How to Use an LLC for Rental Property

A Limited Liability Company, or LLC, is a business structure used by real estate investors to hold rental properties. The primary function of an LLC is to create a legal separation between the business and the owner. This distinction is designed to shield an investor’s personal assets, like their home or savings, from liabilities arising from the rental property.

Forming Your Rental Property LLC

The first step is to form the legal entity. This process involves making several decisions and preparing foundational documents that will affect the company’s management and administrative requirements.

Choosing a State

The first decision is where to form the LLC. Most investors create a domestic LLC in the state where the rental property is located. This approach is the most straightforward, as the LLC operates under a single set of state laws. The act of collecting rent is considered “doing business,” which necessitates registration in that state.

Alternatively, an investor can form an LLC in a state with strong asset protection laws and then register it in the property’s state as a “foreign LLC.” This process, called foreign qualification, can offer enhanced liability shields. However, it also means the LLC must comply with the rules, fees, and reporting requirements of both states, increasing administrative complexity and costs.

Naming Your LLC

Selecting a name for the LLC is a formal step governed by state rules. The chosen name must be unique and not deceptively similar to any other business entity registered in that state. The name must include a designator that identifies it as a limited liability company, such as “LLC,” “L.L.C.,” or “Limited Liability Company.”

Before finalizing a name, you must conduct a name availability search through the state’s business entity database, which is managed by the Secretary of State. This search confirms that the desired name is not already in use.

Appointing a Registered Agent

Every LLC must appoint and maintain a registered agent in its state of formation and in any state where it is foreign-qualified. The registered agent is an individual or company designated to receive official legal and tax documents on behalf of the LLC, including service of process in a lawsuit.

A registered agent must have a physical street address in the state and be available during normal business hours. An LLC member can serve as the agent if they meet state requirements, such as having a physical in-state address. Many investors hire a commercial registered agent service, which fulfills these duties for an annual fee and offers additional privacy by keeping the owner’s address off public records.

Filing Articles of Organization

The LLC is officially created by filing a document with the state, most commonly called the Articles of Organization. Filing fees vary by state, ranging from around $50 to $250. Once approved by the state, this document legally establishes the LLC.

The Articles of Organization require the LLC’s name, principal business address, registered agent information, and management structure. Some states also ask for a business purpose or the names of the members or managers.

Creating an Operating Agreement

While the Articles of Organization create the LLC, the Operating Agreement governs its internal operations. This internal document is highly recommended even for single-member LLCs, as it reinforces the separation between the business and the owner. The agreement outlines the rules for how the LLC will be run, preventing future disputes and clarifying procedures.

An Operating Agreement for a rental property LLC should include:

• Member contributions and ownership percentages.
• How profits and losses will be distributed.
• The roles and responsibilities of members or managers.
• Procedures for decision-making.
• Provisions for adding or removing members.
• The steps for dissolving the LLC.

Obtaining an Employer Identification Number (EIN)

After the LLC is formed, you must obtain an Employer Identification Number (EIN) from the IRS. An EIN is a nine-digit number that functions like a Social Security number for the business. It is required for opening a business bank account, filing certain tax returns, and hiring employees.

You can apply for a free EIN on the IRS website. The online process is immediate and requires providing the LLC’s information and identifying a “responsible party” who controls the entity.

Transferring Property Ownership to the LLC

Once the LLC is formed, you must transfer the rental property’s title into its name. Without this formal transfer, the LLC’s liability protection will not cover the property.

Deeding the Property

The transfer of ownership is accomplished by executing and recording a new deed. A Quitclaim Deed is often used because it simply transfers the owner’s interest without guarantees about the title. A Warranty Deed provides a guarantee that the title is clear of liens or other encumbrances. The new deed must be signed, notarized, and filed with the county recorder’s office to document the change in ownership.

Addressing the Mortgage and Due-on-Sale Clause

Transferring a mortgaged property can trigger the “due-on-sale” clause in the mortgage agreement. This gives the lender the right to demand full repayment of the loan upon transfer of the title to an LLC.

The Garn-St Germain Depository Institutions Act provides some exceptions for lenders enforcing this clause, but this federal protection does not explicitly extend to transfers to an LLC. The most direct approach is to contact the lender to request permission for the transfer. Many lenders will consent, provided the original borrower remains personally liable for the loan.

Title Insurance

An owner’s title insurance policy may be voided when the property is transferred to an LLC. Review the existing policy, as some newer policies may extend coverage to an LLC wholly owned by the original insured.

If not, the LLC should obtain a new policy or an endorsement to the existing one. This involves a one-time fee but ensures the LLC’s investment is protected.

Operating Your LLC and Maintaining Liability Protection

To ensure the liability shield remains intact, you must operate the LLC as a legitimate and separate business. Failing to follow operational formalities can lead a court to disregard the LLC’s separate status.

Upholding the Corporate Veil

The “corporate veil” is the legal separation that protects an owner’s personal assets from business liabilities. Courts can “pierce the corporate veil” if the LLC is treated as an extension of the owner’s personal affairs rather than a separate entity.

Maintaining this separation requires adhering to formalities like keeping separate financial records and signing contracts in the LLC’s name. For multi-member LLCs, this also includes holding regular meetings with documented minutes.

Maintain Separate Finances

A requirement for maintaining the corporate veil is to open a dedicated bank account in the LLC’s name. All rental income must be deposited into this account, and all property-related expenses must be paid from it. This creates a clear financial record for the business.

Mixing personal and business finances is known as commingling funds and is a primary reason courts pierce the corporate veil. Do not pay for personal expenses from the business account or deposit rent checks into a personal account. Any transfer of funds between the owner and the LLC, such as a contribution or profit distribution, must be formally documented to maintain a strict separation.

Properly Titling Leases and Contracts

All business must be conducted in the LLC’s name. Tenant leases, vendor contracts, and insurance policies must list the LLC as the responsible party. When signing documents, the owner must do so as a representative of the LLC (e.g., “John Doe, Manager of XYZ Rentals, LLC”).

Maintaining State Compliance

An LLC must remain in good standing with its formation state by filing an annual or biennial report and paying a fee. Failure to file on time can lead to penalties or administrative dissolution, which eliminates liability protection.

LLCs are also subject to the federal Corporate Transparency Act (CTA), which requires filing a Beneficial Ownership Information (BOI) report with FinCEN. However, in early 2025, federal agencies suspended this requirement for most domestic companies following legal challenges. Owners should monitor these federal rules for new developments, but state-level compliance remains the most immediate task.

Tax Considerations for Your Rental Property LLC

An LLC offers tax flexibility, with default rules determined by the number of members. This is known as “pass-through” taxation, where profits and losses are not taxed at the business level but are passed through to the owners’ personal tax returns, avoiding double taxation.

Single-Member LLC (SMLLC)

A single-member LLC (SMLLC) is treated as a “disregarded entity” for tax purposes. The owner reports all rental income and expenses on Schedule E (Form 1040) of their personal tax return.

On Schedule E, the owner lists rental income and deducts eligible expenses like mortgage interest, property taxes, insurance, repairs, and depreciation. The net profit or loss is then combined with the owner’s other income on their Form 1040.

Multi-Member LLC

An LLC with two or more members is taxed as a partnership. The LLC files an informational tax return, Form 1065, which reports the company’s annual income, deductions, and profits or losses.

The LLC issues a Schedule K-1 to each member, detailing their share of the income and deductions. Each member uses their K-1 to report this information on their personal tax return.

Depreciation

The IRS allows owners to recover the cost of a residential rental building over 27.5 years via an annual tax deduction for depreciation. This non-cash deduction can reduce taxable income, and the rules are the same whether an individual or an LLC owns the property.

In an SMLLC, this deduction is reported on the owner’s Schedule E. For a multi-member LLC, it is calculated on Form 1065 and passed through to members on their Schedule K-1s.

Optional Tax Elections

An LLC can elect to be taxed as an S Corporation or a C Corporation. However, for a rental property holding company, these elections are often not advantageous.

S Corporation status can create complications with passive income rules, while a C Corporation structure subjects rental income to double taxation. For these reasons, most rental property LLCs retain their default pass-through tax status.