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WHEN & WHY to start LLC?
A little background: We are in WA.
We have heard about people in the tents gam starting LLCs. And we are wondering if we should start a LLC and why...
So we bought our first house about 4 years ago and lived in it for a year and remodeled the whole thing. We mover across the state and bought another house as our primary residence and started renting out our first home. This year due to rates dropping we refinanced the first house and took cash out. We decided to buy another house with that money and use it as a single family residence rental as well. We started renting it this last November (2020).
Now our next wonder is we have heard of LLCs and other things and wondering if we keep rocking with what we have and are doing or if we need to move to the LLC world.
We are a family of 4, single income. Under $70,000 a year.
We plan to keep moving ahead and continue in our real estate journey and want to start looking ahead if we start an LLC or not. Any advice is appreciated. Thank you!
Yes, you should, especially if you're going to continue and view your RE operations as a business. It will have some limited protections, but can also claim some expenses. As for loans, you'll most likely still be personally guaranteeing them anyways.
It's very simple to create one, 15-20 minutes for an LLC, EIN, and maybe 30-45 min to get your business bank acct. set up. Not going to change much operationally, financially, etc. though.
Thank you, but why I guess? Can you explain more?
And right now any profit, I just put into my account. If it was a LLC, would I then have to pay quarterly or yearly taxes based on the profit if I had a LLC?
Is it also easier to get more loans for additional houses if we have a LLC?
I think there's an extra level of paperwork to do to have an LLC for one rental property (for newbies reading this). I would just keep them in your name. You can quit-claim deed them into a LLC once you get a little bit of size to your portfolio. Risk management is all it is. I'd also certainly carry an umbrella policy when you've got significant assets. That's one of the best buys in the insurance world. Ask your agent for a PUP policy. Buy at least a $1 million umbrella. If you've got millions of dollars in assets, you may want to buy a $5 million umbrella. You can buy a $1 million umbrella on liability for $300 or $400 in most states. If you have significant assets in other places, I'd probably go ahead and drop it into a limited liability company in that case or if you decide to purchase more properties in the future. Hope this helps!
I appreciate the response George!
Thank you so much for taking the time and abating your advice. We don’t have an umbrella policy but I think it would be a good idea to get one for sure!
@AJ Howard
As a newcomer to real estate myself and having bought my first investment property, I've done a lot of research on LLCs, S Corps, umbrellas, etc, and I've even spoken to two asset protection companies. While I haven't started one yet, I agree with the other comments here that once you've reached a sizable number of doors you'll want to consider protecting your assets. Of course you can do this a number of ways, but if you decide the LLC route, what I've learned is that its also important "where" you incorporate because laws are different in each state. There are many rules and laws to asset protection as well as taxes, and depending on which state you do it in may or not be beneficial. From my understanding some of the better states to incorporate are Nevada and Wyoming for the flexibility and leniency on business laws, taxes, corporate veils, etc. On the flip side one of the worse states are California, where I live. Not sure about WA though. Anyways I know it's important to protect your assets mainly to avoid or protect yourself in the event of a lawsuit from one of your properties. Then again I do also have a friend who has 10 doors and does not have an LLC and is doing fine. Really its all about protecting and managing risks. Something I am definitely considering once I begin to scale or even sooner. Hope this helps you.
Jordan, first of all, thanks for your time and information. We were wondering who we should talk to or who to ask questions... should our tax dude know? Do we figure that stuff out? Is there someone to talk to to coach through?
@AJ Howard, welcome to BP bud. There are pros and cons to forming an LLC. If run correctly LLCs provide a fair amount of liability protection. However if you don't have a lot of assets it is protection of nothing. Next if it is a single member LLC you simply add the properties to your individual tax return. You deductions are the same whether you incorporate or not. You will have more trouble getting loans. Fannie, Freddie loans are a thing of the past. Expect to pay about 1% more in interest and only get 20 year loans with 25% down on purchases. I currently have 3 companies, but still own 3 rental houses in my personal name because of strange events. I carry $500K liability on each house. I am currently looking into an umbrella policy (after 25 years of investing) and it looks like about $900 per year for 2 million, but it only covers my personal rentals and the bigger company. If it were me I would max out the number of personal loans that you can get before jumping over into an LLC, but it is a matter of personal preference. Do you want cheaper loans or higher asset protection? My state is landlord friendly so I lean towards cheaper loans, but it is a personal choice. Best of luck and Merry Christmas.
@Jerry W.
Thanks for the informative post.
Can you please explain why is it harder to get loans once you become an LLC?
Any time you're bringing in other people, you're going to want an LLC. The legal liability protection alone is enough to get one. There's also potential public privacy (depending on the set up) so disgruntled tenants, partners, etc. can't thoroughly ruin your wealth. People only sue what they can see. You don't want to lose your personal assets. Operating under an LLC also adds credibility, which can lead to more negotiating power, more financing opportunities, and more.
There's also tax breaks in formally starting a business. Especially if you're flipping, you'll want to review your potential savings on capital gains taxes. Of course, see a tax, business, and/or asset protection lawyer before rushing into anything.
@AJ Howard
You definitely want to speak with CPAs, tax advisors, or business advisors who specialize in asset protection. Not all standard tax folks know or are even qualified to advise you on such things. One of the companies I researched and actually spoke with was Anderson Associates. Their ceo Clint Coons has a ton of a great content on you tube that’s pretty easy to understand.
I appreciate all of your responses. Thank you so much. This forum post was well worth it, I was hoping for good content. Now I will be posting all sorts of questions!
You definitely want to get a real estate attorney. If you plan on continuing he or she will be a vital part of your team. Most people have given you the biggest reason: protection. You want someone to sue the LLC not you personally if it ever comes to that. That way if they win they can only take what's in the LLC not what you personally own. I'm not a lawyer but that's how mine explained it to me.
One other benefit I haven't seen anyone else mention is private money. Some private money/hard money lenders can or will only lend to a business not an individual. This might just be a rule in my state so check it out in yours.
Thank you Anthony! That’s a great point. And thank you for the direct person, real estate attorney, I need to find one in my area I think.
Also good to know about the private money part of things. We have been wondering about that moving forward.
@AJ Howard, you obviously need to listen to all the advice, then make up your own mind. I am not an expert, but some of this advice is directly opposite to my experience. First, financing is not cheaper using an LLC. I have been borrowing from banks and help do loans for hard money and have never heard of a hard money lender preferring to loan to a corporation. Now they do NOT want to loan to someone who plans to make the house their residence. Next banks will always make you personally guarantee a loan. I have always found loan rates higher for LLC loans than personal loans. I have been borrowing for over 40 years. The Fannie Mae Freddie Mac loans are not available to LLCs that I have heard of. If it has changed it would be good to know. Most new investors I know try to max out those loans before forming a corporate entity. I have found the rates to be about 1% lower borrowing personally as compared to from a company. There are no benefits tax wise to having an LLC than owning it personally. The sole exception I am aware of is forming an entity as a SUB S company. That is mostly used by flippers to try to funnel money to you as wages in order to avoid some short term capital gains taxes. If anyone has different knowledge please speak up and enlighten me using the tax code. There are benefits to liability using corporate entities. You must use them correctly. However very few landlords get sued. It does happen especially if you do it wrong. First don't break the law, of course if you do the LLC won't protect you. Next try to keep the assets to reasonable numbers in each LLC. My preference is a million or less to each entity. Next buy good insurance, and get educated on how to do it right. Read the local housing laws.
There are some very good liability protection firms out there, and they will preach to you the benefits of an LLC for each property and their special secret sauce that will protect you and make you anonymous. If you are already a multimillionaire you might want that, especially if you are buying million dollar properties with great cash flow. The reality is that most folks cannot afford it and it really hampers your ability to be a real estate investor. Buying property is inherently risky, that is why it can pay so well. Think about buying the best and safest car, maybe a limousine. Say it is $400K. You could buy a Toyota for $25K and would probably be ok. Is it worth the extra $375K to only buy and drive Limos? Your call. To a beginner the fees like Anderson charges will easily be $15 to $20K. That will kill the profit for most new investors and you will lose the ability to network or benefit from REI groups if you try to remain an anonymous investor. Finally, in my opinion, anonymity simply doesn't work if you are a hands on investor.
I do like LLCs, I prefer to not make them Sub S taxed, but I do have Sub S companies. Make your own mind up, but learn the costs of doing it each way. Good luck and Merry Christmas.