If you’re familiar with Uber, Airbnb, DoorDash, or Care.com, then you’re already well acquainted with the gig economy. This emerging phenomenon has gained a lot of traction in recent years as many people decide to make extra cash in new ways like food delivery or vacation home rentals. The gig economy has an anticipated growth of 17.4% by 2023 and doesn’t appear to be stopping anytime soon. Pair that with small business, which generates nearly 50% of all U.S. GDP.
In many cases, the short-term rental market meets in the middle of these two booming economies. Vacation rentals are no longer seen as side hobbies, but still, many people only manage and rent out vacation homes on a small scale, with one or two properties. If your vacation rental has blossomed into a flourishing business of its own, it might be time to consider turning your property into an LLC.
You might have heard of an LLC (Limited Liability Company) in the business realm. An LLC is a business structure where the owners of said company are not personally liable for debts or liabilities accrued by the company. Simply put, it adds an extra layer of protection for vacation rental owners.
Turning your vacation rental into an LLC makes it so that you, or the “members,” i.e., the owners of the company or any stakeholders, aren’t held personally liable in case of any financial issues the company faces.
There aren’t any specific rules or regulations for becoming an LLC when it comes to vacation rentals. That being said, LLCs are only for registered business entities, which does require you to meet certain conditions. The licensing and permits vary between states, but if you don’t have a business license yet, this would be the first step prior to becoming an LLC.
Vacation rentals would follow the same process as any other company would. We’ll get more into the process later, but for now, let’s take a look at some of the advantages and disadvantages.
Pros and Cons of an LLC for short-term rentals
There are many advantages to making your short-term rental business an LLC, but if it were too easy, everyone would do it! It can be a tricky process depending on your state or location, but there’s good reason to implement it while also keeping in mind some of the negatives before making your final decision. As with most business measures, there will always be drawbacks alongside the benefits.
Pro: LLCs protect your assets
The greatest tragedy is when a small business owner is forced to close down and loses everything in the process. Fortunately, there are ways to avoid your personal wealth being depleted in the case of your small business going south. You’ll need to establish that your short-term rental business is precisely that: a business.
In the eyes of the U.S. government, if your vacation rental home is a hobby or side-project, then you’re responsible for any loss. However, if your property is a proven business, then your earnings are safe in the event of anything going wrong financially. It will be viewed as the fault of your business rather than your own miscalculations.
Con: LLCs come at a cost
You’ll indeed save money by converting your short-term rental business into an LLC, but it does have an initial cost. It’s not free to become an LLC, and in some states, like New York, where the filing fee alone is up to $4,500, it can be rather pricey. Filing fees aside, there are also extra charges for obtaining an employer identification number (EIN) and a one-time fee for the Operation Agreement.
If you’re not confident in navigating the legal and accounting world, you’ll also have to factor in the cost of an attorney, accountant, CPA, or financial advisor. Depending on the complexity of your case, the cost of hiring a professional can well exceed the fees.
The cost of turning your vacation rental company into an LLC needs to be well thought out before taking the plunge. The costs associated with an LLC license can add up and might not make the most sense for your property.
Pro: There are tax benefits for LLCs
You might have to spend a bit for the initial cost of an LLC but, for some, the tax benefits make the switch worth it. When you make your vacation rental an official business, you’re entitled to more tax write-offs. Depending on the state, some of these deductions could include repairs, property taxes, home loan interest, and operating expenses (that even includes your Lodgify subscription!).
Con: With tax benefits come tax drawbacks
The IRS is a tricky system to navigate. In some ways, you can save money on taxes and in others, the government makes business ownership quite costly. When you file taxes as an LLC, there are some additional tax liabilities that you wouldn’t have to worry about without the LLC title.
For example, if your vacation rental business is in California, you’ll have to pay a recurring yearly franchise tax of $800.
Of course, the more money you earn from your vacation rental LLC, the more you’ll have to pay in taxes. This is common practice with and without the title, but your tax filing might be under more scrutiny with an LLC title than it would be without.
Vacation rental owners who file as an LLC are 5 to 12 times more likely to get audited than individuals without a business. Audits can cost business owners some serious cash, so be ready for this extra surveillance and the costs associated with more frequent audits.
Pro: Makes vacation rental accounting easier
Juggling your personal finances alongside a business can be complicated and risky. By making your vacation rental business an LLC, you avoid accidental accounting mistakes or tax miscalculations. Most LLCs are automatically filed as pass-through entities, meaning that the earnings from the company are distributed to the owner(s). So instead of having to worry about what funds and bills belong to which bank accounts, your net income will go directly to the owners of the LLC. With your earnings streamlined into your account, you won’t have to worry about manually distributing income.
When it’s time to file taxes, the LLC owners will pay based on their personal tax rate rather than a corporate tax rate, another benefit for some owners.
To better keep track of your finances, you can turn to the Lodgify accounting tool. Making your vacation rental an LLC will make your finances more manageable, but Lodgify will completely uncomplicate them altogether.
Con: You might have trouble with financing
There’s no personal liability with an LLC, which is a big plus for you, but a negative for banks and lenders. Because you wouldn’t assume any personal liability for things like mortgage repayment, lenders are hesitant to offer financing options to LLCs.
If you’re applying for loans under an LLC, you might have difficulties finding a lender to assume that risk. Even if you’re converting an existing business with a mortgage to an LLC, you might run into trouble. Thanks to the due-on-sale clause, otherwise known as the acceleration clause, lenders have the ability to ask for full repayment of a mortgage if the borrower converts to an LLC. Lenders will typically invoke this clause if there are grounds to believe that there is a risk, so there are other ways to prevent this from happening, such as cosigning or transferring the property to a living trust.
LLC vs. Simple Sole Proprietorship for vacation rentals
The most significant difference, as implied in the LLC name, is the liability. LLCs omit the need for personal liability, but a Simple Sole Proprietorship does not. A Simple Sole Proprietorship, or SSP, is also limited to one person. At the same time, an LLC is managed by whoever is named a “member” of the business, making it a better option for couples or vacation rental businesses with multiple owners.
Some homeowners might find that the SSP is a better option due to its simplicity. It’s a lot more basic in terms of owner protection, but it’s also a lot more straightforward as a result. There’s no separation of the business for sole proprietors, which is something to keep in mind. Beyond liability, taxes, fees, and debts are directly tied to the owner, unlike an LLC which acts as some sort of barrier.
Choosing the right option depends on the vacation rental owner. If there’s less risk of liability involved, then maybe an SSP would be easier and cheaper. On the other hand, an LLC functions well for property owners who assume more responsibility, such as multi-unit vacation rental businesses.
How to set up an LLC for shared vacation homes
After deciding that making your vacation rental business an LLC is the right move, you’ll have to learn how. That’s where we come in! Turning your business into an LLC will save you a lot of trouble in the long run, but it does require some initial effort. Jumping through the hoops of bureaucracy might not be the easiest, but fortunately, it’s a one-time process. Once you’ve established your business as an official LLC, you’ll never have to do it again!
The setup of an LLC for a vacation rental business varies case by case, so it’s best to consult a local financial advisor or attorney. To be more prepared for the application process, you can start to gather some of the important documents. At a minimum, you’ll need:
Your business name
The registered agents
Articles of the Organization (found on your Secretary of State website)
Business licenses and permits
Statement of Information form
Local licenses and registrations
IRS federal tax forms 1065 and 8832 and local tax forms
The process will depend on where you file so be sure to read up on your state’s LLC requirements before filing. In terms of time, this too will vary. Typically, it takes 7-10 business days to complete the process, but some states, like Arizona for example, have a window of 4-6 weeks.
The time for preparation is an additional factor to consider. Some of the documentation needed have processes of their own. Obtaining business licenses and an EIN (employer identification number), for example, also takes time. Before scheduling your LLC filing appointment, make sure you have the necessary documentation prepared so the process goes smoothly.
Should I start an LLC for my Airbnb?
Airbnb initially branded itself as a side hustle for laymen. As a result, many are still in the dark as to if Airbnb is an official “business.” The reality is that Airbnb is a primary source of income for many and far from a hobby project. Depending on the amount of income you receive from Airbnb, it might be more than worth it to start an LLC for your Airbnb. There’s no distinction between a general vacation rental LLC and an Airbnb LLC. It really comes down to personal preference. If you believe that your Airbnb has a low liability then maybe an LLC isn’t the right choice.
Takeaways: Should your vacation rental property become an LLC?
Making your vacation rental business an LLC is ultimately a personal decision. You must decide what is right for you and your business. As a recap, the factors you may want to consider are as follows:
Tax options and benefits
Necessary members of the LLC
Some vacation rental owners might opt to make their business a sole proprietorship or general partnership as an alternative to an LLC license. Ultimately, the proper licensing will depend on the business owner. Having an LLC for your vacation rental might be the right decision for you in giving legitimacy to your business.
Having the proper tools, like an LLC license and vacation rental software, will turn your short-term rental hustle into a recognized business. Go pro by adding automation tools, reservation systems, centralized calendars and inboxes, and a fully equipped website to your business. Don’t believe us just yet? Let us prove our expertise with a free 7-day trial.
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