While an LLC offers liability protection, it does not change how taxes are reported unless treated as a partnership or corporation.

@Andrew Slezak I recommend you first articulate precisely the liability events or concern which are pushing you to transfer the property to an LLC.

As long as you have the insurance liability, property and flood if you are in a flood plain.

Haven't had any issues, but I am worried about liability should something happen like a fire. 

What ROI do you need to justify the liability and active nature of owning a rental property?

I don't think you are going to be able to get insurance for two separate living units in a single-family when they are both illegal and likely do not have the correct egress windows (basement) for fire safety which could subject you to huge liability if something happens to either party.

As far as being expensive; if the tax liability is not large enough then yes I agree, however, it depends on what is being sold too.

Who do you feel will end up with more liability here?

Also make sure to have owners add you to their property insurance policies, so you have liability protection. 

Liability insurance covers negligence.