LLC for first time flipper?

Question

Hello BP, Im a new Investor and I'm planning on Flipping a house soon once I figure out my funds, but my question is do I need to get an LLC before hand? Or is it just better to have it in general?

Katie L. · Answer

@Paul Fagot

There are several considerations that can go into the analysis of whether you need an LLC  or whether a large insurance policy will suffice. Will depend on  several factors like the type of property, type of tenants, your risk  tolerance, other assets you own, your estate planning, laws where the  property is located, etc.

Any lawsuits would be limited to the assets of the LLC and not your personal assets (assuming you run the LLC  appropriately and the corporate veil is not pierced). But, an LLC will  not limit you from liability in total. You can still lose your  investment in the LLC. If you're going the umbrella insurance route,  make sure it will cover you for several things including just the  routine slip and fall. You'll also want to ensure you have a good  property manager to look after the upkeep of the property if you are  not there to notice anything deteriorating or which may need attention.

You  also want to look at whether a pass-through entity helps your bottom  line and your taxes. There is a new 20% pass through deduction you may  qualify for that could help you, but not everyone qualifies. You should  still be able to get this even if the properties are not in an LLC,  if you qualify. But some people are looking at creating two different  entities and structuring it in such a way so as to be able to take  advantage of the tax arbitrage in rates.

These are all things you  will want to discuss with your attorney and CPA. If you need references  for either of them in San Diego, let me know.

*This post does not  create an attorney-client relationship or CPA-client relationship.  Readers are advised to seek professional advice.

Brian Schmelzlen · Answer

Hi Paul,

Flipping is not something that you want to do in your own name or through an LLC.  As a general rule, you want to use an S-corporation.

While liability concerns are an issue, that is not the main reason I am saying to use an S-corporation.  There are 2 main tax reasons why you will want to use an S-corporation.

1) Flipping houses either individually or through an LLC will generate self-employment income, which is subject to a 15.3% tax.  If instead you use an S-corporation, you avoid self-employment taxes.  You will pay payroll taxes, but you have more control over that.

2) You do not want a "dealer" classification attached to you by the IRS.  If you are deemed a dealer, all your properties will be considered inventory and taxed at ordinary income rates when sold.  That is fine if you are flipping because that is the proper treatment there, but it is a major problem is you eventually also have rentals that you occasionally sell (you also cannot 1031 inventory, so dealer status is also problematic there).  If you use an S-corporation, the dealer status is attached to the S-corp and not to you personally.  If done through an LLC, the dealer status attaches to you personally.

Brian Schmelzlen · Answer

Hi John,

It is a bit of a balancing act with the costs and benefits of LLCs.  Personally, I would not recommend a separate LLC for every rental property.  It means extra, unnecessary costs to you because you would have to file a tax return for each LLC which means more filing fees and more preparation fees.  Your CPA would love you, but your wallet would not.

On the other hand, if you own a number of rental properties I wouldn't necessarily put them all into the same LLC (especially if they represent your life's savings).  Assuming that there is a liability greater than your insurance coverage, everything within the LLC is at risk if the LLC is the one being sued.  Therefore, if you only have 1 LLC all of your assets are at risk.

There are a few ways I would consider breaking it up.  1) One LLC per state that you are investing in.  It keeps things a bit cleaner.  2) One LLC per certain dollar value of investments.  For example, one LLC for every $5 million of investments (that number was picked arbitrarily).

Also, unless you have a reason to, I would own the LLCs personally rather than through an S-corporation.  There have been times when my clients had a good reason to have their S-corporation own their LLCs (or a percentage of them), but that was because there was a non-tax/non-liability reason to do so.  If you don't have a good reason, it just adds to your tax preparation costs.

Brian Schmelzlen · Answer

If you want an entity for liability protection (probably a good idea) either an LLC or an S-corporation could work.  To minimize self-employment/payroll taxes, an S-corporation is might be the right choice.  However, to maximize the benefit of the qualified business deduction (Section 199A deduction), an LLC might be the better choice even with the higher self-employment taxes.  A CPA would have to look closely at your situation and run the numbers.

John Spina jr · Answer

Thank you @Brian Schmelzlen for breaking it down for me. At least I have a better idea now of some of the basic structure. Id obviously like to keep costs down as much as possible while still protecting my assets. I won't be lost when I initially sit down with my CPA. Much appreciated!

Katie L. · Answer

@John Spina jr there’s a lot that goes into that analysis. Not as simple as giving you a 2 lined answer. You’ll want to speak with someone who is fully aware of your estate planning situation, tax situation, liability situation, etc. The answer will be different for each person. Depends if you’re doing the work yourself or you’re passive too. If you’re in NY and doing business in NY it also probably makes sense to find a person familiar with NY tax laws which can themselves be their own beast. You can try starting with Basit who is a regular contributor and based out of NY.

@Basit Siddiqi

John Spina jr · Answer

@Katie Lepore and @Brian Schmelzlen I'm also interested in flipping. Especially buy,fix and hold. I have a general contracting business under an S-Corp. I currently do not have rental properties "yet". But when I do, what would be the best way to protect them. Would it be best to put them each in their own LLC? And if they are put into an LLC does that all go into the S-Corp or is it all separate?

Paul Fagot · Answer

Also if I were to wholesale properties, I should put that in with an S-corporations

Paul Fagot · Answer

Thanks @Brian Schmelzlen I will be on the search for a CPA!

Brian Schmelzlen · Answer

I would not have the rentals in the same entity that you are using to do flips.  For the rentals, you would either want to own them individually (with large insurance policies) or through an LLC.

California taxes LLCs and S-corporations differently, so you will want to work with a CPA.

LLC for first time flipper?

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