to manage properties, make quick decisions, and adapt to market changes.
Simplified Transfer: Owning property through an LLC simplifies the process of transferring ownership. Whether you are transferring partial ownership to a family member or selling the entire property, conducting the transaction through an LLC can be less complicated than a personal sale.
Estate Planning: An LLC can serve as an effective vehicle for estate planning. It enables an easier transition of property ownership, and it may offer benefits in terms of inheritance and gift taxes.
Credibility: Operating under an LLC can lend credibility to your rental business, making it easier to work with vendors and attract tenants.
Incorporating as an LLC can add a layer of complexity to your financial operations. Still, the benefits often outweigh the downsides for property owners serious about long-term investment and protection.
Work With Your Accountant
Be sure to work with your accountant to understand and follow federal tax laws when applying an LLC incorporation to your Detroit real estate investment business. You'll also want to avoid commingling personal income or funds (i.e., keep a separate bank account for personal funds) with income from your rental properties in the LLC.
In most cases, setting up your LLC is simple and affordable. Your lawyer or accountant can walk you through the process of setting up a business name, filing the appropriate paperwork, and paying the fees.
Be sure you understand annual tax requirements and filings to maintain your company's legal status as an LLC. However, LLCs have fewer legal requirements and tax responsibilities compared to an S Corp. For these reasons (and others), most real estate investors prefer the simplicity, tax benefits, and protections of an LLC versus other types of incorporation.
Does Each Rental Property Need a Separate LLC?
It depends! It's primarily a personal preference decision, but putting each rental property into its own LLC does have some benefits.
The decision to form a new LLC as the business structure for each property boils down to weighing costs against benefits. While your attorney and accountant can help you arrive at the best decision for your goals, many investors create separate LLCs for individual properties.
It's also crucial to establish the LLC before making the purchase. This approach offers dual advantages: it shields personal assets and insulates each property from the financial and legal risks associated with the others. This means if one property is involved in a losing lawsuit, only the income from that property is impacted — not any income from other properties set up in their own LLCs.
This layered protection strategy can provide robust asset management and risk mitigation for serious property investors.
What Is an S Corp?
If an LLC doesn't seem quite right for you and you're building a significant real estate investment portfolio in Detroit, it might be worth considering an S Corp as your legal entity. However, with an S Corp comes more tax and reporting requirements that can become a hassle without the right counsel and property management help.
Consider an S Corporation if:
You plan to have shareholder investors in your real estate investment business
Your business will have only one class of stock
Your shareholders meet specific eligibility requirements
Your business is based in the U.S.
Building an extensive Detroit real estate portfolio to generate significant wealth often involves shareholders funding investment properties. Therefore, with larger portfolios, sometimes an LLC doesn't offer enough protection compared to the benefits of an S Corp.
However, be prepared to experience tax benefits that might not improve your take-home income at the end of the day. You'll also deal with shareholders, hold meetings, and deal with more government involvement in your tax and profit structure.
Use the Right Business Entity As Protection To Invest in Detroit Property
Own It Detroit helps investors create tremendous cash flow and thriving real estate investment portfolios. When you invest in Detroit property, our team can also help protect your properties and income and encourage the incorporation of your rentals with the right entity.
Whether you choose a few rental properties or have your goals set on a significant portfolio, our seasoned experts can help you successfully manage each investment! If you're ready to talk more about how a best-in-class real estate investment team can keep rentals safe and boost ROIs, let's connect.
Learn more about protecting your rental properties when you download a free copy of "Protecting Your Investment Property: A Guide."