Should I get LLC for my first property?

Question

Greetings.

I'm new to real estate with a question regarding LLC. Currently, I'm getting ready to buy my first property wondering if I should get an LLC. What I was told is you don't need one until you generate some serious wealth. Additionally, I will have to appoint a lawyer to handle anything legal, even evicting a tenant. The extra legal fees toward something I'd learn to handle myself doesn't sound attractive.

This advice was given to me by my neighbor who has over 10 properties. They stressed the annoyance in extra legal work for both time and money.

What do you think I should do?

Justin Kay · Answer

@Ian K Laszlo LLC's have a number of pros and a number of cons. I won't list them all here, but a few that will point you in the right direction:

- Pros: limited liability, estate or asset protection planning, business credibility, property management benefits (I've heard landlords state its easier to put an LLC on the lease form and tell the tenant "you just work for the company" as they'll give you less issues, but I don't know if it's really true), and business growth potential (easier to hire employees and file state/fed reporting forms [940/941] as a corporation).

- Cons: increased costs (for filing and maintaining an LLC, for filing separate tax returns if you choose to do so [but don't have to]), depending on your state increased legal fees (you didn't put where you're from, but in some states only attorneys can represent corporations in evictions and small claims court), financing "challenges", insurance "challenges", contract and lease "challenges", not unlimited limited liability (you can still be sued individually), and loss of TBE protection (tennancy by the entireties) if your state recognizes it.

If you're doing it for limited liability reasons, you're better off getting a good insurance policy. It'll cost you less, and will cover more. I tell people to look at it like this: you're flying a jet [your business], and you have an ejector seat [limited liability] and R2D2 sitting in the back to fix your problems [insurance]. R2D2 will fix the small issues, like an oil leak or a misfire on an engine, mid-flight to keep you going. But R2D2 won't help you if the jet is exploding. An ejector seat will protect you in the event the jet has a catastrophic failure and you need to ditch it, but it won't help for a "check engine light." If you pull the cord [invoking limited liability] when the "check engine light" comes on, you'll lose a multi-million dollar jet over a $100 problem. So you're forced to pay the $100 to fix the problem anyway, not really gaining protection from limited liability. While an ejector seat is nice, I'd much rather have an R2D2. If I can't afford both, I'd get the R2D2. If I can afford both, go for it.

While I am an attorney, this is not legal advice for you. I don't know your specific facts and circumstances, so please consult an attorney.

Account Closed · Answer

I am not a lawyer by trade and my advice shouldn't be taken as such.  I have a single family home rental property that I created an LLC for.  My LLC was created in Missouri and was easy to create.  If I remember correctly, I was able to do it all online.  The thing about creating an LLC is that you need to have an operating agreement to go with it.  This is where you probably want to hire a lawyer; to create the operating agreement.

The advantage I saw in an LLC was limiting or separating my liability to the rental business so that if I got sued, the company would go down and I personally wouldn't be as harmed from the potential fallout.

The disadvantage of an LLC is that it becomes harder to get financing terms starting out.  I haven't been able to find a bank who would provide me a mortgage for my next deal in the name of my LLC.  I would need to go the commercial route in order to do that.  With that being said, my bank in Missouri would be willing to write commercial loans for single family rental properties once I have enough for a down payment.

Additionally, an LLC is not the only way to go, you can also create a Trust for everyone of your properties.  My wife's real estate agent did this for her rental properties, each one was in a Trust.

Rob Leavell · Answer

Thank you for all the detailed feedback @Justin Kay!

Justin Kay · Answer

@Rob Leavell, generally speaking no. C-Corp, S-Corp, Partnerships, LLCs, Trusts . . . they're all separate legal entities, and the same issues apply. They'll have very different tax issues though.

Trusts have fewer issues as it relates to valuing transfers in though. It's assumed that you're not getting something back of comparable value when you transfer to a trust. But in order for a trust to legally exist, you need a Settlor (person giving assets), a Trustee (person holding assets), and a Beneficiary (person the assets are being held for the benefit of). Two of those positions can be the same person, but not all three. Which means if you as an individual that owns a home wants to put it into a trust to shield liability, you'll need to either have someone else be the Trustee (good luck without paying them), or the Beneficiary (maybe your kids, but doesn't seem to make sense if your goal was to hold on to the properties). You'll also have a harder time getting the assets out of the trust, should you want to later. Last point, Trust tax filings are often more difficult than disregarded LLC entities, so keep that in mind. Because of this, Trusts are usually great asset planning and asset succession tools, but not the greatest asset protection tools, in my opinion. State law applies though, so it may vary state to state.

Realistically speaking though, it doesn't really create that much more layer of work. You just need to put the playbook out there in advance and follow it. It isn't something you should just throw together.

Rob Leavell · Answer

Yikes, @Justin Kay. That seems to create a layer of work that is not altogether required, and potential for more conflicts.

Any idea if there are other types of corporations that would come with less strings, so to speak, or if putting property into a trust comes with potential downsides?

Justin Kay · Answer

@Rob Leavell Yes you could start an LLC after the portfolio is started, but there are some tricks you need to look out for. For one, if the property has a lien on it, it'll typically be an event of default if you transfer the property to another owner. In the vast majority of situations the bank will never actually invoke the default, as long as the payments remain current. But if the bank undergoes a restructuring event, or wants to lighten its books in a certain area, they'll immediately claim default and begin the foreclosure process. As it's owned by an entity, there are fewer hoops they'll need to jump through in the foreclosure process, giving you a small amount of time to restructure your loan situation. I've seen it happen, and it isn't pretty (clients typically had to get very high interest loans, as they were the only ones that were willing to loan in short time windows on properties in foreclosure). So if you transfer a property to an LLC, you either need the bank's approval in advance or you need to refi at that time, and refi'ing with a new LLC can sometimes be challenging, even if it is cash flowing (not impossible though).

There are also some legal concerns. You need to treat the LLC like a separate and distinct legal entity, because it is. You can transfer the property to the LLC in exchange for stock, valued accordingly, or you can transfer money to the LLC in exchange for stock and then sell the property to you in exchange for the money you put into the LLC. But you have to make sure the valuations are roughly accurate. If I put $100 in an LLC and then sold a property with $20k equity in it to me for $100, it could be challenged later as a sham corporation (not likely but still possible).

Lastly there are some tax consequences. It all depends on the valuation you put on the property, who the owners are, if they have full member interests or partial economic interests, ect. Not impossible, just make sure you have your ducks in a row before you do it.

The issues are significantly less if the property starts and ends in the LLC.

Rob Leavell · Answer

If I could piggy back on @Ian K Laszlo's question based on the feedback provided, could it be more beneficial to create the LLC after a portfolio is started instead of creating it for the first property? Seems, again based on the feedback, that obtaining a loan for the next property is problematic, but if there is a steady cash flow already in place with a number of properties, creating the LLC with those cash flowing properties could resolve that issue (not a lender, so speculating here).

Plus at the point when you have multiple properties, maybe you're at the point of expanding your business where an LLC could make more sense (attracting employees, completing state/fed documents, etc.)

Again, just speculating a hypothetical and wondering if there is any merit to planning to incorporate at some point in the investing cycle.

Jingru Sui · Answer

I ran into problem with LLC before. Ideally set up an llc to hold my title but my lender wont lend to llc. then I bought the property using my name and later try to change title but my lender wont allow me to due to a clause that's in place. My solution for now is I got myself a huge personally liability insurance coverage.

Ben Raygor · Answer

I love the example!  Thank you for that!I agree with the pros/cons provided above.  I generally summarize the benefits of a SMLLC for holding a rental property like this:- Tax - Generally None- Legal - Definitely- Financing - Generally More ExpensiveNext Steps:- Consider the administrative burden of an LLC (formation, annual renewal fee, and running a rental operation through a separate checking account that is not your personal account).- Discuss your options with an insurance agent.  You might find that beefing up the main insurance on the property itself and/or adding an umbrella policy that covers multiple assets is quite affordable.

Bob Okenwa · Answer

I am not here to give legal or tax advice. You should consult an attorney and/or CPA with questions like this. Unless your neighbor holds such a position, find a professional. What is good for the goose isn't always good for the gander.

An LLC will make financing a bit more unfavorable as the terms are not as friendly as buying in your name. There are umbrella insurance policies that can provide protection, but you'd want to consult with an insurance agent to get more details on how it works and what it would cover.

Should I get LLC for my first property?

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