Real Estate Investment Strong for 2013, But Should Properties Be Owned by an LLC

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According to a recent survey conducted by ORC International, almost half of the residential property investors plan to increase their purchases in 2013 and about a fourth intend to maintain their previous levels. The Watson CPA Group explores the ins and outs of having an LLC own residential rental properties.

Jason Watson, EA, MBA

if a property owner fails to maintain the rental in a proper and safe condition the owner of the LLC will be personally named in the lawsuit

New investors continuously consider putting rentals into an LLC. Why not? Everyone else does. The real answer is Perhaps. There are several myths out there regarding the use of an LLC as a shelter from potential lawsuits and litigation. While consultation with an experienced attorney is strongly recommended for each unique situation, as rental property consultants the Watson CPA Group feel the excitement of the LLC has overshadowed the reality of a litigious society.

In other words, if a property owner fails to maintain the rental in a proper and safe condition, good chances are the owner of the LLC will be personally named in the lawsuit and held liable if someone gets hurt. Officers and directors of corporations are occasionally held criminally liable for the wrongful actions of the corporation. This is called piercing the corporate veil (Enron anyone?).

Piercing the corporate veil is typically most effective with smaller privately held business entities (close corporations) in which the corporation has a small number of shareholders or limited assets, and when separating the corporation from its shareholders would promote fraud or an inequitable result.

Consider that a two-member LLC which owns rental properties would easily be considered a close corporation. And if those members were grossly negligent in the way the LLC managed the rental properties, separating the corporation from its shareholders would certainly not promote fairness from a liability perspective.

On the contrary, if an investor owned shares of Ford Motor Company, he or she was not personally responsible for the damage caused by the Ford Pinto.

Furthermore, if an investor owns multiple properties and thinks he or she can protect other assets in the event of a lawsuit on one, think again. In the Watson CPA Group’s non-legal opinion, if a landlord faces a credible lawsuit arising out of negligence there is a chance everything he or she owns is going to be pursued by the injured party’s attorney including personal residences, cars, college funds, LLC assets, etc.

Securing a decent umbrella policy both at the personal and commercial level is a strong recommendation for liability arising from injuries on residential properties. It appears that many credible lawsuits will commonly sue to the limit of coverage to avoid lengthy and expensive trial litigation. Again, please consult an attorney for each unique situation.

More importantly, keep your rental in proper working order- tight railings, shoveled sidewalks and driveways, cooler hot water temperature settings, newer tempered windows, carbon monoxide detectors, current fire extinguishers, etc. Don’t give a jury the chance to attach the slumlord label to an investment.

Having said all that, it is not a bad idea to have an LLC own a rental property. An investor might also consider having the tenants sign Hold Harmless Agreements. This is essentially adding layers to the liability onion. Additionally, if multiple investors are teaming up, then an LLC with a solid operating agreement might be the only way to properly handle the ownership.

The Watson CPA Group is a progressive tax consultation and preparation firm embracing internet technology to provide worldwide tax service from offices in Colorado Springs, Colorado USA. A secure online Client Portal allows remote taxpayers to exchange financial information, tax documents and tax returns saving valuable time and resources.

Since 1997, The Watson CPA Group prepares individual and corporate tax returns for a flat fee, and specializes in LLCs, small business and corporate taxes, pilot and flight attendant tax deductions, rental property owners and expat tax clients.

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Tina Watson, CPA, MBA
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