Best Business Entities for Starting in Rental Properties?

Question

Hi all,

4 months ago my husband and I bought our first home & rental home together in Lafayette, Louisiana.  The home we stumbled upon is in a great area and was a 1br/1ba at 1670 sq ft. It was built for a widowed grandmother only, however it came with a decked attic space of 600 sq ft.  The home also had a guest house on the property, very nice and slightly away from the main house, that was used as a rental, fetching $700/mth.  Due to the unconventional layouts of the house, being 1br/ba, and having a guest house, comps were very hard to find, and the home appraised lower than we were actually willing to pay.  The sellers lowered the price to match the appraisal, and we bought the home.  We have since had renovation crews in to add 2br/1ba in the attic, which our anticipated appraisal after construction came back very favorable to the investment, due to it improving it's functionality and improving it's comparables zone.  We currently rent the guest house to my husband's best friend, a youth pastor, for the best friend rate of $550/mth.  He does so much around the property and we trust him with everything so it's well worth the discount.  Anywho, I just wanted to give the backdrop to our steps into real estate and rental income. We have learned so much from the process of buying this home and rental & selling my parents' home FSBO that we are obviously interested in pursuing other real estate rental opportunities as they come.

My question lies in the reporting of the income from the guest house rental in efforts to maximize our loan potential for future buying power.  I understand that we would want to show a history of rental income on our tax returns in order for that money to count toward a loan.  In that it is a guest house and part of the one home purchase and mortgage, how should we report this?  Create a separate entity and is it possible to allocate the guest home value to that entity, then track income/expense?

What are the best ways that you guys have found for tax management in a married couple to record rental income/expense? S Corp, LLC, etc.?  Do you have any experience with a guest house rental attached to the property that you are currently LIVING in?

Thanks for any feedback!

Charity

Robert Leonard · Answer

Hello @Charity Phillips! Only your tax and legal advisers will know enough about your personal financial circumstances and need for asset protection to give you the right answer for you.  The right answer is different for different individuals.

Just for the sake of discussion, usually it's best to hold rental property in an LLC.  It's usually best to own flips/wholesales in an S Corp or LLC taxed as an S Corp.  Your combined owner occupied/rental property presents a unique set of circumstances that your advisers can best address.

LLCs cost different amounts and your ability to borrow money in their name is very different from state to state.  They offer very low cost asset protection in LA and they are not hard to borrow money under favorable terms.  No, not the same as consumer rates/terms, but still very attractive rates for sound business purposes.  Your own credit will matter when you start.

Ashley St. Gelais · Answer

Hey @Charity Phillips

Welcome to BP!

A few thoughts for you.

1) You should get a CPA or accountant to do your taxes for you. Once you get into the world of owning property things can get complicated fast.

2) You don't have to have an entity to show rental income under.  You tax preparer should be able to file a schedule e for you under which you can report earnings and expenses for rental property - even if it is owned in your name.

3) Lastly, owning a property in an LLC is great for liability protection, however, it can prevent you from obtaining conventional mortgages, which offer the longest terms and the best rates.

My 2 cents! Hope this helps.  And if you wanna know more about investing in rental real estate profitably.  Shoot me a private message and I'll share my free training with you. : )

Ashley

Ned Carey · Answer

Presuming the guest house is on the same property dividing it up to put the guest house in an LLC may be complex and expensive. It may also be to your disadvantage when you eventually sell down the road.

It is very easy to have that income show up on your tax return. As others have said no LLC needed for that.

This is clearly a situation where you want good legal and accounting advice. The accounting advice should come form a CPA very familiar with investment property.

Manolo D. · Answer

I wouldn't sweat it that much into incorporating, llc or s corp or c corp, since the rental room is just part of the house, even an enrolled agent can figure that out, cpa is an expensive way to get the books intact. I like the idea of shared employee, so I hire someone as weekend staff, they hve regular jobs but needs the extra boost for that bag she likes at the department store, this helps out an individual and is cheap, extra income is always good, they also tend to help and go out of their way for you. Just declare your taxes as an individual. The only way that will make sense incorporating is if you rent a separate building to some, but still I won't incorporate unless it is around 5 doors.

Logan Hicks · Answer

S Corp with a collection of LLC subsidiaries.

LLC Pass through with an S Corp Pass through to the owner. The S corp allows for up to 200 separate individual investors, and allows you to issue Class A stock, which will allow you to both increase the value of your stock as you acquire property, portfolios, and/or notes, and also allow you to add partners easily by issuing stock based on their cash value add, while still having the option to opt out to C corp once you get big enough, but it also keeps you built to be a great acquisition target.

Charity Phillips · Answer

Thank you guys, you all are quite helpful!  We have followed along the BP podcast for almost a year now but joining the forum we are so happy to receive such an amount of feedback!

@Robert Leonard Thank you for your help once again!

Best Business Entities for Starting in Rental Properties?

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