If you’ve started renting out your home or another property, you might be wondering whether you should form a Limited Liability Company (LLC) to hold it. On the surface, it sounds smart. After all, business consultants often tout LLCs as the gold standard for business owners who want legal protection and professionalism. But when it comes to rental properties with a personal mortgage, the decision isn’t always straightforward. Let’s walk through the pros, cons, and tax implications so you can make an informed choice.

Forming an LLC for Rental Property

Before we get too deep into the details, let’s be clear: we’re not attorneys, and this isn’t legal advice. Think of this as a guide to help you understand the financial and tax side of things. This way, you’ll know what questions to ask your attorney or CPA.

That said, one of the most common reasons people put a rental property in an LLC is for liability protection. If a tenant or visitor gets hurt on the property and sues, an LLC can help separate your personal assets from your rental business.

However, there’s a big catch. If your property still has a personal mortgage, transferring it to an LLC can be tricky.

The Mortgage Complication

Most personal home loans include a “due-on-sale” clause, which means your lender could demand immediate repayment of the loan if you transfer ownership to another entity, like an LLC. And yes, that includes transferring it to an LLC you own yourself.

In reality, many lenders don’t enforce this clause if you continue making payments on time. However, technically, they can. If they do, you’d have to refinance the property under a commercial mortgage. This typically comes with higher interest rates, stricter lending criteria, and a bigger down payment.

So, if your rental started as your personal residence or vacation home and you simply decided to rent it out, transferring the property into an LLC might not be worth the hassle. This is especially true if you managed to borrow when mortgage rates were at record lows.

Liability Insurance Can Be a Simpler Form of Protection

If you’re primarily concerned about personal liability protection, a landlord insurance policy (sometimes called “dwelling fire insurance”) might be your best first step. This type of policy covers damage to your rental property, loss of rental income due to certain covered events, and liability claims if someone gets hurt on the premises.

Think of it as your “safety net.” It’s typically much cheaper and easier to get than setting up an LLC. Especially if you’re only renting out one or two properties. Unlike transferring property ownership, updating your insurance coverage doesn’t risk triggering a due-on-sale clause.

The Tax Perspective of Creating an LLC for Rental Property

Here’s where many landlords get tripped up. Forming an LLC does not necessarily change how you report rental income or expenses for tax purposes.

If you’re the sole owner of the LLC, also known as a single-member LLC, it’s considered a disregarded entity. This means all of your rental income and expenses flow right onto Schedule E of your personal tax return, just like if you owned the property in your own name.

Your tax benefits don’t change either. You can write off the same business expenses:

• Mortgage interest and property taxes
• Repairs and maintenance
• Depreciation
• Property management fees
• Insurance premiums
• Utilities (if you pay them)

So, if your main goal is tax efficiency, forming an LLC won’t give you any special advantages. LLCs are more about liability protection and business structure, not taxes.

Beware of Owning Real Estate in a Corporation

If an LLC doesn’t make sense for your rental property, what about an S corporation? That’s an even worse idea.

The biggest problem with holding real estate in an S corporation is the limitation on the shareholder’s debt basis. In an S corporation, your ability to deduct losses is limited to your stock basis plus any direct loans you made to the corporation. This limits your ability to deduct losses from the rental property.

Transferring your rental property into the corporation may also be taxable. When you transfer real estate into a corporation, the IRS treats the transaction as a sale. This means you may be required to pay capital gains taxes on any appreciation in value since you purchased the home.

Certain exceptions may allow you to avoid paying taxes when transferring the rental property into an LLC. But you could face tax consequences when you want to get it out of the LLC, too.

Let’s say years from now you want to gift the property to your adult child. When you distribute it from the corporation back to yourself, the IRS will treat this as a deemed sale. They’ll treat it as if the corporation sold the property at its fair market value, which could result in a capital gain.

When an LLC Might Make Sense

If you own multiple rental properties or plan to grow your portfolio, an LLC can help you separate each property’s risk and simplify your accounting. It also makes sense if you’re buying a rental property specifically as an investment, and you get a commercial loan from the start.

If you decide to form LLCs for your rental properties, consider creating a separate LLC for each investment property. This structure helps isolate risk. If something happens at one property, the assets of the others are protected. Each LLC should also have its own EIN (employer identification number) and business bank account to keep income and expenses separate. This simplifies your bookkeeping and tax reporting when you have multiple rental properties and reinforces the legal protection. This comes with running your rentals as distinct business entities.

But if you’re renting out only one rental property or you rent out your former home with a personal mortgage, it’s often better to keep things simple. Get liability insurance coverage, keep excellent records, and consult your accountant and attorney before making any ownership changes.

It’s Not About the LLC, It’s About the Liability

Forming an LLC can be a useful tool for landlords, but it’s not a magic shield. For most small-scale landlords with a single rental home and a personal mortgage, the best protection often comes from good insurance, responsible management, and solid bookkeeping.

If you’re considering putting your rental property in an LLC, talk to your attorney about the legal implications and your tax professional about the financial ones. Don’t lose sleep over missing out on special tax benefits because, in this case, LLC or not, your rental income and deductions will look exactly the same on your tax return. If you’re unsure whether forming an LLC is the right move for your rental property, contact Countless. We can offer clear, practical guidance tailored to your situation.