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Experienced landlords know that leasing can be a complicated and tricky venture. For individuals newly coming to the real estate leasing business, highlighted below are several important issues to consider that will help improve your experience and potential success.
First and foremost, make sure that you are using a comprehensive form of Lease Agreement that adequately addresses all the issues that may come up during the tenancy. If you are renting out residential real estate, issues such as security deposit, pets on the premises, rental insurance, payment of utilities, roommates, late payments and holding over after the lease term ends are necessary provisions to consider. Equally important are the provisions setting forth the rights of the landlord in the event of a default, which in Pennsylvania, in many instances, is controlled by a statute known as the Landlord Tenant Act of 1951.
If, on the other hand, you are going to lease commercial space, issues such as obtaining the personal guarantee of the owners, requiring appropriate insurance coverages, identifying which party is responsible for the maintenance and repairs in the building, the tenant’s hours of operation, assignment and subleasing, and modifications and improvements to the leased space are just some of the issues that should be addressed, depending on the type of space being rented and the business of the tenant.
Sometimes in their quest to save money, inexperienced landlords will find a form Lease Agreement on the internet, thinking that a “one size fits all” approach is possible. In some instances, these form leases contain state specific or locality provisions that might not make sense in Pennsylvania, can materially differ from what has been verbally agreed to by the parties, or could actually be in conflict with the Landlord-Tenant Act. In other instances, landlords may make attempts to modify these lease forms, or even write up their own, without realizing that removing or adding language or omitting important provisions could substantially affect the rights, liabilities or obligations of the parties. Neither of these approaches is advisable. Leasing is a business, and hiring an attorney who understands leasing issues to help you use the proper form of lease is highly advisable.
A second important issue to address is insurance coverages, and a business professional to bring into your corner is a knowledgeable insurance agent. Your agent can help analyze the proper types of policies and coverages you need, based on whether you are going to be a residential or commercial landlord, and whether or not you are leasing in your individual name or through a business entity, such as a corporation or a limited liability company (LLC). Properly protecting against the risks and liabilities you may face during a period of tenancy, with appropriate amounts of general liability and umbrella coverages, provides peace of mind if an unexpected claim arises.
Finally, reviewing the tax issues created by your leasing activities is another area where proper planning and expert advice should be sought. Securing the services of an experienced accountant can help new landlords avoid costly mistakes such as incorrectly reporting income, expenses, and depreciation when filing the federal, state and local tax returns. Renting as a sole proprietor versus through a business entity can result in different tax considerations, depending upon a number of facts and circumstances. If the landlord is going to be legal entity, such as a corporation or LLC, which has multiple individual owners, additional planning and tax issues may need to be considered. And sometimes having an accountant help with the bookkeeping takes a lot of time and stress out of the process.
It should also be specifically noted that it would be advisable to consult legal, insurance and tax professionals when engaging in the business of short-term rentals, such as Airbnb, HomeAway or VRBO, especially if that rental is occurring in your own home. As to the legal aspects, some counties and communities have passed specific ordinances or statutes governing short term rentals. In other communities, these types of rentals may be prohibited without securing a business license. If third parties are staying in your personal residence for business purposes, you should disclose that to your insurance carrier to determine if your homeowner’s policy provides coverage for that types of business activity. And gaining an understanding of state and local taxation of short-term rentals is another issue to review because many municipalities want to collect taxes from these rental activities. Therefore, conducting a thorough review to determine the rules and laws impacting short term rentals in your community is important.
One other question that regularly arises in the discussion of leasing is whether it is better to own a rental property in one’s individual name or hold the ownership in a business entity, such as a corporation or a limited liability company (LLC). Articles on the subject abound on the internet, highlighting various opinions or experiences about the pros and cons of both types of ownership from any number of standpoints, including flexibility, taxes, costs and protection.
One of the biggest advantages of holding a rental property in a business entity is that it can afford the individual owner protection from personal liability. If the landlord entity is sued, then only the assets of the company would normally be subject to satisfy claims, assuming of course that the individual owners have observed proper business formalities to confirm that legal separation from themselves. But the personal liability issue is only one piece of the puzzle. And until the other pieces of the puzzle are analyzed, the truly lawyerly answer to the question of whether a business entity should be formed is: “It depends.”
Every client’s situation has specific facts and questions to consider, the combination of which will help an attorney produce an accurate and tailored analysis. Some of the questions are as follows:
- Is protection from personal liability and protecting personal assets a concern?
- What are the costs of forming an entity such as an LLC?
- Do you already own the property in your name or are you currently purchasing it?
- If you are purchasing, are you obtaining financing from a lender?
- If you own the property already, is there an outstanding mortgage on the property?
- Would real estate transfer taxes be incurred by transferring it to an entity?
- Are there specific tax advantages to be gained by the transfer?
- Do you anticipate refinancing the property in the near future?
- What is the difference in insurance cost?
- Do multiple owners have an interest in the investment?
- Do you own multiple rental properties or just one?
- Will there be multiple tenants in the building?
The list of questions above is not exhaustive. But the answers are important. For example, the analysis for a client who wants to transfer a second home with a current mortgage on it to an LLC to generate rental income is much different than for two brothers who are partnering together to pay cash for a new investment property that will be leased to multiple tenants.
As stated at the beginning of this article, leasing is a business that should be approached with careful planning and proper advice. Seeking out objective and experienced professional advisors may be one of the best decisions landlords can make to ensure their success.