Although real estate investors may directly own property as sole proprietors, rental property is often held in a limited liability company (LLC) or trust. Both entities are vehicles that may help investors protect assets and reduce potential risk, although an LLC and a trust are used for different purposes.
In this article, we’ll explain the difference between an LLC and a trust and review the pros and cons of holding rental property in an LLC versus a real estate trust.
Are you worried about what to do with the rental property you worked so hard to get? Perhaps a financially savvy friend told you about irrevocable trusts, or your lawyer brought them up at your last meeting. What brought you here? I’m going to tell you everything you need to know about putting your rental property in a trust that can’t be changed.
What Exactly Is an Irrevocable Trust?
Let’s start with the basics. An irrevocable trust is a legal arrangement in which you (the grantor) give your property to a trust that can’t change or reverse it without the beneficiary’s permission. When you put your rental property in this type of trust, you’re giving up control of it.
As Columbia Property Management explains, with an irrevocable trust, “the grantor cannot be a trustee nor a beneficiary. The trust has its own tax ID for the purposes of taxation and a separate identity from the grantor.” This means you no longer have any legal say over the property and cannot force the trustee to do anything.
This is not the same as a revocable trust, where you keep control of the asset and can make all financial and management choices.
Top Reasons to Consider an Irrevocable Trust for Your Rental Property
1. Asset Protection
One of the best things about an irrevocable trust is that it protects you from lawsuits and creditors in the future. In most cases, your personal creditors can’t touch the property because you no longer legally own it.
As FinanceBand notes, irrevocable trusts can “protect assets from your creditors” and provide “great protection from future creditors and lawsuits as well as bad marriages.”
2. Estate Tax Minimization
According to LegalClarity, irrevocable trusts provide “a higher level of asset protection” and are “often used by individuals in high-liability professions or those looking to minimize potential estate taxes”
Since the property is no longer part of your taxable estate, it won’t be subject to estate taxes when you die. FinanceBand confirms that “assets transferred by a grantor to an irrevocable trusts are generally not part of the grantor’s taxable estate for the purposes of the estate tax.”
3. Medicaid Planning
If you’re concerned about qualifying for government assistance programs like Medicaid in the future, an irrevocable trust could be helpful As Columbia Property Management points out, holding assets in an irrevocable trust “may also be used as a tool to permit [you] to pass assets to your heirs after your death without the assets counting now as your personal wealth or assets for the purposes of determining Medicare eligibility.”
4. Capital Gains Tax Benefits
FinanceBand notes that “Irrevocable Grantor Trusts can offer excellent asset protection with little to no Capital Gains tax implication.” The present law allows trust assets to receive the same beneficial tax treatment when the grantor passes away.
5. Privacy Protection
LegalClarity points out that a trust offers privacy benefits: “When a property is held in a trust, the public record lists the name of the trust, not the individual owner.” While this privacy isn’t as bulletproof as it once was due to online databases, it still provides some level of anonymity.
The Downsides You Need to Know
Nothing’s perfect, and irrevocable trusts definitely come with some significant drawbacks.
1. Loss of Control
This is the big one. As FinanceBand bluntly puts it, “you can’t change them. And you can’t act as your own trustee either.” Once you set up the trust and transfer your rental property, you no longer have control over it.
2. Expense and Complexity
Setting up an irrevocable trust isn’t cheap or simple. LegalClarity notes the process requires “an attorney creates the trust document” followed by formally transferring the property’s title with a new deed, notarization, and recording with the county recorder’s office.
Columbia Property Management adds that “Setting up a trust brings with it paperwork and fees for attorneys that you won’t incur if you decide to put the rental property in your personal name.”
3. Mortgage Considerations
If your rental property has a mortgage, transferring it to an irrevocable trust could trigger the “due-on-sale” clause. LegalClarity mentions that while there are some exceptions under the Garn-St Germain Depository Institutions Act, this is something you’ll need to carefully consider.
Columbia Property Management points out that “it is generally easier to get a mortgage in your own name, rather than as an LLC or an irrevocable trust, because lenders prefer the ability to go after personal assets in the case that you default on the loan.”
4. Tax Complications
With an irrevocable trust, tax filing becomes more complex. FinanceBand explains that because an irrevocable trust “is a separate legal entity for tax purposes. It must obtain its own tax identification number and file annual income tax returns using Form 1041.”
Is an Irrevocable Trust Right for YOUR Rental Property?
So, should you actually put your rental property in an irrevocable trust? Here’s my take based on the circumstances where it makes the most sense:
Consider an irrevocable trust if:
- You’re in a high-risk profession with significant liability concerns
- You have a substantial estate that could face estate taxes
- You’re planning for Medicaid eligibility in the future
- You want to ensure the property passes to specific beneficiaries with restrictions
- You have multiple rental properties and need comprehensive estate planning
Maybe skip the irrevocable trust if:
- You want to maintain control over your rental property
- You might need to sell or refinance the property in the future
- You have a limited portfolio of just one or two properties
- You’re still actively building your real estate investments
- You’re comfortable with simpler solutions like liability insurance
Alternatives to Consider
If you’re not convinced an irrevocable trust is right for you, there are alternatives:
1. Revocable Living Trust
As LegalClarity explains, a revocable living trust is “the more flexible option. The grantor often serves as the trustee and beneficiary during their lifetime, maintaining complete control over the property.” This type of trust still helps avoid probate but doesn’t offer the same asset protection benefits.
2. Limited Liability Company (LLC)
Columbia Property Management mentions that forming an LLC is another option if “your main concern is protecting yourself and your other personal assets from liability.” However, they note there are “definite pros and cons” including “limited access to financing” and potential transfer taxes.
3. Robust Insurance Coverage
Sometimes the simplest solution is comprehensive liability insurance. While not offering all the benefits of trust structures, good insurance can protect against many common risks rental property owners face.
Steps to Setting Up an Irrevocable Trust
If you decide an irrevocable trust is right for your rental property, here’s a simple breakdown of the process:
- Consult professionals – Work with an attorney who specializes in estate planning
- Create the trust document – The attorney will draft the trust according to your needs
- Select a trustee – Choose someone reliable who will manage the property
- Transfer the property – Execute a new deed transferring ownership to the trust
- Update insurance – Notify your insurance carrier about the change in ownership
- Obtain tax ID – Get a tax identification number for the trust
- Ongoing management – Ensure the trustee properly manages the property according to the trust terms
The Bottom Line
Putting your rental property in an irrevocable trust is a serious decision with lasting consequences. While it offers significant benefits for asset protection, estate planning, and tax purposes, it comes at the cost of giving up control over your property.
As FinanceBand concludes, “Irrevocable trusts are an important tool in many people’s estate plan.” However, they’re not for everyone or every situation.
My advice? Talk to professionals—an estate planning attorney, a tax advisor, and maybe even a property management company—before making this decision. The right choice depends on your unique financial situation, long-term goals, and comfort level with surrendering control of your investment.
I’ve seen plenty of rental property owners make different choices based on their individual circumstances. There’s no one-size-fits-all answer, but with the right information, you can make the best decision for your real estate portfolio.
LLC for rental property
An LLC is a separate business entity formed according to the statutes for the state in which a rental property is located.
The individual owners of an LLC are called “members,” and most states do not restrict the type of ownership or the number of members. As the Internal Revenue Service (IRS) explains, members of an LLC can be corporations, other LLCs, foreign entities, and individuals.
In most cases, states also allow “single-member” LLCs with one owner. Rather than holding rental property as a sole proprietorship as an individual, a real estate investor may consider forming a single-member LLC to hold investment property.
Pros
- LLCs are separate businesses from their members, and they may be easier and cheaper to set up and run than corporations.
- There is no limit on how many people can join an LLC, which could make it a good choice for group investing.
- Members of an LLC can give the business either equity capital or debt financing in the form of a loan. They can also do a mix of the two.
- If the laws in your state allow it, you can form a single-member LLC to hold rental property instead of owning it in your own name or as a “doing business as” (DBA) name.
- Income or losses from a rental property owned by an LLC are passed through to each member and reported on their own tax returns. Income taxes are paid based on the individual rate of each member, so corporate profits are not taxed twice.
- Each member’s other business and personal assets are usually safe from lawsuits or creditor claims if the group files for bankruptcy or goes to court.
- The rules in an LLC’s operating agreement say that members can buy and sell their individual shares without having to sell the rental property itself.
Cons
- Many states charge an annual fee to keep an LLC going and require members to hold meetings every year.
- LLCs need to file tax returns every year, even though they usually don’t pay taxes. They also need to give each member a Schedule K-1 that shows their share of income or losses, deductions, and credits.
- It’s possible for members of an LLC to be held less responsible if the LLC is found to have done something illegal.
- Members of an LLC may be able to sell their shares, but in some states, if there is a change in membership, the old LLC has to be dissolved and a new one has to be formed.
- Also, it might be harder to get more money with an LLC structure than with a corporation, like an S corp, which can sell extra stock shares instead of getting a bank loan.
LLC vs. real estate trust
An LLC and a real estate trust can both be used for asset protection. While LLCs and trusts are created at the state level, the entities are used for slightly different purposes.
An LLC is a distinct business entity, similar to an S corporation, that is formed to help protect investors from potential legal liability and separate other business and personal assets from those held in an LLC. But a real estate trust is set up so that people don’t have to pay taxes when they pass on real estate from one family member to another or from one generation to the next.
Before continuing, keep in mind that when deciding whether to hold rental property in an LLC or a trust, you may wish to speak with a financial advisor or attorney.
What happens when put your home into an Irrevocable Trust? – Podcast Episode 28
FAQ
Can you put rental property in an irrevocable trust?
There are 2 types of real estate trusts for rental property: revocable and irrevocable.
What are the disadvantages of putting your house in an irrevocable trust?
An irrevocable trust, however, is mostly set in stone. Once you move assets into it, you typically can’t take them back or make changes without permission from the people involved. You also give up direct control over the assets.
Why should I put my rental property in a trust?
Some of the benefits of putting rental properties in a trust are: estate planning: trusts avoid public probate proceedings and make it easier for beneficiaries to get assets. Asset protection: Depending on the type of trust, it may offer extra protection from creditors.
What assets should not be placed in an irrevocable trust?
You shouldn’t put personal use assets like your home, cars, retirement accounts (IRAs, 401(k)s), and actively used bank accounts into an irrevocable trust. Doing so could make it hard to get to your money or leave them open to liability, which could cancel out the trust’s protective benefits.
What is an irrevocable trust?
Understanding Irrevocable Trusts: An irrevocable trust is a legal arrangement where you, the grantor, transfer ownership of your rental property to a trustee. This trustee manages the property according to the terms outlined in the trust document, and you relinquish control over it.
Should I put my rental property in an irrevocable trust?
No Tax Breaks: Once the rental property is transferred to an irrevocable trust, you cannot claim tax breaks for depreciation or other costs related to it. Making a Smart Choice: Deciding whether to put your rental property in an irrevocable trust is a difficult choice that can have big legal and financial effects.
Can a grantor revoke a rental property trust?
Irrevocable Trusts: Grantors cannot easily change or revoke these trusts once established. Some of the benefits of holding rental properties in a trust include: Estate planning: Trusts avoid public probate proceedings and facilitate smooth asset transfers to beneficiaries.
Should I add real estate to my irrevocable trust?
Take a closer look at some advantages of adding real estate to your irrevocable trust. One of the most significant benefits of placing your house in an irrevocable trust is that it allows your beneficiaries to avoid probate. When your loved ones lose you, the last thing they want to do is deal with the courts.
Can a real estate trust be used for a rental property?
Real estate trusts also may be used by multiple owners of a rental property as a way to document ownership interests and relationships. Assets held in a trust are not treated as part of the grantor’s personal assets, which may help to lower an individual’s tax liability.
Are there different types of real estate trusts for rental property?
There are 2 types of real estate trusts for rental property: revocable and irrevocable. In both cases, rental property is transferred from the original owner (the grantor) into a trust, but the control that the grantor has is different.