How do you have your BRRRR business set up?

Question

Hi BP members,

My husband and I are BRRRR investors in central Wisconsin (marital property state). We currently have one LLC, taxed as a disregarded entity, through which we purchase properties, rehab them, and then rent them out. Our current property (in the rehab phase) we will be renting out on a short term basis through Airbnb. Other properties will be used as long-term rentals. We will be moving into using private lending to fund the acquisition and rehab of properties.

In a recent meeting with our attorney, he recommended that for liability purposes we have two separate businesses: one for acquisitions and rehabs and one for holding the properties as rentals. His reasoning was that if something goes south in the acquisition or rehab phase, lenders (or other harmed parties) would not have access to our rental property portfolio. In this case, the "acquisitions & rehab" business would be an LLC taxed as an S Corp and the rental business an LLC taxed as a disregarded entity (though I understand that short and long term rentals are taxed differently, so I wonder if those would be separate as well?).

On the other hand, our CPA recommended that we keep everything in one LLC, taxed as a disregarded entity, in order to avoid the necessary "reasonable compensation" requirement that comes with S Corps.

I would truly appreciate anyone's advice that has formed an LLC to complete BRRRR deals. Especially advice on how to move forward by renting on both a short and long term basis.

I know that many of you out there don't use LLCs at all, and I'm happy to hear your advice as well, but to be clear we will be using an LLC to conduct our business.

Thanks so much!

Kamil Baldyga · Answer

Hey Jordan, great question! I agree with the attorney, especially if your plan is to begin automating your business down the road. Currently the way I have my LLCs set up is I have one specifically for acquisitions and rehab. Upon completion of the rehab I quitclaim it to another one my LLCs to hold it. I like to treat each LLC as a "basket" of five properties. Should one of the properties have a capital expense for example, the other four help contribute to help repair it. In short, I have one vacancy, repairs, capex, etc fund for the LLC. I take it a step further and have the acquisition and basket LLCs be operating LLCs under my main holding LLC where funds are sent and distributed to my and my partners' personal LLCs. Its a lot of layers. Let me know if this doesn't make sense, LLCs can be a bit confusing sometimes.

Marcus Auerbach · Answer

Keep it simple, attorneys sometimes like to make things complicated. And one size does not fit all. A legal strategy that is suited for a portfolio of a number of large apartment complexes is not necessarily what you want.

We have been BRRR-ing for over ten years and I separated the acquisition side from the holdings early one. Separate bank accounts to manage your cash flow and separate legal entities. I actually believe there is nothing wrong with buying and financing in your personal name - the benefit is a 30 year fixed rate loan. As you grow your portfolio you have to go commercial anyway. which requires you to hold the properties in a LLC.

I agree with Kamil to keep several properties in one LLC as a holding "basket" - the number does not matter as much as the value. You can target a million of property value, or even half, before you start another LLC, which requires it's own books and bank accounts and credit cards etc. This is why you want to have an entity for acquisition and then when you put the property in service, you'll move it over to an LLC.

Scott Schultz · Answer

Let me throw a wrench into you lawyers theory, Read your loan docs. Most Commercial/portfolio loans reach across all properties and entities. The protection only comes into play in liability, borrowing at a professional level, there is very little protection. This is why I advocate Low Debt. This puts you in the drivers seat and it’s not a problem

David M. · Answer

@Jordan Pupols

In my opinion, just be careful of the quit claiming "method."  It just doesn't pass the "logic test" when it comes to the alter-ego requirement for protecting your corporate veil.  If you refinance along with the deed transfer, then it "seems" much better.  Here are just a couple of prior threads.

https://www.biggerpockets.com/...

As for your question, yes you usually want have separate companies for different business ventures.  Profit on the short term flips are taxed as ordinary income at your marginal rate and subject to self employment income tax because the IRS sees you as selling inventory, not an investment.  Your long term holds are investments and categorically defined as passive.

It looks like your attorney is trying to help you segregate the liabilities which is the point of having separate companies.  Remodeling a property (regardless of your exit strategy) presents a myriad of liabilities, i.e. risks.  However, once its fixed up and rented, you have a different set of liabilities.  By doing everything in one LLC, you are exposing your whole portfolio to just about everything.  Even if you flip something, its possible that some years down the road some owner could sue you for your remodel, e.g. lets say 5 years later it burns down because of "faulty" electrical wiring and they come after you as the owner/GC who ordered the remodel (even though, of course,  you used a licensed electrician).

One idea that comes to mind is to form a Remodeling LLC.  Let your "Property LLC" take Title, but have the Property LLC, the owner, contract with the Remodeling LLC to do the rehab.  Its really the same but different idea of using a Mgt LLC to handle leasing.  Now, if somebody wants to sue the responsible party for doing the remodeling, then they are sueing your Remodeling LLC which has no assets.  Just be cognizant of your local licensing/registration laws for Home Improvement Contractors and commercial insurance / workers comp, etc.  Also, if done "correctly," you won't be generating any "profit" on the Remodeling LLC which would generate active, ordinary income...

By the way, you say "We currently have one LLC, taxed as a disregarded entity..."  So, I guess just one of you is a Member since only single member LLC's are taxed as a disregarded entity...

As you may know, S Corp is only just a tax status which you elect anytime after forming a LLC or C Corp.  Also, its "bad" for tax reasons to hold real estate in a S Corp because it has corporate-like qualities.  I'm guessing your attorney doesn't realize that, but your CPA does.  Also, you need to be doing a fair amount of flip profit to make it affordable to have the S Corp.  With only one member, its tougher to justify.  The amount you save on SE taxes is eaten up by payroll fees (I assume you will pay someone to set that up since local laws are always changing) and you have additional tax filing and corporate related stuff that you have to do.  If you really are "banging out" the flips, then elect the S Corp status later.  If you are really just doing rehabs with a long term hold, then you really don't have any flip income.The Holding LLC concept I've always figured was to keep a "central point" to tie all your other entities together.  Personally, I might do it just to help prevent co-mingle funds.  For example, if you had to move funds from one LLC to another, now they would flow through the Holding LLC's bank account and no funds would ever touch your bank account.  No chance of being charged with co-mingling and everything can be audited from "business accounts/ledgers."  Also, as a single member LLC is "transparent" for Federal tax filing purposes anyway...Does any of this help?  Between a Remodeling LLC and a Property LLC (or multiple ones as you get larger if you want multiple LLC) I think you can achieve what you want, or are being advised.  The Holding LLC is optional...

I'd be happy to chat, just direct message me.  Good luck.

David M. · Answer

@Jordan Pupols

Definitely direct message me so we can talk instead of me trying to type out a lecture  :)

Jordan P. · Answer

@David M., David, so glad to hear from you again. I always appreciate your thorough responses to my constant questions!

I am definitely going to need to do some research on the logic test and alter-ego requirements for protecting our corporate veil. As I asked above, I'm curious if securing private lending (where the lender holds first lien) in the acquisitions and rehab phase would hinder our ability to quitclaim into a separate LLC through which we would secure commercial financing. Or, because the lien is tied to the property and not the LLC, does it not matter?

This is a very interesting idea, and I assume has positive tax benefits since, like you said there are no "profits," so you have no tax liability, right?: "One idea that comes to mind is to form a Remodeling LLC. Let your "Property LLC" take Title, but have the Property LLC, the owner, contract with the Remodeling LLC to do the rehab."

Or would you be potentially be required to pay the "Remodeling LLC" for their services (probably based on state law)?

Re: taxed as a disregarded entity

Wisco is a martial property state, so my husband and I are both members of the LLC.I'll direct message you about all this, because .... it's crazy.

Thank you so much!

Jordan P. · Answer

@Marcus Auerbach, thanks so much for the insight, much appreciated. If we're seeking private lending to fund the acquisition and rehab of properties, then holding them in an LLC would be necessary, correct? And, if we're using private lending, are there issues that arise, or even make it impossible, to quitclaim into a holding LLC through which we would refinance?

Jordan P. · Answer

@Scott Schultz, thank you for bringing that point up - I appreciate it!

Jordan P. · Answer

@Kamil Baldyga, thanks for your input! You had me up until the holding LLC. I have a loose understanding of this concept, but it's still hazy for me. So, could an initial set up for us potentially be:

Holding LLC [taxed as ......?] in which we have:

Acquisitions & Rehab LLC [taxed as an S Corp]

and then quitclaim to either:

1) Long-term rental LLC [taxed as a disregarded entity]

2) Short-term rental LLC [taxed as an S Corp]

The world of LLCs is certainly a complex one!

How do you have your BRRRR business set up?

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