FAQ Forum Question: Do I Need an LLC?

[Mindy Jensen]

Hello BiggerPocketeers!

In an effort to clean up the forums, we're creating an FAQ Forum, where the most-asked questions will be prominently featured, along with some really great answers.

I need your help!

Please take a moment to give me your very best answer to the question: Do I Need an LLC? Any variation of the question can be answered, such as

"Do I need an LLC before I start investing?"

"What protections does an LLC offer me?"

"Should I put my properties into an LLC?"

Once I have some really great answers to this question, I will create a new thread in the new FAQ forum, and through the magic of computers, make it appear as though these amazing answers all came in order. So please give me your best answers!

Thank you!

[Brian Burke]

This is a hot topic, @Mindy JensenHere goes:

Should I or Shouldn't I?

Everyone who is getting started wants to know if they should form an entity or not. Folks think it's the first step to becoming a successful investor and a necessary exercise to protecting their butts. Others who are new to the business jump on the bandwagon and overwhelmingly agree that you should form an entity and asset protection attorneys (who sell legal services) add more wood to the "form an LLC" fire. The question was asked once on BP--"has anyone been sued and your LLC saved you?" No takers.

If you are investing with someone else (a partner or a passive investor that is not simply making you a loan), an LLC is necessary versus the two of you going on title as individuals. You don't want your partner's troubles clouding your title. I'll endorse that.

But I don't endorse the concept that everyone needs to own all real estate in an entity. Entities add additional layers of cost not just to form them, but to maintain them whether it's annual fees to the state or the cost of doing a corporate tax return.

So Many Newbies Go Wrong

Just outside of Tucson AZ there is a boneyard of thousands of old military airplanes that are no longer used. They just sit there collecting dust, waiting for their turn for the scrapyard or to have parts taken from them, or perhaps the distant chance that one day all hell breaks loose and we need thousands more military planes to defend ourselves.

Such is the same with LLCs for new real estate investors. Everyone that wants to try their hand at real estate investing is anxious to run out and create an LLC so they can get started.

Somewhere out there (maybe it's in Tucson too?) there must be a boneyard for all of these scrapped LLCs. A high percentage of budding real estate investors don't make it. Why? Perhaps because they are focusing on the wrong things like entity structure when they should be focusing 100% of their energy and dollars on acquisition. So what am I saying? Forget about LLCs, go out and get deals done before you worry about that stuff.

Have a Business Name Without an LLC

You can run your business in your own name for free. If you would rather be "ABC Homebuyers" you can file a fictitious business name with your county clerk for less than a hundred bucks. You still take title to the real estate (and borrow money) in your personal name but your business cards, letters, bank accounts, etc. can all have the business name. No LLC required. Better yet, you don't have to pay hundreds to thousands of dollars for an unnecessary LLC and you won't take up more space in the graveyard of abandoned real estate LLCs if you decide that the lifestyle of the real estate entrepreneur isn't for you. Save the LLCs for when you hit the big time. The people of Tucson will thank you.

But What About Lawsuits?

I've owned over 700 properties, most in entities but many were not. Not once has one of these entities offered me any level of lawsuit protection. That is what my insurance is for. I've been sued several times (and fortunately have won every one of these nuisance shakedown suits).

Everyone is so concerned about Judgments, but they are missing the point. Before there is a judgment you must first be sued. The bigger problem with lawsuits isn't a judgment; it is the cost of defense.

So let's say you (or your LLC, doesn't matter) get sued. You (or your LLC) have to defend the suit in court. That legal defense can cost thousands to hundreds of thousands. If you have insurance that covers the risk, the insurance company pays for that legal defense. If you choose no insurance but just go with an LLC, the LLC is the one paying for that legal defense. If the LLC has no money to pay for the defense, you'll be injecting money into the LLC yourself to cover the legal fees, just as if you had no LLC at all. And if the issue at the heart of the lawsuit isn't covered by your insurance, you'll still be funding the defense, LLC or not.

Your best protection from judgments is to operate an honest business, treat people right, and follow the law and your contracts. Your second best protection is your insurance. Entities don't rank much higher than an afterthought in my book. But I'm not a lawyer so ask yours how they should rank for you.

Bottom line, the cost of defense in many cases is covered by insurance. Damage awards are typically covered by insurance (except willful torts--but you won't commit those, right?), and many plaintiffs will settle within policy limits rather than go to trial in an effort to reach your personal assets (assuming you have large policy limits and especially if you have limited assets).

To LLC or not to LLC, that is the question.

While it’s tempting to take the free advice of your fellow investment peers, real advice on this topic must come from your trusted legal counsel. Not an online legal site, not an asset protection seminar lawyer, not a podcast, but from an experienced business lawyer that knows your individual circumstances. There is no one-size-fits-all answer to this question but hopefully you are now going into your lawyer meeting with your eyes wide open and some good questions to ask.