New Investor Business Structure Options

[Mitch Kline]

Hi Everyone,

Looking for some advice on business structuring as I am currently under contract for my first investment property.

Situation: My brother and I have decided to partner up and tackle real estate investing together. We both have high credit scores and low DTI. We intend to buy houses in our personal names and go back and forth with who is on the mortgage so that we can each scale to 10 properties and own 20 properties between the two of us. Our current property is under contract and I am buying it under my name with a conventional loan and we intend to short term rent it and my wife is going to manage it (she currently manages STRs for a Co-hosting business).

One of the lenders we talked to who is also an investor recommended that we start an LLC and rent the property to the LLC so that we can erase the DTI since we wouldn't be able to do that if we short term rent it. I like this option, but want to get opinions on the best way to structure this.

Question: Do we start an LLC 50/50 ownership as property management company with me and my brother and then sign a year long lease from me personally to the business for PITI so that it removes it from my DTI? We intend to pay my wife 20% of income for the property management, would it be best to make her an employee of the LLC and pay her commission? Or have her act as a contractor to the LLC? Additionally, if we go the LLC route would it be better to run all of the income and expenses through the LLC? Or should I run all income and expenses through my personal accounts? How would insurance work? Would I have to get STR insurance as the owner (personally) and STR insurance as the business?

Goal: Grow our portfolio and reduce our DTI by showing income from these investments. Find the best way to reduce the amount of taxes we get stuck with. Employee my wife so that eventually she is making enough in her own name so that we can add another 10 houses down the road under her name.

Thanks in advance!

[Doug Smith]

With all due respect to @Chris Seveney , there are reasons why the lender said an LLC MIGHT be a route for you. I've been a lender for 32 years and a real estate investor for the past 17 years. Sometimes lenders DO know what we're talking about. (not gonna lie, Chris, you're Rule #1 was a bit insulting...a lot of us have pretty strong business operations experience). Sorry to start with the negative, but insulting a group of BP users/contributors with "Rule #1 of investing: NEVER listen to a mortgage lender on business operations advice" is not cool. Now that I'm done defending the honor of lenders, let's get back to your question.

I'm not going to touch on the tax or liability side of the question, but from a lender's perspective, holding the asset in the name of an entitly opens up a lot of possibilities as you scale. If you're just going to do one or two properties, then it's fine to stay with conventional financing, but debt to income ratios quickly become an issue as you add more mortgage loans to the mix. When a lender lends to an entity for a commercial purpose (such as real estate investing, then the a lot of the income verification requirements from post-2007-collapse legislation like Dodd Frank melts away. Lenders can use the cash flow from the property only instead of doing a global cash flow on you...that allows you to fit more property into your portfolio and, thus, scale. I suspect that is what the lender was trying to convey. I'll refer you to an asset protection attorney for a lot of your question. Good luck to you.