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Five reasons to sing “All I want for Christmas is an LLC” if you own rental real estate or AirBnB

Updated: Jul 23, 2019

It’s that time of year again -- Your neighbors get a little friendlier, family and friends start having Christmas parties, and the thought of losing weight can wait until January. With all those great home cooked meals who would want to lose weight now? Pass the eggnog!


Think about what you’re going to ask for the Holidays. Got it in your mind? Good. If you rent out your home using AirBnB or own rental real estate I hope you said an LLC. If not, then change it right now! I know what you’re thinking. An LLC is no fun, an LLC isn’t sexy, an LLC is so boring.


If you are renting out to tenants here are five reasons why you should ask for an LLC from good ol’ St. Nick.


5. Financing – When you have a mortgage in your personal name you may get better rates but if you default on your mortgage banks came come after you personally. You are personally responsible for paying back the mortgage after the bank forecloses on a property with a deficit.


An LLC to the rescue!

If you finance through your LLC, the LLC is on the line. The LLC is a separate legal entity from you and you are not on the line personally.


Special note on AirBnB – If you AirBnB your home check with your lender to make sure they can’t call in your loan in full if you rent out your home. It’s a scary wakeup call when a bank calls in your full loan because of renting out your home.


4. Flexibility – You probably rent to tenants because you want more flexibility in your life. More time with family, less time in the office, maybe even money for a nice vacation. An LLC helps give you that flexibility by keeping the real estate separate from your personal investments. You don’t have to co-mingle assets and expense then worry about what is business vs personal. The flexibility makes it much easier at tax time and gives you the freedom to live the way you want.


3. QBI – QB what? Is this about football? No sir, No ma’am. QBI or Qualified Business Income is a new deduction in the 2018 tax law change. Without going into too much detail, the QBI deduction allows you to take up to 20% of your business income. Guess what? Real estate investing may qualify for it. The QBI 20% deduction is offered to trade or businesses, and while it is hard to get real estate investing classified as a trade or business, an LLC shows the IRS that you are beginning to take the necessary things to run your enterprise like a business.


2. Tax deductions – Besides QBI mentioned in #4, the IRS allows real estate investors to take a variety of deductions on a Schedule E. Setting up an LLC is one of these deductions. As of writing this, the State of Illinois charges $150 to set up an LLC. That is a deductible cost.


You may have heard that an LLC needs to complete additional tax forms. With a Single Member LLC (SMLLC) that’s not the case. A SMLLC is known as a disregarded entity or pass-through entity. What this means is that your SMLLC does not pay tax on a separate level, rather it passes through to your personal taxes. This means you can still take all those great deductions on your Schedule E, while keeping yourself protected from liability.


1. Liability, Liability, Liability - I cannot stress this enough. Owning a rental property or renting your home with AirBnB puts you up for unlimited liability. Let’s say you have this not-so-great tenant and he trips and falls because of a faulty stair. He then gets a fancy lawyer who sues you for $500,000. Let’s go through two scenarios:


Scenario 1: No LLC – You try your best in court, but the judgement comes down and you owe $500,000. The rental real estate bank account has nowhere near that kind of money. The building is worth $400,000 and has a $100,000 mortgage. The building is sold, and the mortgage is paid off leaving you with a balance of $200,000. Since your real estate operations have no money the collectors come after your personal assets. This means your personal bank account, your personal residence, even your retirement accounts are up for grabs. You can even be forced to declare personal bankruptcy. Ouch!


Scenario 2: LLC – Same facts and figures as above but now you have your rental affairs run out of an LLC. The building is sold, and the mortgage is paid off leaving you with a balance of $200,000. The real estate operation has no money and declares bankruptcy. The bleeding stops there. Your personal assets go untouched and you continue contributing to your nice robust 401K. Phew!


You may be thinking -- retirement accounts? I am young, I don’t have that much. I have time to rebuild. Not so fast, a bankruptcy follows you around for seven to ten years and destroys your credit. Do you want to take a seven-year itch of bankruptcy? I sure don’t.


Another thing you may be thinking about is liability insurance instead on an LLC. Yes, liability insurance is important, it’s recommended with or without an LLC, and will kick in if you are sued. Here is the caveat, once you use your insurance your premiums will increase. Without an LLC, this is personal insurance. It can become expensive to re-insure yourself and your family. With an LLC it’s all about the business. Personal insurance isn’t a factor and can save you money.


Conclusion:

I’ll admit, you may be able to save money in the short term by not incorporating under an LLC, but in the long run an LLC offers many advantages that more than pay for themselves, especially if an unfortunate event happens and a lawyer comes knocking at your door.


Put aside the 4K TV this year and make sure to ask for an LLC.

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