Should rental property be in an LLC or trust? Unfortunately, the answer is not as straightforward as you might think.
Whether you’re planning your will or setting up a company to manage your growing real estate portfolio, you need to know exactly what type of entity you should use to shield your properties from legal trouble. If you make the wrong decision, you could potentially expose your holdings to unnecessary risk, costing you hundreds of thousands of dollars down the road (or, at the very least, giving you a big headache).
So, first, let’s start with a basic definition of "LLC" and "Trust" as they apply to real estate investing.
(If you just want the pros and cons of each option, feel free to scroll down to the bottom of this article).
An LLC is a limited liability company.
It’s one of the most popular legal entities that a person can set up to operate their business. You don’t need any employees or a board of directors, and you can use it to separate your business assets from your personal finances. That way, if you ever find yourself on the losing side of a lawsuit, the only assets you’ll be forced to give up are those assets held within the LLC (in this case, your rental properties).
If someone sues you and wins, they can’t take away your personally-owned assets (like your car, primary residence, and your kid’s college fund).
Sounds like a pretty sweet deal, right? You could theoretically make some risky moves with the assets you put under an LLC and then dissolve that LLC in case you get into any trouble. The only risk is the asset, right?
Well, not so fast. There are some instances when your personal assets might be at risk, and you definitely shouldn’t start an LLC for the sole purpose of doing something nefarious.
There are a few instances when, if you use an LLC to hold your rental properties, you’d be putting both your rental properties and personal belongings at risk. Those instances include:
Furthermore, an LLC can create a kind of avalanche effect. As soon as one property is attacked under an LLC that holds multiple rental properties, your entire portfolio can take a hit.
You’ve probably heard about trusts as they relate to estate planning. By putting certain assets in a trust, you can guarantee exactly how and when they’re distributed. This way you can avoid a solid chunk of estate taxes, since the assets in a trust aren’t considered your personal property, or even protect your assets from heirs that are likely to mismanage them.
One solution is putting all of your properties under separate trusts. There are a few different types of trusts: revocable, irrevocable, pay-on-death (POD), and living trusts. For our purposes, we’re just going to focus on revocable and irrevocable trusts.
What are the benefits to putting your rental properties in a trust rather than an LLC?
So, to review, what are the pros and cons of each option?
Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.
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