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A common question we often receive from people looking to purchase their first vacation rental property is how should they hold title. Unlike purchasing a residence for your family to occupy, purchasing a property to run a vacation rental business out of is completely different.
So how should you hold title with your new vacation rental property? With running any vacation rental property comes risk, and some property owners prefer to mitigate that risk as much as possible. Legal structures available to you to mitigate that risk come in the form a limited liability company (“LLC”), or a corporation. Of course there are other ways to hold title, which we will address the pros and cons of each approach below.
Holding Title Of Your Vacation Rental In Your Name
It is not uncommon for vacation rental property owners to hold title of their property in their name. The pros of this approach is it is the least expensive way to hold title (as compared to the out of pocket costs of forming a trust or an entity).
You purchase the property and on the deed it simply reads your name as an individual (or husband and wife if you are married). The risk associated with this approach is the net worth of the individual, or the married couple holding title, would be at risk of any potential law suits submitted by guests, or anyone else who wants to file a legal complaint against the property.
Holding Title Of Your Vacation Rental In The Name Of Your Trust
The most common way that we find vacation rental property owners hold title is in the name of their trust. Many people create revocable (or irrevocable) living trusts to hold assets while they are alive. These trusts then become irrevocable upon their death (depending on if it is setup as an irrevocable trust). An example of holding property in a trust that we would see on title is “John Smith Revocable Trust”.
The purpose of holding your property in a trust is to avoid the dreaded time and expense of probate, as well as to provide instructions for the management of their assets in the event they become incapacitated. According to the Schomer Law Group, probate in the State of California can take six months to two years to complete.
Avoiding that delay, the cost of setting up a trust is typically a one-time fee paid to your trust attorney in the range of $1,500.00 to $3,000.00. Once it is setup, it is good for your lifetime and you would move all your properties into the name of the trust.
According to Annestadlaw, if one did not have a trust the costs of probate would be significantly greater. According to California Probate Code § 10810 statutory probate fees paid to the personal representative and the attorney handling the estate are 4% for the first $100,000.00, 3% for the next $100,000.00, 2% for the next $800,000.00, 1% for the next $9,000,000.00, and one-half percent for the next $15,000,000.00. That means if your net worth is say for example $1,000,000.00, the attorney can charge your estate $23,000.00 and the personal representative can charge your estate $23,000.00.
Holding Title Of Your Vacation Rental In A LLC
First, we have to understand what is a LLC? According to Investopedia, a LLC is a business structure in the United States whereby the owners are not personally liable for the company’s debts or liabilities. Limited liability companies are hybrid entities that combine the characteristics of a corporation with those of a partnership or sole partnership. In the State of California all LLCs must file a Form 3522 and pay an annual franchise tax of $800.00, regardless of revenue or activity. With a ongoing annual $800.00 expense why is a LLC beneficial to short term rental owners? For the following reasons.
- If you were ever to receive service for a lawsuit filed against you, only the assets at stake would be those owned by the LLC. In this scenario, just the property and not any other assets you own would be at risk.
- If you own multiple properties and setup an individual LLC for each property, only the individual LLC would be at risk, not all your other properties. If you setup a LLC and held multiple properties under one LLC, then if someone filed a lawsuit against you on one property within the LLC, the other properties also held by that LLC would also be at risk.
- It allows pass-through taxation and the ability to potentially reduce your taxes if you pay self-employment tax. You have the benefit of attributing the income made from your vacation rental “passed-through” to your individual income tax return. If you set up your LLC as a “C” or “S” corporation, you may be able to further reduce your taxes if you pay self-employment. You will pay yourself as if you are an employee of your own company. Please seek the help of a CPA or a qualified tax consultant to discuss this further.
So How Should I Hold Title To My Vacation Rental?
How you should hold title to your vacation rental is a personal decision and depends on an individual’s appetite for risk.
Here at Haustay we recommend you seek the opinions of legal, financial, and accounting professionals to help you make the most informed and best decision you can.
If you require any recommendations to professionals in these fields, we would be happy to assist in connecting you to the right people. When you hold title to your vacation rental and you are ready to engage property management to maximize your returns, give us a call at (858) 522-9127.