Do you or do you not need an LLC to start investing?

Question

Greg Gaudet · Answer

@Dina Smolenski I think you're getting ahead of yourself. It seems like you're looking 5 steps ahead. I recommend focusing on your next step - find your next deal. Once you have that deal work on the funding. If at some point during the deal you find out you really should have an LLC, then you can start one. I don't have one, but I use traditional financing to purchase single family units. To protect myself I have good insurance and an umbrella policy. There's no reason for me to have an LLC at this point. But I can always start one if I feel like it'd be best for a future deal, it doesn't take long or cost much to get an LLC so I wouldn't worry about planning it out too far in advance.

It's very common for beginning investors to get caught up on obstacles that are way down the line from them; like worrying about how they're going to get financing on their 11th property before they've even started. Like Brandon Turner says, when you get to your 11th property you will know how you're going to finance it. It's important for me to remember this advice too, I think we all get ahead of ourselves.

Dustin Beam · Answer

If you're planning on getting a nice 30 year fixed, an LLC will ruin that.

For me, I started an LLC from the get go. Some people will tell you that a good umbrella policy is enough. I don't think there's a one size fits all approach, however I have always intended to be as professional as I can, which to me says "LLC". The only real drawback to an LLC is the financing terms (commercial vs traditional fixed). But again, that's how the big dogs do it, and I always told myself I want to be a big dog too :)

If you plan on investing in 5+ unit buildings, you may as well get an LLC since you'll be in commercial financing anyway.

Costin I. · Answer

@Dina Smolenski Here is a diagram I put together when I was looking for the answers to the same questions:

Thomas Franklin · Answer

@Dina Smolenski I would strongly suggest you establishing a Corporate Entity such as a S Corp or a LLC. This is a relatively inexpensive process. I invite you to Google "Creating a LLC or S Corp in _____," "Division of Corporations in _____," or another phrase. You can go to http://www.sunbiz.org and see how Florida does things, to give you and idea what to look for, in a website. I invite you to please consider the following, from a Federal Income Tax Filing Perspective. I cannot stress the importance of finding a very good Investor Friendly CPA. Below are some things you may wish to consider, as to which Corporate Enity is best, for your Business Model as well as your REI Goals and objectives.

Flipping Properties

If the primary objective of your real estate business, or one of your real estate businesses, is to buy, potentially fix up an existing property and resell it within one year, the Internal Revenue Service can consider that to be an active trade or business. Unlike passive rental income, the income from an active trade or business is subject to self employment tax (a nasty. If your goal is to reduce that self-employment tax to a minimum, an S Corporation is the best entity to use. Why?

It is the only entity structure whose rules allow the business owner to take a “reasonable salary” (subject to social security and medicare) and then take the remaining profit (often as much as 50% of the remaining income) out as distributions not subject to self-employment taxes.  Correspondingly, all business income taken from an LLC under similar circumstances is subject to self-employment taxes.

Holding Properties

When holding properties as a cash flow investor, the LLC (or LP) is generally the better choice because an LLC has more liberal distribution rules. The key here is flexibility. LLC distributions come out of the LLC at cost basis. The members of an LLC are issued K-1 Form and have to pay taxes on all profits as though it were income, which could expose the owners to high employment taxes. Also, an LLC can elect to be taxed like an S Corporation.

While there is never only one answer that is correct for all circumstances, there is a general rule that is almost always the correct choice. So remember, for legal and tax planning, a good CPA will recommend that clients hold their properties in an LLC or Limited Partnership and run their businesses as S Corporations to avoid self-employment taxes.

Dina S. · Answer

Thank you everyone for your insights!! ...it’s been very helpful. I think the key is to start small, be smart and it will be semi-obvious what’s the next best thing to do.

Thomas S. · Answer

Statistically the numbers I have heard is that about 50% of real estate investors have a LLC. The reasons are varied. For asset protection what you require the most is adequate insurance. That will be your first line of defence regardless of weather you have a LLC or not.

I don't believe a LLC is needed starting out, I do believe the majority of investors have one only because they were told they need one without any actual proof to support the need.

Exavier Hamilton · Answer

Jaysen is correct, but some private money lenders are changing how they view sole proprietors without an LLC.  There's so many advantages for running your business as an entity even though its not required its strongly recommended.

Jaysen Medhurst · Answer

@Dina Smolenski, you don't need an LLC for any kind of REI. An LLC has many distinct advantages, but is in no way required.

Do you or do you not need an LLC to start investing?

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