Tuesday, March 2, 2010

WHY IS AN LLC THE BEST WAY TO HOLD TITLE TO RENTAL PROPERTY?

An LLC is the best way to hold title to investment (rental) property for two reasons:

First, a California Limited Liability Company (LLC) offers its owner-members the same limited liability protection as a corporation.  Cal. Corp. Code Sec. 17101(a). 

Even if you have insurance, a judgment may exceed the insurance coverage, and if the property is your individual name, the judgment creditor/claimaint will be able to attach your personal assets (including other properties, your home, bank accounts, stocks, etc.) to satisfy the judgment.  If the owner of the property is the LLC, the judgment creditor may only attach the assets of the LLC, not the other assets of the member-owner of the LLC not owned by the LLC.

If you own multiple investment properties, it may be adviseable to have a separate LLC own each of the separate properties.  In the event of a judgment against one LLC, the judgment creditor can only go after the assets of the defendant LLC, and not the other LLC's.

Second, there are several tax advantages for holding title to the rental property as an LLC.   Like a sole proprietorship or partnership, a California LLC enjoys pass-through taxation.  This means that owners (known as "members") report their share of the income or losses on their individual returns.

A single-owner LLC offers the benefit of being automatically classified as a sole proprietorship, meaning that the owner reports the LLC's income or losses on his or her own personal return.

While it is true that an S-Corporation can do both of the above, S-Corps have a negative tax treatment when the the shareholders (owners) of the S-Corp want to transfer the asset to other entity, or sell the property in exchange for a another property to be held by the S-Corp because the sale or transfer would immediately trigger the capital gains tax on the fair market value of the asset minus its basis.  Also, any losses that may have been realized by the sale are limited to the shareholder's basis in the S-Corp. 

Moreover, the S-Corporation cannot take advantage of the 1031 Exchange tax treatment.    The same transfer or trade by an LLC can result in a tax-free transaction if done properly. 

While both corporations and LLCs must pay the $800 annual franchise tax, most California real estate LLCs holding a single property can avoid the gross receipts tax if the LLC's gross receipts are below the statutory minimum.

The above discussion involves only rental/investment properties.  Never put your personal residence in an LLC because of the loss of the federal capital gains tax exclusion on the sale of personal residence.

DWIGHT EDWARD TOMPKINS
Attorney at Law

http://www.tompkins-law.com/

This blog is intended for informational purposes only and is not a substitute for legal advice from a qualified attorney in your jurisdiction.  Nothing in this blog should be considered tax advice.

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