When to form your entitiy?

Question

I am just curious to see what experienced real estate investors do in terms of the timing to form their entity?  For example, do most people form their entity prior to their first deal and pay the fees associated with this path?  Or, do investors flip a few houses first (for example) and put the notes/titles in their name?  If choosing the latter, is the assumption that the home owner's insurance is enough to cover any potential issues that occur during rehab?

Troy Fisher · Answer

Depends. Haha. Just like everything else in real estate. I always suggest to people that they get the first deal going before they focus on the business stuff. There's no point in having a business if you don't have a product.

Most people I've met just deal in their personal name for awhile before going through the expense of setting up legal entities.

Jeff Copeland · Answer

Hi @Josh C.,

I posted the info below (at bottom) in another discussion. Sharing here for your reference.

Another thing to consider - on a flip purchase or a distressed property, in many cases you are unable to purchase traditional homeowners insurance initially because of the condition of the property.

A carrier will not insure a home with a leaky roof, plumbing/electrical issues, no HVAC, etc. - at a minimum, most underwriters will require a 4-point inspection (plumbing, electrical, roof, & HVAC) before issuing an insurance policy.

In some cases, you may be able to get a "liability only" policy that would provide some protection and a duty to defend in the event of an injury or other incident on the property, but you run the risk of an award exceeding your insurance limits and dipping into (or at least tying up) your personal assets, making the LLC or other legal entity even more critical.

In my opinion, if you are serious about moving forward as a rehabber or landlord, the expense to form an LLC or corporation is minimal and should be one of your first moves.

Previously posted elsewhere:

"An LLC is more for asset protection than tax advantages (though it may provide some tax benefits if you opt to tax it as a corporation...talk to your accountant).

Example: Contractor falls off the roof and breaks his leg at your property. Even if he doesn't intend to sue you, his insurance company almost certainly will (called subrogation).

If the house is in your name, they would be suing you personally, and going after all of your personal assets and income...anything that is in your name is fair game.

If the house is in the name of your LLC, they can only go after the LLCs assets.

Many people form a different LLC for each property (or every 3-5 properties) for this reason.

Similarly, if something like this were to happen, you might have the option of declaring that particular LLC bankrupt without affecting your personal credit (personal loan guarantees notwithstanding), and you might still have several other LLCs that are still operating and financially sound...the bankruptcy of one does not necessarily affect the others.

So it's a matter of not putting all your eggs in one basket (and not mixing personal eggs with business eggs!).

Forming an LLC is quick and easy, and well worth it. Note that for courts to uphold this protection, the LLC truly has to be a separate entity, with separate bank accounts, etc."

Hope that helps!

James DeRoest · Answer

I spend a lot of money with my lawyer each year, and I get some very good advice from him.

And some of that advice, I won't post on a forum.

If you would like to spend a paid 2 hours with your lawyer discussing ways of protecting assets, and then post all that advice you got on a forum for everyone else, free of charge, knock yourself out!

James DeRoest · Answer

I'm the client of a lawyer.

Aaron T. · Answer

Then why would anyone pay you 1k for advice? or did i miss the "I am joking font"?

Aaron T. · Answer

James are you a lawyer?

James DeRoest · Answer

Tapco (in FL will insure just about anything), but it's done at a price, we're paying about $1.20 per square foot. Just don't ever tell them property is empty or it doubles.

We put every house in it's own LLC, but we warned that FL single member LLCs (and many other single member LLCs) are broken and won't protect the member or asset in a lawsuit. FL single member LLCs were broken by a lawyer a couple of years ago.

Doesn't affect us as our LLCs are multi-member.

There is another way of protecting the asset which our realty lawyer told us about which protects you from anything and everything. Send me a check for $1k and I'll point you in the right direction. I'm all for giving advice on a forum - but I'm not that generous ;)

Ed Neuhaus · Answer

Yes I can't find any traditional bank that will write a loan directly to an LLC.  you can use hard money or private money, but any retail loan that will be resold on the secondary market will have to be in your name.  There are plenty of people who will loan directly to an llc, but they don't lend at 4%.

Josh C. · Answer

@Troy Fisher and @Ed Neuhaus - thank you for the information, that is great advice.  I did not know that banks will not lend a TM to an LLC.  So the only options are commercial lenders or personal/private money?  If you do not mind sharing, what methods do you guys use for raising capital?  In particular, early on where you may not have had the track record of proven results?

Troy Fisher · Answer

So Builders Risk insurance is what you are looking for.  It insures you for that rehab and protects you with all of your different options.  You are absolutely correct that you can't get regular homeowners insurance, but that's because it doesn't actually protect you from anything that you are doing during a rehab anyhow. I suggest you ask around your network for insurance agents, you sometimes have to shop around to find an insurance agent who can actually help you fulfill you needs.

The biggest problem is that people get to focused on spending money and time on building a business before they actually have a business.  Find a deal and get it under contract, then worry about business implications.

But there are always two camps.  Insure and LLC!  And while I maintain that intricate LLC's not only provide great asset and tax protection and are fun to scheme with your CPA and Attorney they are usually more than a beginning investor needs.

When to form your entitiy?

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