Q: I own a number of single-family residences that I rent out to earn a bit of extra money. I own the houses myself and have a concern that I might be exposing my own home and other assets to risk if something bad happens at one of my rentals. One friend told me I should put the houses in a limited liability company, but another said as long as I have adequate insurance I should be all right. Is one better than the other?
A: Your question is obviously centered on the legal liability of owning rental property. What happens if a tenant or a visitor to the rental property is injured at the rental? I always touch on this subject when discussing the tax issues of owning rental property, but I also always advise that because this is a legal matter, a competent attorney should be consulted. So I have taken my own advice and have asked an attorney friend, Carla Ranum of Mathieu & Ranum PLLC, to offer some advice. Here is what she told me:
If you never have to pay a claim in excess of your liability insurance, and if your insurers never exclude a claim brought against you, then liability insurance may be enough. However, there is always the possibility your insurance may not cover the claim and you would have to pay the uncovered amount out of your personal assets. Placing the properties in an LLC, or better yet, a separate LLC for each property, can provide additional credit protection for claims not covered by your insurance. To exemplify how LLCs can protect you, let’s assume: Your total wealth is $950,000, consisting of three rental properties valued at $150,000 each and other assets valued at $500,000; you purchase liability insurance providing limits of $100,000 per occurrence, $500,000 in the aggregate; and a tenant or invitee of one of your rental properties successfully sues you for $700,000.
- If you do not place the rental properties in an LLC, then you would have to pay $600,000 of the claim out of your personal assets if your insurance policy covers $100,000 of the claim, or up to $700,000 if your liability insurance, for any reason, does not cover the claim. That is a significant portion of your total assets, and could force you to sell one or more of your rental properties to settle the lawsuit.
- If you place all of the rental properties in one LLC, then the creditor could reach all of the assets in the one LLC ($450,000 for all three properties). However, subject to certain qualifications, this $450,000 is the most the creditor should be able to reach even if your insurance does not cover the claim. The result is that you still may lose one or more of the rental properties.
- The best solution is that you place each rental property in a separate LLC. The creditor could only reach the assets in the LLC that owns the property ($150,000 for the one property). However, again, subject to certain qualifications, this is the most the creditor should receive even if your insurance does not cover the claim.
This example illustrates a claim arising out of the business of operating or owning the rental properties. LLCs also may enable you to protect your rental properties from liquidation in the face of creditor claims arising from lawsuits not related to your business but aimed at you personally for other actions. Further, the LLCs may also help in the negotiation of a reduced settlement with creditors (you are less inviting as a target).
Thanks, Carla. The bottom line is: Identify your potential risk and plan accordingly. Because there are many nuances and issues that can arise in the use and structuring of a business entity, it is best to speak with an experienced attorney in the course of setting up an LLC to hold a rental property or any business entity.
To ensure compliance imposed by IRS Circular 230, any U.S. federal tax advice contained in this article is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed by governmental tax authorities. The answers in this column are meant to offer general information. You should consult your tax adviser regarding the specifics of your situation.
Peter Robbins is a partner in the Boise office of CliftonLarsonAllen, LLP specializing in tax matters for small businesses, individuals, and trusts and estates.
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