LLC, CPA, depreciation, tax write off - Rookie turning residential into rental

[Kayl Kam]

Hi all,

I am planning to turn the current residential property (SFH, 4b/3.5b) into a rental since I am relocating to another state. I put 5% down 2 years ago (conventional loan with PMI), fixed interest rate of 2.875%, and the SFH has already appreciated by approximately 15%. Rent can potentially be close to/at break-even despite only putting 5% down. The inside of the house is in great condition, but the landscaping and deck/front porch need a bit of work to make it rent-ready (grandfather clause can likely apply for the deck/front porch wood railing that is not up-to-date for codes).

I am working with a property management company and will have a realtor and contractor come to the property to estimate how much money I will need to make the property safe for potential tenants (major expense would be the deck, front porch, and landscaping). Here are my questions.

1. LLC: If I set up an LLC for this rental property for liability protection, what steps should I take to make it happen? Do I need to ask my lender first to make sure I would not trigger the "due on sales clause", or should I just consult an attorney and have him/her do all the work? Should I find a real estate attorney located in the state where the rental property is located?

2. CPA - Would a CPA in any state be able to give tax advice and do my taxes when the time comes, or is it best to find one where my rental property is located? How much do they usually charge if I want tax advice?

3. Apparently, landscaping (cutting down some trees, removing some shrubs, etc.) is considered a capital improvement; could the amount of money spent be depreciated with the value of the house? I will consult my CPA (after I find one) but I would like to have a rough idea before meeting the contractor. 

4. Fixing the deck—if it is just to strengthen the structure of the deck, would that be regarded as a repair and thus a tax write off?

5. If the deck and landscaping take time to get done, should I still find a tenant and put limits and boundaries in the leasing contract, something like use the deck at your own risk, etc.? Especially if I do not have too much cash to get all these done up front immediately? If tenants get in and out of the house exclusively through the attached garage, and not using any pending-to-be-fixed/improved-amenities outside of the house, the current status of the house is perfect. 

Any comments would be greatly appreciated. This is my first SFH purchase and my first SFH rental. Never set up an LLC before. I am interested in continuing to do RE investment, and I think this SFH will be a good start.

Thank you! 

[Nathan Gesner]

Quote from @Kayl Kam:

An LLC is useful for two things: anonymity and legal protection. In most cases, neither is warranted.

Warning: I am not an attorney and this can be a complicated topic. Please note the information provided below is a layman's definition designed to provide a basic understanding for the general audience. You should consult an attorney or CPA for your specific situation.

ANONYMITY: When you create the LLC, your name is recorded on the documents and published on the Secretary of State website for all to see. So you're not completely anonymous. If you want to be completely anonymous, you can use a Registered Agent. The Registered Agent will record the documents on your behalf so only their name and information appears on the documents. I've done this with my properties because I'm well known in my small town and don't want people to know what I own.

LEGAL PROTECTION: By placing your assets in an LLC, you are legally separating them from your personal assets. If someone injures themselves and sues, they will be suing the LLC and not you personally. If your insurance coverage isn't enough, they could seize the LLC assets, but not your personal assets.

Additional thoughts:

1. An LLC is not free. You can spend as little as $100 to form an LLC, or you could use an attorney and spend $1,000 or more. There are also additional costs of operating and maintaining an LLC, like separate bank accounts, annual report filings, tax filings, etc.

2. There are rules to follow! If you fail to follow the rules, you may open your personal assets to a lawsuit. An example of this would be mixing your personal money and LLC money in the same bank account.

3. You do not need a separate LLC for each property or a series LLC! Don't make your life more complicated than it has to be. Most professionals will recommend a separate LLC for every $1 million in assets but I don't think that's necessary. In my case, I have residential rentals in one LLC, commercial properties in another, self storage in a third, and my real estate company operates in a fourth. Some have more than $1 million in equity while others have less.

4. The need for an LLC is grossly exaggerated on BiggerPockets and other websites. Have you ever heard of a Landlord being sued by a Tenant and losing property? I've been on this board since 2010 and haven't found an example yet. You've probably heard of big Landlords losing property, but only because they were flagrantly violating Fair Housing, running a slum, or otherwise violating the law in an egregious manner. You are more likely to be struck by lightning twice. The vast majority of lawsuits against Landlords are for wrongful eviction, security deposit disputes, and Fair Housing Violations. Your basic insurance policy with $300,000 in liability coverage should be sufficient in 99.999% of all lawsuits.

5. The best protection for you and your investments? Know and obey the law. I manage around 400 rentals with 12 years experience and have never been sued once. Even if I were sued, I document everything and obey the law, so I won't be found guilty. Even if I were found guilty, the cost would be in the thousands, not in the millions. Insurance would cover it, I would pay the deductible, and no assets would be lost.

If you are in an area like San Diego where people are more likely to sue, a judge is more likely to find you guilty, and the payout is likely to be higher, then you may consider an umbrella insurance policy. This policy will provide additional coverage above what your existing policy covers. It's easy to obtain, costs very little, and doesn't require additional, on-going effort to maintain.