How to structure the purchase of my first rental

Question

Hello BiggerPockets,

I am looking to buy my first rental property soon. I have been talking to everyone I know about real estate and it caught my fathers interest. We are now considering on buying property together (my father, my soon to be husband, and myself).

I am unsure on how we should structure the deal. I have been thinking about buying property under and LLC created by the three of us or just buying the property with all three of our names each owning a 3rd? I am currently doing more research into it and plan to speak to a lawyer for advice before any purchase is made but any help would be greatly appreciated!

Thank you!!

Scott Smith · Answer

Hey Michael,

I am going to hit you with a bunch of information, but hopefully it will give you a strong understanding of how to approach the issue for yourself. First, I want to discuss asset protection generally, and at the end I will touch on partnerships. When I sit down with clients, I always discuss (1) their personal assets, and (2) what their current investments portfolio and other business ventures are before discussing (3) their future goals. Each of these variables will dramatically change the advice I give the individual asking me this question. Generally though, I break it down into the "five pillars" of protecting your assets.

The first pillar is avoiding unnecessary and risky activities (don't drink and drive, insurance generally won’t cover your poor decisions) and take good care of your investments(maintain your property, etc) - these simple steps will help you prevent lawsuits before they even occur.

The second pillar is a good insurance policy as that cover the majority of your exposure. However, insurance is limited because it only protects you from one type of liability: accidents/negligence. Insurance doesn’t protect you from any part of the sale or acquisition of a property (e.x. Somebody wanting to sue for you backing out of a bad deal or accusing you of selling them a property with defects like unknown termite damage). Insurance also doesn’t protect you from misunderstandings, especially those made in writing and email. What happens in these misunderstandings is that something goes wrong either in the sale or after, and then they sue you for some statement you made that they “misunderstood”. That lawsuit is a claim for fraud, and that’s what fraud typically is...a misunderstanding and someone being “injured” and wanting to hold the other responsible for it. Insurance never protects you from these kinds of claims and they happen all the time.

The third pillar applies after you have good insurance You need to protect yourself from what insurance doesn’t cover by compartmentalizing your assets. Compartmentalization means that if something happens to one property, people suing can’t touch you or the other properties. You should use either LLC’s (the old and expensive way) or a Series LLC (the new and more cost/time effective way). No matter where you live or where you own assets, I personally recommend the Series LLC to be a great tool for the individual investor who is planning to expand their operation, as it allows for you to scale infinitely for FREE. If you’re interested in using an LLC, this article  also further explains the advantages of a Series.

The fourth pillar is somewhat similar - you want to separate your operations from your assets. One company owns everything and does nothing (this is your SLLC a/k/a “asset holding company”) and a completely separate company handles all of your operations (this is a traditional LLC a/k/a “operating company”) For the operating company which serves as your face to the world and through which you do all your business, you establish a Traditional LLC to carry out the operations of your investments. The operating company takes on all of the liability that would otherwise blow back on you including: paying property management, paying contractors, collecting rent, marketing, etc.

The fifth pillar is owning everything anonymously. If people don’t know that you have assets, then they are less likely to sue because there’s no use in suing people that qualify for food stamps. This anonymity can be accomplished for free by using land trusts to own your companies as well as the assets. Trusts create this anonymity by removing your name from public record. Even if they can see you used to own a property, when properly transferred it will look like it was sold to investors. If they somehow guess you are the owner though, it still doesn’t matter because you would not be the owner. The land trust and the LLC are the owner of the asset/real estate, so even in the scenario that potential litigants guess, they would guess wrong.

I always encourage people who are investing with partners to work within an entity that has strong liability protection, and my personal preference is the LLC. Here is a link for investing through an LLC, and a more general article on different partnerships.

If you intend on investing more in the future I would really recommend finding an experienced attorney who can easily guide you through this process. If you have more questions or concerns on the topic, just let me know. And double check this article to make sure you cover all the basic questions you should discuss with any partners, especially family, before getting into a deal together.

Feel free to shoot me a message if you have any questions!

Maxwell Fontaine · Answer

An LLC I would recommend getting set up. That way within the LLC structure you will have the ownership percentages laid out and how to handle potential issues if someone wants out or how to vote on decisions not everyone agrees on. I'm not saying its the only way but it is a good place to start because it starts the "put everything on the table" discussions. I hope that helps some. Congrats on the decision to get started in investing.