Rental: To Incorporate Or Not

[Laurian]

Hi John,

About a year ago, I purchased a property with my brother who is deployed. It was a fixer upper in a very good neighborhood.  In fact, even in this declining market, it has increased in value. Originally, I was to rent out my current home and move in as I wanted to declare it as my primary place of residence. However, renovations too much longer than anticipated and got to a point in time where the new property was easier to rent than my current home.  Now that it is a rental, I'm trying to assess if I should incorporate. What are the benefits?  And if so, would I need to change ownership to the business?  Thanks very much for your help.

Sandra

[Garanwyn]

Sandra -

Whether or not to incorporate is a matter of liability protection and sometimes a tax question.

If someone takes you to court for some reason involving your rental property and wins a judgement, they can go after the house and all your personal assets.  For example, if they slip and fall and sue you for medical bills, loss of income because they miss work, and "pain and suffering", they might get an award for $1,000,000.  If your rental house is worth $500,000 they will take the house and then come after your personal assets, such as any other rental property you have, money in your bank accounts, or your personal home.

If you incorporate and the corporation owns the rental property, they can only go after the assets held by the corporation - usually just the rental house.  Bottom line - incorporating keeps people from taking your personal assets if you are taken to court in the future.

Most rental property owners form a limited liability company(LLC), since it is cheap and easy to form, provides the same liability protection, and costs less to administrate than a corporation.  With an LLC, all the loss or profit flows through to the personal tax return of the owners - the LLC itself doesn't file a tax return.

Whether you incorporate or use and LLC comes down to your specific circumstances and how you intend to develop your business in the future.  If you plan to continue buying rental properties or flip houses as the housing market rebounds over the next year or two, the LLC might be the best way to grow your business without a lot of administrative overhead.

Since I work a lot with estates, I recommend that you do something with your ownership approach that might sound a little complicated but is really very simple.  It goes like this: If you pass away and your property is held in your name, it goes through probate and could be hit with probate fees of up to 45% of the value of your assets before ownership of those assets is released to your heirs.  If you have a trust and your trust holds your real estate and other expensive personal items, your estate does not go through probate when you pass away and probate fees are not paid.

So... what I always recommend is that you form a trust and hold ownership of your LLC in your trust.  In other words, you are the trustee("owner") of your trust, and your trust owns the LLC.  This way, if you pass away your heirs receive ownership of the LLC and all the property the LLC owns without the probate fees being assessed.

I hope this helps,

John