Owning residential or commercial property you rent to others comes with an inherent risk of liability. While maintaining adequate insurance can protect landlords against many conceivable risks, it cannot completely insulate the landlord from liability. All insurance policies have limits, exceptions and carve-outs. In some cases injuries to tenants or guests, for example, could result in damage awards that far exceed insurance coverage limits. If the property is held in your individual name then the injured party has the ability to go after your personal assets. Instead, we advise our clients to own investment property in a California Limited Liability Company (LLC). Holding title to rental property in a California LLC provides the owner with asset protection, as well as potential tax and estate planning benefits.
By segregating the assets of the LLC from the owners’ other assets, a California LLC provides its owners with personal liability and asset protection. A claimant or creditor usually can only look to the LLC’s assets to satisfy liability and debts and this is why we typically advise a separate LLC per investment property so that the risk to the owner’s other assets is limited. In addition to providing LLC members with personal liability protection from the LLC’s business debts and liability, the LLC also protects the LLC and its owners from exposure to any debts or personal liability the other LLC members/owners may incur that are unrelated to the LLC’s property ownership.
A California LLC can also provide tax advantages because like a sole proprietorship or partnership, a California LLC benefits from pass-through taxation. No income tax is paid by the LLC and the members of the LLC report their share of the income or losses on their individual tax returns. This has advantages over C-Corporations which are subject to “double tax” at both the personal and corporate level; and while S-Corporations are also pass-through, they have disadvantages if the property is ever transferred or sold because such transfer immediately triggers capital gains tax, and S-Corporations cannot participate or benefit from a 1031 Exchange.
California LLC’s do come with the annual $800 expense for franchise tax but the benefits provided by holding title in an LLC are worth the expense. LLC’s are also subject to a gross receipts tax if the company’s gross receipts equal or exceed $250,000, but receipts of this size for a single investment property LLC are not common.
Further, a California LLC can be a great estate planning tool for families that wish to pass ownership of their property to the next generation. Each member’s percentage of property ownership is represented by the member’s LLC shares while the deed or title to the property remains 100% in the LLC’s name. Rather than having to deed additional ownership, LLC members can transfer ownership to their children by increasing their membership percentage in the LLC. Further, with incremental yearly increases you can take advantage of the tax free gift of up to $15,000 per year along with a valuation discount of up to 40%.
If you want to explore placing your investment property in an LLC please reach out to me or the FLAS attorney with whom you work with most frequently.
Olivia K. Marr, Attorney
(Direct) 805.966.7199
[1] In the event you own investment property that realizes gross receipts at or above $250,000 with little profit to pay gross receipts tax, consult with our office because you may fall into the category of investment property owners where a multi-entity limited partnership structure is a better option.
DISCLAIMER: This Advisor is one of a series of business, real estate, employment, estate planning and tax bulletins prepared by the attorneys at Fauver, Large, Archbald & Spray, LLP. This Advisor is not exhaustive, nor is it legal advice. You should discuss your particular situation with us or with your own attorney. Our legal representation is only undertaken through a written engagement letter and not by the distribution or use of this Advisor.
