Should I start an LLC before buying my first rental property?

Question

I'm living in the bay area, CA and looking to invest in the Phoenix, AZ area. Should I start an LLC first before buying or later on down the road move it to an LLC when I have a couple properties?

Thanks in advance for the help!

Axel Meierhoefer · Answer

@Fahren Fonacier As is often the case the issue you want to resolve first is "Purpose".

You said you like to have the LLC for asset protection. To do that you would want to have what's called "A Series LLC Child" for each property you buy. Then the liability and protection is limited to just that one property in that particular "child LLC" and that's all you could ever lose.

I disagree with @Bruce Woodruff that the corporate veil can be breached easily. That very much depended on the state the LLC is registered in. IN CA it's very easy, next door in NV its almost impossible.

That put aside, the purpose could be different, as in my case. I created the LLC to run my investments like a business. I call this an "Operations LLC". It is in place to have all operations go through it. The rents come into it, the mortgages, insurance, property taxes, etc. are paid out of it. Any accumulation of cash flow is used for more investments. My Va's to help with operations are paid from the revenue that's generated. I can even hire myself into that LLC as an employee.

All of these transactions and activities lead to a tax return that si independent (initially) of your personal tax situation. If you are creating an S-Corp LLC, the losses or gains from this operations LLC flow through to your personal taxes. It's a very clean setup.

If you decide to create a "Series LLC structure" your operations LLC would be what's called "The mother" and each of your properties would be held in the "child LLC's". The depreciation, etc. that impact taxes for each property will roll up to the mother, so you only have one tax return.

I know this sounds complicated and I am neither a lawyer nor a CPA but am following this approach myself.

Some people mentioned that it's not as easy to get financing for an LLC as personally. It's not completely true, but you can always transition the ownership of a property you initially bought in your name to one of your Child LLC's. If you want to be a "perfect person" you can even notify the lender of that transfer and show them that your rental income will cover their mortgage easily.

long story short, just having any LLC is not really the question or an easy answer.

If you can see yourself developing a portfolio of properties so you can create sufficient cash flow to live off it and no longer have to have a job, then doing it the professional way, create a business (Operations LLC) and put your assets in Child-LLC's for asset protection is the professional way to go.

Yes, you can live without all that but please be aware that in a case of a lawsuit for whatever reason, all your assets, your income, your primary residence, your car, 401K, anything of value can be used to pay for any judgment against you as the result of a lawsuit.

I recommend going the professional route from the start, not because it is legally needed if you only have one house, but because it is part of the overall investing journey.

Eric Janson · Answer

The lenders that I work with in MN will not do a loan with an LLC, so you might want to check with your lender first.  If you have to buy in your name, but you want to put the asset into an LLC, then you can Quit Claim deed it into the LLC.  Your closer should be able to help you with this.

Todd Rasmussen · Answer

@Fahren Fonacier

No, just carry adequate liability insurance and you'll be fine to get started. Starting an LLC is unnecessary and (from California) very expensive.

Megan Templeton · Answer

I would recommend starting with an LLC to have projection from the start. Liability starts as soon as you have tenants so getting the LLC in place first allows you protection throughout your time as a landlord and setting it up initially also avoids operational complications that can come from trying to switch to an LLC after your biz is established and running.

John Niemeyer · Answer

I also disagree with the folks saying liability or umbrella insurance is sufficient.  Insurers will find a way to deny your claim if they can.  So liability/umbrella insurance is great if a claim unquestionably falls 100% within the terms of the policy.  But if an exclusion potentially applies to a catastrophic event (i.e. were you aware that the electrical panel needed replacing but you hadn't gotten around to it yet, and then a fire resulted?), your insurance might not protect you.  As boring as it would be - ask for your insurance policy and read it so you know what exactly is covered and not covered.  Before I put my properties in an LLC (and manage them properly, with their own bank accounts etc.) I had a broker try to sell me an umbrella policy to cover an out of state triplex I purchased, but the policy only covered properties with 3 or more units if the owner also lived in the property.  I obviously didn't purchase the policy, but before reading the actual policy the broker assured me the policy would cover that property, which it clearly didn't.

If you have other assets in your name, an LLC provides an additional level of protection if you operate and maintain the LLC properly.  You should purchase insurance under the LLC's name, maintain adequate funds in the LLC's own bank account, etc.  It is more expensive than just buying in your own name and having personal umbrella insurance, but you absolutely have an additional layer of protection than just in your own name.  It isn't bullet proof, but if you maintain the LLC correctly or are in certain states, your personal assets should be protected from any lawsuit.

Basit Siddiqi · Answer

@Fahren FonacierJot down all your 'what if' concerns.Speak to an insurance agent to see if your 'what if' concerns are resolved by having proper insurance coverage.speak to an attorney to see if your 'what if' concerns are resolved by having an LLC or other entity.

Costin I. · Answer

@Fahren Fonacier

If you are new to REI you should be primarily concerned with finding good deals and growing your business first. I would not suggest to look into establishing LLCs and asset protection strategies till you have at least $100-300K in equity (!) and only after you covered properly the "other" aspects of risk management (insurance, umbrella insurance, proper property management, etc.).

Unless you are doing flipping (or AirBnb), in which case I suggest you look into Series-LLC and you operate each flip in its own child-series (if not clear why, ask for more details).

I spent numerous hours researching from multiple sources the whole LLC question and asset protection matter and all the rabbit holes it opens. I gathered all my notes in a 50+ pages document touching on formation and maintenance of LLC and business structures, transferring assets, protection strategies, trusts, anonymity, insurance, levels of protection, etc. including when you should do it, how many properties per LLC, due on sale clause, selecting an attorney, fees, checklists and resource materials.

Doc:  https://www.biggerpockets.com/files/user/CosIorg/file/tritoriam-file

Asset Protection Decision Diagram - to help assess the need for asset protection, and what to implement :   https://www.biggerpockets.com/files/user/CosIorg/file/asset-protection-decision-diagram

Asset Protection Onion Diagram - what, when and at what cost one should implement in terms of asset protection  - https://www.biggerpockets.com/files/user/CosIorg/file/asset-protection-onion-diagram-v2

What is needed for a complete asset protection OR the domains that need to be intersected to find asset protection.  - https://www.biggerpockets.com/files/user/CosIorg/file/asset-protection-spectrum-diagram

How a fully implemented asset protection layout might look. -  https://www.biggerpockets.com/files/user/CosIorg/file/asset-protection-structures

Let me know if have questions or want to chat further - I can give you my investor perspective.

PS.  Read this book first -  https://www.amazon.com/Every-Landlords-Property-Protection-Guide/dp/1413307000 - before getting into more complicated and expensive measures of protection.

PPS. If you reach the conclusion you need ASSPRO right now, since you are from CA, you should look into DSTs - Delaware statutory trust.

James Hamling · Answer

@Fahren Fonacier the question of too LLC or not too LLC is easily one of my top 3 "hate" subjects for the sheer monumental volume of disinformation put out on the subject.

First item to understand is that just the action of having a property in an LLC provides exactly 0 protections what so ever, this is in all 50 states. All having an LLC does is set a stage where a person could build the construct that would create asset protection, without it, well, it's nothing.

The entire point of asset protections is in an instance of being sued. An attorney 2 weeks of passing the bar knows that the first thing they will laser focus on in suing you is NOT your entity structure, that means nothing, it will be the MONEY, they will follow the money and see where it goes, how it's handled, what it mingles with as this will be the first and most major item that decides what is and is not "fair play" in connecting in a suit. So great, you have an LLC, but you have 1 bank account you do everything from for all properties, or even worse yet you do personal things from it too, this is called comingling of funds and it means that everything in connection to those comingled funds is all attachable as common assets and or common operations, making the LLC a disregarded entity which is fancy legal language for "does not exist".

So at the most basic level you MUST have 100% segregated funds and banking, but also will need segregated rules of operations, employment, resources etc.. I still have not yet seen any investor who's operation worked in a "safe" manner in this regard or asset protection via LLC, and this could be why not a 1 of the high net worth persons I have ever worked with use it for their asset protection vehicle. For REAL asset protection, study O.J. Simpson, and how he has retained everything, all assets, all monies, even after loosing a lawsuit for huge amounts, all 100% legally.

Danielle Jackson · Answer

There are other ways to protect yourself outside of an LLC. There are certainly pros and cons to both sides (as with most all things). Another way you can approach the liability piece is looking into an umbrella insurance policy.

John Woodrich · Answer

No need to set anything up until you are in contract to purchase.  I have had many clients pay to organize a company and have the company dissolve without any activity.  We add "or assignee" to our PAs and let the seller know we would be setting up a new LLC before the purchase.  As mentioned above - depending on the loan product you may not be able to purchase in the name of your LLC.  This is common for a conventional loan/FHA product.  You can purchase 1-4 units with a commercial loan which would allow you to title in the LLC however the loan terms aren't typically as good.  5+ are typically commercial loans so no issues titling directly to an LLC.  Talk to your lender first.

Should I start an LLC before buying my first rental property?

Most Popular Reply