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LLC vs. Living Trust: How to Protect Your Assets

When it comes to protecting your business assets, should you use an LLC or a Living Trust? Trust & Will explores the advantages and differences of both.

Mitch Mitchell

Mitch Mitchell, @MitchMitchell

Product Counsel, Legal, Trust & Will

Are you looking for ways to shield your hard-earned property from potential risks and uncertainties? You’ve come to the right place! In this guide, we’ll be introducing two popular strategies: the Limited Liability Company (LLC) vs. the Living Trust. Whether you’re a business owner, investor, or someone simply curious about how to safeguard property, understanding the nuances and differences between these two structures is advantageous. Keep reading to find out the differences between the LLC vs. Living Trust, what they have to offer, and what types of assets or property they can protect best for your Estate Plan. 

What is an LLC?

A limited liability company (LLC) is a structure used by U.S. business owners to protect themselves from personal liability for debts or legal issues incurred by the LLC itself. 

These companies are entities that have the characteristics of both a corporation and a partnership or sole proprietorship, making it a hybrid structure of sorts. It is similar to a corporation in that the owners have limited liability, but the flow-through taxation of LLC members mimics a partnership more than a corporation. 

LLCs are permitted through state statutes rather than at the federal level. Because of this, they are regulated by the state, meaning that specific rules can vary from state to state. Most states do not restrict who can be an LLC member, such as individuals, foreigners, corporations, and sometimes even other LLCs. However, they do not allow certain entities to form an LLC, such a bank or insurance company.

If you choose to form an LLC, you are required to file your articles of organization, which creates a formal business agreement, with the state. Not only is this easier to do relative to setting up a corporation, it often offers more flexibility and protection.

An LLC also offers the option of flow-through taxation. This means that instead of reporting and paying taxes as an LLC, the owners report profits and losses in their personal tax returns. However, keep in mind that creditors may be able to go after owners directly if the LLC fails to meet legal or reporting requirements or fraud is detected. 

Now that we have established how an LLC works and its advantages, we will demonstrate how you can use an LLC to protect your rental property. Before we do that, however, here is an introduction to the Living Trust. It will soon make sense as to how the LLC can fit into the Living Trust (and vice versa) as an asset protection and estate planning strategy. 

What is a Living Trust?

When it comes to estate planning, two popular tools come to mind: the Will and the Living Trust. Both of these options serve the same purpose of allowing you to distribute assets and property to loved ones after your passing. However, they differ greatly when it comes to their function and potential outcomes.

A Living Trust can be used to move any property and assets you don’t want subject to the probate process out of your personal estate. After you fund the Trust with property, the Trust itself is the owner thereafter. However, you still get to control the property by appointing yourself as the Trustee during your lifetime. When you pass away, your successor Trustee takes over and manages the property for the benefit of your beneficiaries. 

Unlike a Will, Trusts allow you to set up terms that lay out exact instructions on how Trust assets should be distributed to your beneficiaries. These assets won’t be put through the lengthy and costly process of probate, and will be transferred to your beneficiaries per your agenda instead of state law. 

Many individuals choose to bolster their Estate Plan with the use of a Living Trust in addition to their Will for these reasons. 

Using an LLC to protect your rental property

There are a variety of reasons to set up an LLC, such as to protect personal assets from business assets when starting a business. From an estate planning perspective in particular, an LLC is a great tool to protect your rental property. While you may think of your rental properties as more of an investment rather than a business, setting up an LLC can offer you added protection. 

Transferring your rental property interest to an LLC creates a legal barrier that will protect your personal assets. Let’s say that a creditor goes after your rental property for business reasons. By having an LLC, they cannot go after your personal home, bank accounts, or investments. 

Once you transfer your investment properties into the LLC, the LLC will become the legal owner of the properties thereafter. You will remain the underlying “Owner/Member” of the LLC. Rent checks from your tenants should be made out to the LLC rather than to you. Similarly, lease agreements will indicate the LLC as the landlord, and any and all business related to the property or properties will be conducted through the LLC and its own bank account. 

Now, here is a neat estate planning trick: while you can appoint yourself as the underlying owner of the LLC, you can also appoint your Living Trust as the Owner/Member instead.

Here’s how this adds an extra layer of protection. As the Trustee of your Living Trust, you will still have control over your rental properties during your lifetime. However, what if you were to pass away or become incapacitated? Here, you can have peace of mind. When setting up your Trust correctly, you will have appointed a successor Trustee. This means that this individual has the legal authority to immediately set in and take control over the management of your LLC and thus your rental properties without a hitch. 

This strategy prevents the need for any lengthy and costly court procedures such as probate or conservatorship. From an estate planning perspective, appointing your Living Trust as the Owner/Member of your LLC is a winning strategy for your heirs, property tenants, and any business partners.

If you do not have a Living Trust appointed as the Owner/Member of your LLC, then your investment properties, business holdings, and financial accounts owned personally by you at the time of your passing legally must pass through probate. This can cause detrimental interruptions to your business operations, cause inconveniences to your tenants, and take away from the legacy you worked hard to build for your beneficiaries. 

How to set up an LLC for rental property 

Mentioned earlier, the laws governing how an LLC must be formed vary from state to state. To set up an LLC, it is recommended to consult your state’s statutes to ensure your business entity is legally compliant. 

With this in mind, here is a general overview of how to form an LLC for your rental property or properties:

1. Consider consulting a legal or financial professional to ensure that creating an LLC for your properties makes sense for your desired outcomes.

2. Select a business name. Your business name must be unique. You can often conduct a business name search provided by your state to ensure your desired name isn’t already taken.

3. Prepare your “Articles of Organization” and “Operating Agreement” that provide the basic information of your business and describe the structure of your business finances and decision-making. You can find plenty of free templates and examples online. 

4. Register your business name along with your required documents with your state.

5. Obtain an Employer Identification Number (EIN), which is required for filing your state and federal taxes. The EIN is similar to your personal Social Security Number, but is used solely for your LLC.

6. Open a business bank account. This is extremely useful for keeping your personal and business income and expenses separate. Not only is this necessary to stay legally compliant, it is very helpful when tax time comes around. Make sure that any rental income is made out to your LLC and any business-related expenses come out of this designated account. This also means that you’ll want to obtain a debit card and checkbook associated with the account for practical use. 

Increase asset protection with a Living Trust 

The hassles of the probate process (the costs, the delays, the emotional burden, and other inconveniences that come along with it) can be avoided with a property Estate Plan, and more specifically, with the use of a Living Trust. 

While this alone is reason enough to implement a Trust in your Estate Plan, there are several other advantages associated with the Living Trust. 

First, the Living Trust allows you to maintain full control and access of any assets and property placed within the Trust. Discussed earlier, you can have peace of mind knowing that asset management won’t be interrupted by appointing a successor Trustee in case anything should happen to you.

Further, Living Trusts provide asset protection that can help minimize taxes for both your estate and your heirs. Depending on the state in which you live, as well as the size of your estate, moving your property to a Living Trust can help minimize estate related taxes such as inheritance tax, estate tax, and gift tax. 

You can also use a Living Trust to finesse the manner in which your beneficiaries will inherit property. For instance, let’s say that you are a property owner. You set up an LLC for your rental properties and designate the Living Trust as the Owner/Member. You have a son who is only 14 years old. You eventually want him to inherit these rental properties so that he is set up with a significant amount of equity and passive income for life. However, you worry that he is too young to inherit these properties if anything were to happen to you today. 

This highlights yet another key advantage of the Living Trust. You can lay out in the Trust’s terms that these properties will only transfer to your son once he reaches the age of 30 (or other age of your choice.) Further, you can add other stipulations. For example, you could require that your son must have a property management certification in addition to turning 30 before he can inherit the properties.

Living Trusts provide asset protection in customized a way that the probate process could never offer. 

How to set up a Living Trust

The process of setting up a Living Trust typically involves drawing up your Trust document, funding the Trust with your desired assets and property, and naming a Trustee and successor Trustee(s). However, the exact process and rules will vary from state to state. Here is an example of how to set up a Living Trust in California.

LLC vs. Living Trust: which is better?

From an estate planning perspective, choosing between an LLC vs. Living Trust depends largely on your personal circumstances. They both offer a unique set of advantages, and therefore, one isn’t necessarily better than the other. Perhaps the better question to ask is: can I take advantage of both?

This guide revealed a powerful strategy in which you can combine an LLC with a Living Trust. By placing your business assets (such as the rental properties we discussed in this guide) into an LLC and then transferring ownership of the LLC to your Living Trust, you can take advantage of the objectives and advantages provided by each.

Ultimately, the choice between an LLC and a Living Trust depends on your specific goals and circumstances. Seeking professional assistance can help your decision-making much easier, as it can help you sort through a variety of options and match up the tools that will best help you meet your objectives. Whether you would like to set up a Will, a Living Trust, or help with navigating the Probate process, we have something for everyone! 

At Trust & Will, we’re here to help keep things simple. You can create a fully customizable, state-specific estate plan from the comfort of your own home in just 20 minutes. Take our free quiz to see where you should get started, or compare our different estate planning and settlement  options today!

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