What are the basic steps for forming a business entity for my rental property?
Since businesses are formed at the state rather than the federal level, the process of forming a business entity depends on your state as well as the type of business entity you want to form. Generally, the process includes meeting certain requirements, filing certain documents about your business with your state, and paying a fee. At minimum, these documents require the name and address of your business, its legal representative or agent, and the business purpose. Some states require those forming certain business entities to provide more specific information, such as the names of the initial directors or the number of shares of stock the business may issue. With a little preparation and the right help, forming a business entity can be easier than expected.
How do I decide which business entity type is right for my rental business?
The type of business entity that is best for your rental business depends on a number of factors and considerations.
Individual landlords typically create business entities to limit personal liability while maintaining control over the administration of their rental property. A Limited Liability Company (LLC) maximizes these benefits without imposing complicated accounting requirements or subjecting the owner to double taxation.
If multiple people invest in your rental property without taking an active management role, an S-corp might be the best business entity type. An S-corp protects shareholders, prevents double-taxation, and continues to exist independently of the individual who formed it.
C-corps are the most complicated form of business entity. They provide the most control over the issuing of stocks and other forms of equity but come with complicated accounting requirements, detailed restrictions on management, and double taxation. As such, they are typically reserved for the largest and most complex rental businesses.
Sole proprietorships, which are the default business form in most states, do not shield their owners from liability. Nonprofits are limited to very specific public interest purposes, which generally do not include for-profit rental operations. As such, neither is well-suited to a rental business.
Which state is best for forming a business entity for my rental property?
Assuming you live in the same state as your rental property, the easiest and most affordable option is typically to form a business entity in that state.
If you live in a different state from your rental property, you may want to consider forming a business either in the state where you live or the state where the property is located. Even if forming your business in the state where you live is cheaper, you may still be required to register your business in every state in which you own and operate rental property. To determine the best location for your business entity, however, you may want to ask a lawyer.
Are additional steps required to complete the transfer of ownership of my rental property to my business?
Yes, and the steps vary by state. The process for transferring property depends on state law, though most states require that a Quitclaim Deed or Warranty Deed showing the change of ownership be filed with the appropriate state agency. It is important to note, however, that an outstanding mortgage on the property may restrict transfer of the title. For example, most mortgages have a due-on-sale term that requires the property owner to pay the full value of the mortgage before transferring ownership to a business, even if they are the sole owner of the business.
Any rental property that you owned before forming your business is required to be transferred to your business for it to be covered under the limited liability of your business entity. If you plan to have your LLC manage the property while you retain ownership, you may be required to obtain a real estate license first, as many states require a real estate license for businesses to manage any properties they do not own.
Are new Lease Agreements required for existing tenants after forming a rental business?
In most cases, a new Lease Agreement is not required upon transferring ownership of your rental property to your business. Your business simply becomes the landlord under the terms of your preexisting leases. That said, you may wish to specify that the business is assuming the existing leases on the property by laying it out in the documents that transfer ownership of the property from you to your business. You may also ask existing tenants to sign a Lease Amendment clarifying that the business is the new landlord. Because such an addendum would not change the substantive terms of the lease, you can expect tenants to be amenable to signing it.
Can starting a real estate business for my rental property impact my property or personal taxes?
Yes, but it depends on the type of business entity you form. Some business entity types, such as LLCs and S-corps, have pass-through taxes, which means that owners and shareholders are taxed only on their personal tax returns, not on the business’s returns. Others, such as C-corps, are subjected to double taxation, meaning that shareholders are taxed both on the business and individual level.
The experts at Rocket Tax can help you consider the complicated and substantial tax consequences of a business formation. If you have more questions about forming a business entity for your rental property, reach out to a Rocket Lawyer network attorney for affordable legal advice.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.