New Investor Business Structure Options

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New Investor Business Structure Options

Mitch KlinePro Member
Member since 2022 · 6 posts · 0 votes

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!

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Doug SmithPro Member
Lender · Tampa, FL · Member since 2013 · 2k+ posts · 2k+ votes
3y

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. 

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  • Chris SeveneyBusiness Member
    Moderator
    Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
    3y
    Quote from @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!


     Rule #1 of investing: NEVER listen to a mortgage lender on business operations advice. 

    There is a lot to unpack here, but look at the LLC as asset protection as it does nothing for tax consequences. Keeping them in your personal name and getting an umbrella insurance policy is the simplest thing. Since your wife is managing them, if she gets an LLC then she may need to get licensed as a property manager depending on your state, so there is that to consider.

    Once you go down the path of creating all these LLCs things can get a lot more complex and the real question is, do you need all the complexity. What are you trying to accomplish. That is the first question then review what you can do to resolve them. I would argue that in 99.9% of cases on single family rentals having it in a personal name with an umbrella policy is the cure. 

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  • Mitch KlinePro Member
    OP
    Member since 2022 · 6 posts · 0 votes
    3y
    Quote from @Chris Seveney:
    Quote from @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!


     Rule #1 of investing: NEVER listen to a mortgage lender on business operations advice. 

    There is a lot to unpack here, but look at the LLC as asset protection as it does nothing for tax consequences. Keeping them in your personal name and getting an umbrella insurance policy is the simplest thing. Since your wife is managing them, if she gets an LLC then she may need to get licensed as a property manager depending on your state, so there is that to consider.

    Once you go down the path of creating all these LLCs things can get a lot more complex and the real question is, do you need all the complexity. What are you trying to accomplish. That is the first question then review what you can do to resolve them. I would argue that in 99.9% of cases on single family rentals having it in a personal name with an umbrella policy is the cure. 


    Chris, I appreciate the reply. The intent of the LLC would be first and foremost to be able to sign a long term lease (to show secured income) to so that I can clear my debt related to the mortgage so that I can buy subsequent properties without waiting two years to show my short term rental income to lower my DTI so that I can qualify for additional loans.

    Let me know if I am missing something here or if there is additional (better) ways that I could clear that debt off my DTI.

    Thanks for your time.

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  • Doug SmithPro Member
    Lender · Tampa, FL · Member since 2013 · 2k+ posts · 2k+ votes
    3y

    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. 

    1Reply
  • Sean ConstablePro Member
    Attorney · Long Island, NY · Member since 2009 · 34 posts · 20 votes
    3y

    @Chris Seveney anytime people, especially family members, go into any business together, they should formalize it. LLCs offer the greatest flexibility. There is so much more than liability protection to consider. If you want a good easy read addressing some of the issues take a look at The Partnership Charter by David Gage.

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  • Chris SeveneyBusiness Member
    Moderator
    Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
    3y

    @Doug Smith

    Sorry you took it that way but that’s not their specialty and it’s no different why you should also not listen to an agent for entity setup

    Either. I am not insulting anyone just stating that people need to look out for their best interests and listen to people who actually know what they are talking about as there is a a ton of bad information here on BP and also by professionals who step into the other lane

    Do you listen to a plumber for how to wire a house? No, does he know stuff about electrical, yes but that’s not his specialty and these are nuanced things.

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  • Eric Williams
    Accountant · Houston, TX · Member since 2023 · 148 posts · 41 votes
    3y
    Quote from @Chris Seveney:

    @Doug Smith

    Sorry you took it that way but that’s not their specialty and it’s no different why you should also not listen to an agent for entity setup

    Either. I am not insulting anyone just stating that people need to look out for their best interests and listen to people who actually know what they are talking about as there is a a ton of bad information here on BP and also by professionals who step into the other lane

    Do you listen to a plumber for how to wire a house? No, does he know stuff about electrical, yes but that’s not his specialty and these are nuanced things.

    I mean you say there's bad information right after you say an LLC does nothing for tax consequences even though it allows me to form a single member LLC disregarded then file an 8832 to create a C Corporation after which I could file a 3552 to create an S Corporation.

    I couldn’t do that as easy with other entities.

    It also gives me liability protection while allowing for participation in management which is generally hard for limited partners without tax consequences.

    It definitely does something for self employment tax vs a GP.

    By default LLC loans are non-recourse which changes the tax basis under 465.

    Also LLCs don’t fall under 469 passive limitations of limited partners simply because Subchapter K was written before LLCs.

    Also LLCs in community property can be disregarded if owned by spouses and certain conditions are met. This avoids partnership 1065 filings.

    And of course in Texas the LLC creates a Texas Franchise obligation.

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  • Sean Morrison
    Attorney · Slidell, LA · Member since 2016 · 322 posts · 179 votes
    3y

    Disclaimer: I am an attorney, but I am not your attorney. This is not legal advice, just friendly information.

    I'll focus my comments just on the legal stuff. Keep in mind that an LLC that does not own the property, does not protect the property owner. If an LLC manages the property, it will provide the LLC owners personal protections arising from management liability, but an attorney is going to target assets (ie the property) and those will be owned by you personally.

    The last thing I will say is no matter how it's structured, do not run expenses and income through personal accounts. Life will be much easier and safer with a separate account and accounting. 

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  • Mitch KlinePro Member
    OP
    Member since 2022 · 6 posts · 0 votes
    3y
    Quote from @Sean Morrison:

    Disclaimer: I am an attorney, but I am not your attorney. This is not legal advice, just friendly information.

    I'll focus my comments just on the legal stuff. Keep in mind that an LLC that does not own the property, does not protect the property owner. If an LLC manages the property, it will provide the LLC owners personal protections arising from management liability, but an attorney is going to target assets (ie the property) and those will be owned by you personally.

    The last thing I will say is no matter how it's structured, do not run expenses and income through personal accounts. Life will be much easier and safer with a separate account and accounting. 


     Sean,

    Appreciate the information and recommendation. 

    Currently I have a seperate accounts for all things RE related to help ease the burden come tax time.

    With this being my first property we went the more straight forward route, I own and manage the property in my personal name and am utilizing an umbrella insurance policy. I intend to transfer property ownership over to an LLC once I create one (likely on my next RE purchase)

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  • Corby GoadeBusiness Member
    Investor · Boise, ID · Member since 2014 · 3k+ posts · 3k+ votes
    3y

    This topic has been beat to death here, but I'll jump in and speak broadly. I really like what @Chris Seveney said above about taking business advice from a lender, and I'll take it a step further. The only person you should take business structure advice from is your attorney. The only person you should take tax advice from is your CPA. It's vital that you build a team that works well together, but everyone stays in their lane. 

    I've got a client right now who is building their business structure based on advice from their bookeeper, who speaks VERY confidently, but is giving them terrible advice IMHO. 

    Lender should be giving you multiple options based on your situation and you choose with LOAN works for you. That's ridiculous that they are instructing you about entity structure. 

    That being said, it's not as simple as your post (or lender) make it sound. There's no correct way to structure an entity, every type of structure has pros and cons- more or less liabiliy in exchange for more or less cost. Generally, you can structure your business in such a way that your expenses are lower but you'll be taking on more liability. You can structure it so you have less liability, but your expenses will be higher. 

    So much more to it than this, but the bottom line is that you should be speaking with an attorney and a CPA and ignore advice from "pros" who aren't staying in their lane. 

    Best of luck- working with family is tough!

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