From 2001 to 2021, the share of rental properties owned by non-individual investors went from 18% to 27%, and that number’s only growing. That doesn’t necessarily mean that fewer individuals are investing in rental properties; rather, it means that many are shifting the way they go about it.
“Non-individual investors” is a wide group, and includes limited liability companies (LLCs). You may be familiar with the term, as it’s commonly used by entrepreneurs. There’s a good reason for this: it’s advantageous.
Interested in learning more? Then keep reading to see the tax benefits of an LLC for rental property.
Pass-Through Taxation
LLCs are considered “disregarded entities” for tax purposes. Do note that you can choose another tax election if you wish, but this is the default.
What this means is that the income and losses from your rental property are reported directly on your personal tax return (Form 1040, Schedule E). This helps you avoid double taxation, which can happen with C-corporations; both corporations and the shareholders are taxed on income.
Because the LLC itself doesn’t need to pay corporate income taxes, this also simplifies the tax filing process. Plus, losses from the rental can offset other income on your personal tax return. As a result, it’ll reduce your overall tax liability.
If this is already enough to convince you to form an LLC, then use our free business registration service. The only price to pay is the state fee, plus any additional services you wish to use.
Separation of Personal and Business Finances
An LLC is a distinct legal entity, and you enjoy personal liability protection with one. You’ll shield your personal assets should your company go through lawsuits or get creditor claims that are related to the rental property.
Commit to this distinction by getting separate bank accounts and financial records for your LLC. This will ensure a clear line between personal and business income and expenses.
As a result, fax filing will be more straightforward and will reduce the likeliness of audits. And if you’re ever scrutinized by the IRS, an LLC structure demonstrates professionalism, which works in your favor.
Deductible Expenses
When you run a business, you’ll have expenses you can deduct on your tax return, and an LLC for rental property is no exception. These deductions can lower your taxable income, which results in significant tax savings.
Curious about the possible LLC rental property tax deductions? We’ll go through them in this section.
The first is utilities and insurance if the LLC pays for these. You can fully deduct them if that’s the case. You can also deduct repairs and maintenance, such as fixing leaky faucets, having HVAC servicing, or replacing broken appliances.
Do you pay professional property managers for services like tenant placement and rent collection? Then you can deduct those fees too.
More good news is that the interest portion of your mortgage payment is fully deductible. And as far as property taxes go, you can deduct the local real estate taxes asses on your rental property.
Lastly, the IRS allows you to depreciate the value of your rental over 27.5 years. You can reduce your taxable income even without actual cash expenses.
Qualified Business Income Deduction (QBI)
The QBI deduction came into existence as part of the Tax Cuts and Jobs Act of 2017. This deduction allows eligible taxpayers to deduct up to 20% of their qualified business income.
To be eligible, your rental activity must qualify as a “trade or business” under IRS guidelines. Typically, this involves factors like regularity of operations and level of landlord involvement. What’s great is even if your rental incurs a net loss, you can still claim this deduction.
However, you should be aware that the deduction phases out for higher-income individuals; the thresholds are based on filing statuses. In addition, certain types of properties or activities may get additional scrutiny to ensure compliance with IRS rules.
Flexibility in Tax Treatment
We mentioned that LLCs are taxed as disregarded entities by default. On top of that, the other default treatments are that single-member LLCs are taxed as sole proprietorships and multi-member LLCs are taxed as partnerships.
Besides that, you can choose for your LLC to be taxed as an S-corporation or C-corporation. The former can be beneficial if your rental property generates significant income since it lets you reduce self-employment taxes. This is possible by paying yourself a reasonable salary and taxing the rest as distributions.
With so much flexibility, you can tailor the tax treatment of your LLC to your financial and operational needs. If you’re ever unsure, consult a tax professional to explore the best routes.
Potential Estate Tax Benefits
Chances are, you’ll have to transfer ownership of the property sometime in the future. But if you have an LLC, you can transfer it in the form of membership interests in the company.
This is one of the major tax advantages of owning a rental property under an LLC, as it reduces estate taxes. You’ll make use of valuation discounts, such as discounts for lack of marketability or control.
There’s simplified succession too. The LLC’s operating agreement will define how the property will be managed or transferred upon your death, which can make estate planning much easier. By the same token, multi-member LLCs can facilitate gifting shares over time, which will reduce the taxable estate incrementally.
Use Separate LLCs to Protect Each Property
Many real estate investors take extra steps to safeguard their assets by creating a separate LLC for each rental property. This strategy isolates liabilities, meaning that if one property is involved in a lawsuit or faces financial troubles, only that LLC’s assets are at risk. The rest of your portfolio—and your personal finances—remain protected.
This approach also simplifies financial management by keeping income and expenses distinct for each property. While it requires additional administrative effort, the enhanced asset protection and financial clarity often outweigh the extra work. For investors managing multiple properties, this is a strategy worth considering.
Enjoy These Tax Benefits of an LLC for Rental Property
You may have been on the fence about creating an LLC specifically for your real estate venture. However, now that you know the various tax benefits of an LLC for rental property, they should be enough to convince you to move ahead.
Should you have any concerns, make sure you speak to a tax professional or attorney. That way, you’ll be certain that you’re compliant and that your financial setup is optimal.
Sign up with Business Anywhere to use our free business registration service. We can also be your registered agent for your LLC and provide virtual mailbox services too.
