What is a good rule to decide if I should form a new entity for a new property purchase?

Question

I have a few properties in one LLC and am in the process of purchasing an 8 unit also in it. Looking for other properties as well. 
Just wondering what would be a good way to figure out if a new property needs a new entity? I am thinking 8 plex or more new entity would be good... please share your thoughts.

Also, more entities would be annual fees, book keeping expenses, accounting and IRS filing accountant expenses etc. So wanted to get an idea.

Please share your thoughts

David Krulac · Answer

@Brad Johnson

I would agree that a large apt bldg should be in its own entity.   But I would not agree with the people who say each SFH should have its own entity.  Just too much overhead the in your home state of CA, the $800 year fee per each LLC can be onerous not to mention separate tax returns for each LLC.

And LLC is not the only form of entity ownership.

As Frank Romine  mentioned the amount of equity might be another consideration.  As well as the amount of umbrella insurance carried.

The state where located is a factor and the costs per entity, cost of tax prep and filing fees, as well as the purpose of the entity, tax consequences, liability, or anonymous?

Franklin Romine · Answer

The use of entities goes back to the amount of equity and cashflow you have at risk.  If you moved out of your primary residence that had $200K in equity and negative cashflow would you setup an LLC?.  If you owned 10 small houses with a combined equity of 200K and $2,000 per month in cashflow would you setup an LLC?

The cost to operate the entity...ca secretary of state and the accountant... the money would be better spent on see's candy for your insurance agent and umbrella policies.  More LLC's makes your life more complicated.

Brad Johnson · Answer

You might not want to hear this, but you should have one LLC per property. This isn't real practical if you're buying and flipping a ton of homes, but if you want to purchase larger apartment buildings (as you've suggested) each asset should absolutely have it's own entity. If a tenant "trips" and files a lawsuit, you don't want to give an attorney the ability to go after assets outside of the property in question. Furthermore, if you want get a new loan or refinance your apartment building, the lender will likely want to see that property is held in a single purpose (single asset) entity. This is one of the more boring / tedious aspects of real estate investing, but mitigating risk should be a top priority of any investor.

Franklin Romine · Answer

One rule might be the amout of equity you want in one LLC or possibly the risk.  I know investors that have 100's of units under a personal name and carry good insurance.  I'm sticking with one LLC untill I find another business venture or introduce a partner for a specific property.

Bill Gulley · Answer

Not saying all can be pierced, but if you're active in the management you can have issues. In multiple member entities you may not be shielded from other members, depend on having a proper operating agreement and other agreements addressing disputes and indemnification. Accounting can mess you up, how you manage can be an issue, operating outside your stated business purpose can leave you hanging, improperly executing a document can present issues and all these aspects can carry through to other operations, once you screw up, you can kill future liability protection as they look back to an issue. I'd guess that 80% of all those who did the internet LLC thing, DIYers have made mistakes in getting what they think they have. IMO :)

Wade Sikkink · Answer

@Bill Gulley is right, good management and good tenant screening are your best defense.  I will disagree that corporate veils are easily pierced.  Entities exist to limit the liability of the owners.  The problem comes in properly maintaining the entity.  I think the point is that most small operators don't properly maintain their entity.  Co-mingling funds is the one issue that comes to mind first.

To this point, there is definitely value in setting up an LLC or other entity for your RE business, but you must properly maintain it (as well as adequate insurance coverage as this is your first line of defense).  This is where I'll respectfully disagree with @Brad Johnson   Most people will not be able to correctly maintain a complex entity structure involving multiple entities for multiple properties and thereby actually increase their risk by trying to do this.

One property maintained entity with adequate insurance is the way to go, in my opinion.  An added benefit of doing this is you develop a brand and reputation for that company that could help your deal flow and tenant pool if your company becomes known as a player in your market.

My $0.02.

Bill Gulley · Answer

I agree with having separate entities for significant holdings of the same asset class, it is not done as an asset protection ploy but addresses business functions and management.

We have addressed this topic several times, attorneys have posted as to the fog of asset protection being a poor reason to form an LLC, the corporate veil is easily pierced especially single member or closely held mom and pops. Most small RE investors aren't accountants, estate planners or corporate attorneys, failing to manage the details will open the pulls that veil back.

You'll also find that in an active management position, you doing the management, your personal exposure is still there.

The very best assurance of not being a target or being liable for any issue is good management practices. If you keep your property in good condition, have stop signs at cross walks in parking lots and take measures to reduce your exposures you really won't have an issue, but things can still happen.

You must be negligent to be liable.

Then it falls to insurance, if you are sufficiently covered, your assets will never be at risk! Even if you were negligent, found responsible and lose a dime may never come out of your pocket in a $10,000,000 judgment. Having an LLC has nothing to do with it.

But, in the end, if insurance isn't sufficient (can't see how that could be the case even in death cases for small RE investors) your business entity may then come into play. Your entity is not your first line of defense, it's far to the rear.

Reliance on business structures for risk management is way over blown by those who benefit from you using them, attorneys and accounts love them as it's simply more business. :)

What is a good rule to decide if I should form a new entity for a new property purchase?

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