You’re already familiar with the gig economy if you’ve heard of Uber, Airbnb, DoorDash, or Care.com. This developing trend has gained a significant pace in recent years as more people look for new methods to earn money, such as food delivery or vacation home rentals. By 2023, the gig economy is expected to grow at a rate of 17.4 percent, and it does not appear to be slowing down anytime soon. Combine it with a small enterprise, which accounts for approximately half of all GDP in the United States.
Often, the short-term rental market intersects these two booming economies. While holiday rentals are no longer considered side hobbies, many people continue to manage and rent vacation homes on a small basis, with one or two properties. If your holiday rental has developed into a self-sustaining business, it may be time to explore incorporating your home as an LLC.
What is a Vacation Rental LLC?
In the corporate world, you may have heard of an LLC (Limited Liability Company). An LLC is a corporate form in which the owners are not personally accountable for the company’s debts or liabilities. In a nutshell, it provides an additional layer of safety for holiday rental property owners.
By incorporating your vacation rental into an LLC, you, or the “members,” i.e., the company’s owners or other stakeholders, are protected from personal liability in the event of financial difficulties.
There are no explicit rules or regulations governing the formation of an LLC for holiday rentals. Having said that, LLCs are only available to registered business entities, which means you must meet specific requirements. Licensing and permissions requirements differ by state, but if you do not already have a business license, this would be the first step toward forming an LLC.
Vacation rentals would operate in the same manner as any other business. We’ll discuss the process in greater detail later, but for now, let’s consider some of the positives and disadvantages.
The Pros and Cons of Using an LLC for Short-Term Rentals
There are numerous benefits to forming an LLC for your short-term rental business, but if it were too simple, everyone would do it! It can be a complicated process depending on your state or locality, but there are compelling reasons to apply it while also considering some of the disadvantages. As with most business decisions, there will always be negatives.
Pro: LLCs safeguard your property.
The greatest tragedy occurs when a small business owner is forced to close his or her doors and loses everything. Fortunately, there are techniques to avoid depleting your fortune if your small business fails. You’ll need to demonstrate that your short-term rental firm is, indeed, a business.
According to the United States government, if your holiday rental home is a hobby or side project, you are personally liable for any losses. However, if your property is a proven business, your revenues are secure if something financially disastrous occurs. It will be considered your business’s responsibility rather than your errors.
Con: LLCs are not free.
While converting your short-term rental business to an LLC will save you money in the long run, there is an initial expense. It is not free to form an LLC, and in some jurisdictions, such as New York, where the filing fee alone can be as high as $4,500, the process can be rather costly. Apart from filing expenses, there are additional charges for getting an employer identification number (EIN) and for the Operation Agreement, which is a one-time fee.
If you’re not confident in your ability to navigate the legal and accounting worlds, you’ll also need to consider the expense of an attorney, accountant, certified public accountant, or financial advisor. The cost of engaging a professional can easily exceed the costs, depending on the complexity of your case.
Costs associated with converting your vacation rental business to an LLC should be carefully considered before taking the plunge. The expenditures of an LLC licensing can quickly build up and may not make sense for your property.
Pro: Limited liability companies (LLCs) have tax advantages.
While you may incur some upfront costs with an LLC, the tax benefits may make the transfer worthwhile for some. When you incorporate your holiday rental as a corporation, you qualify for additional tax deductions. Depending on the state, these deductions may include maintenance, property taxes, mortgage interest, and running expenditures.
Con: With tax advantages come tax disadvantages
The Internal Revenue Service is a difficult system to navigate. In some instances, you can save money on taxes, but the government makes business ownership rather expensive in others. When you file taxes as an LLC, you incur certain additional tax liabilities that you would not encounter without the LLC designation.
“For instance, if your vacation rental firm is located in California, you will be required to pay an annual franchise tax of $800 on a recurrent basis”, explained Lodgable.
Naturally, the more money you generate from your vacation rental LLC, the more taxes you’ll owe. This is standard practice with or without the title, but your tax file may be scrutinized more closely if you have an LLC title.
Vacation rental operators who file as an LLC face a five- to twelvefold increased risk of being audited than individuals who do not have a business. Audits may be rather costly for business owners, so be prepared for more surveillance and the expenditures associated with more regular audits.
Pro: Facilitates vacation rental accounting
Balancing personal and corporate finances can be challenging and risky. By forming an LLC for your vacation rental business, you avoid making unintentional accounting errors or tax miscalculations. Most LLCs are classified as pass-through entities, meaning that the company’s earnings are paid to the owner (s). Thus, rather than having to keep track of which funds and invoices go to which bank accounts, your net revenue will be distributed directly to the LLC’s shareholders. With your earnings automatically deposited into your account, you won’t have to bother about manually distributing money.
When it comes time to file taxes, LLC owners will pay at their tax rate rather than at their company tax rate, which is another advantage for certain owners.
Con: You may run into financial difficulties.
An LLC has no personal liability, which is a significant advantage for you but a disadvantage for banks and lenders. Because you would not be personally liable for things like mortgage repayment, lenders are unwilling to grant financing to LLCs.
If you seek loans through an LLC, you may have difficulty finding a lender willing to take on that risk. Even transferring an established business with a mortgage to an LLC may cause complications. Due-on-sale clauses, often known as acceleration clauses, allow lenders to demand full repayment of a mortgage if a borrower changes to an LLC. Lenders often trigger this clause if they believe there is a risk, however, there are ways to avoid this, such as cosigning or transferring the property to a living trust.
For vacation rentals, LLC vs. Simple Sole Proprietorship
The primary distinction, as implied by the LLC name, is the liability. While LLCs do not require personal liability, a Simple Sole Proprietorship does. Additionally, a Simple Sole Proprietorship, or SSP, is limited to one individual. Simultaneously, an LLC is governed by anyone is designated as a “member” of the firm, making it a more attractive alternative for couples or vacation rental businesses with several owners.
Due to its simplicity, some homeowners may choose the SSP. It is significantly more simplistic in terms of owner protection, but it is also significantly more straightforward. For sole owners, there is no split of the business, which is something to bear in mind. Apart from liability, taxes, fees, and obligations are directly related to the owner, in contrast to an LLC, which operates as a barrier.
Choosing the appropriate option is entirely up to the holiday rental owner. If there is less danger of litigation, an SSP may be easier and more cost-effective. On the other hand, an LLC works effectively for property owners who take on additional responsibilities, such as those who own multi-unit vacation rental businesses.
How to form a limited liability company for shared vacation homes
After determining that incorporating your vacation rental business is the best course of action, you’ll need to discover how. That is where we enter the picture! While converting your firm to an LLC will save you money in the long term, it will need some upfront effort. While navigating bureaucratic hoops is not easy, it is a one-time process. Once you’ve formed an official LLC for your firm, you’ll never have to do it again!
The formation of an LLC for a vacation rental business is situation-dependent, and it is recommended that you consult a local financial expert or legal. To get a head start on the application process, you can begin gathering some of the necessary paperwork. At the very least, you’ll require:
• Your business’s name
• Registered agents
• Operating agreement
• Articles of Organization (available on your Secretary of State’s website)
• Business licenses and permits
• Statement of Information form
• Local licenses and registrations
The procedure will vary depending on the state in which you file, so be sure to familiarise yourself with your state’s LLC regulations before filing. This, too, will vary in terms of time. Typically, the process takes 7-10 business days to complete, however certain states, such as Arizona, allow up to 4-6 weeks.
Time for preparation is another consideration. Certain types of documents require their processes. For example, obtaining business licenses and an EIN (employer identification number) takes time. Before booking your LLC filing session, ensure that you have all the papers prepared to ensure a seamless process.
Should I incorporate my Airbnb business?
Airbnb first positioned itself as a side hustle for non-professionals. As a result, many remain unaware that Airbnb is a legal “company.” The reality is that for many, Airbnb is their principal source of income and is far from a side hustle. Depending on the amount of income you get from Airbnb, it may be well worth the effort to form an LLC for your business. It is no difference between a vacation rental general liability company and an Airbnb limited liability company. It truly is a matter of personal preference. If you believe that your Airbnb has a low liability, an LLC may not be the best option.
Takeaways: Should your vacation rental property be organized as a limited liability company?
Forming an LLC for your vacation rental business is a personal choice. You must determine for yourself and your business what is best. To summarise, the following are some of the considerations to consider:
• Personal liability
• Tax advantages and disadvantages
• Required LLC members
• Income distribution
As an alternative to an LLC license, some vacation rental owners may choose to incorporate their firm as a sole proprietorship or general partnership. Finally, the appropriate licensing will be determined by the business owner. Creating an LLC for your vacation rental may be the best course of action for you to establish your business’s legitimacy.