When to start an LLC?

Question

At what point is an LLC necessary? I read that the LLC requires a lot more attention to detail in order for it to protect any property. If I own two properties, would it be helpful to have an LLC or is it better to wait until I have 4 or 5 properties.

Is it better just to get insurance to cover any lawsuits and forego any LLC?

Mitch Kronowit · Answer

The general consensus ranges between form an LLC before you even purchase your first rental or wait until you have 100 units or so. Your personal preference may fall somewhere in between, and yes, I believe it is a personal preference.

In many states, forming an LLC is cheap and easy, so why not do it for even one rental? In my state, California, the $800 annual franchise tax for an LLC makes it an expensive endeavor unless you have several rentals to fund it (or just one or two that cash-flow very well).

Lastly, asking when an LLC is "necessary" depends on what you consider mandatory. Some investors operate a lifetime without ever forming an entity, so I guess for them, an LLC was never "necessary". For some who had one rental property and got sued in their second month of operations, their take on what is "necessary" may differ quite a bit.

The best approach is speak to an attorney who specializes in asset protection and estate planning. Lay all your cards on the table and evaluate exactly your risk tolerance and what you have/need to protect.

Travis H. · Answer

One other thing to consider here is corporate formalities.  All of this effort to start LLCs is really quite moot if you don't follow your corporate formalities.  In Texas, for instance, it only costs a few hundred dollars to start an LLC - that's a not brainer.  Even if you have an LLC for each property, though, if the LLC gets sued and the plaintiff can prove that you did not abide by the corporate formalities, they may "pierce the corporate veil," which would leave you PERSONALLY responsible.

Ann Bellamy · Answer

George  Ramsay, No, you don't have to file it in your home state, but in MA and NH - don't know about other states - you have to register your LLC in that state where you are buying the property.  Which costs the same as the original LLC, so you are simply incurring double costs.

Paul S. · Answer

So California seems unique in that it has a high price for the LLC, thus requiring an alternative.

So if I have 5 rentals, than I can have a homeowners policy for the house I am living in, and seperate landlord policies for the 5 rentals.

For third party negligence protection, I can put all 5 rentals in an LLC.

The seperate landlord insurance policies seem to be the most cost effective method for protection in California.

If I want more protection, I can get an umbrella policy that would cover other liabilities, but doesn't seem necessary.

Jeff S. · Answer

It’s not just a trade between insurance and the numbers of LLC’s, Paul S.  Entity selection should at least also consider tax avoidance and asset protection.   Your needs will change over time and with your circumstances.  What else do you own, what’s your tax bracket, what’s your potential exposure, and what is your risk tolerance?  They really play together.

To clarify, there is no benefit to forming your entity in a foreign state unless you have property there. In fact, there can be significant disadvantages. Not only will you have to register as a foreign entity in your home state (and pay the associated fees, as Ann Bellamy correctly noted) but if you’re involved in a lawsuit, the court will interpret the rules according to local state law, not the state in which you filed.  Worse yet, if you don’t register your foreign entity, it will go completely unrecognized in a local lawsuit. Too many gurus selling aged Nevada and Wyoming LLC’s on the 3am infomercials forget to point this out.

Worse yet Ann, the state of California expects you to pay the $800 minimum franchise tax fee for each series in a series LLC.  It’s questionable whether this is constitutional, but no one wants to be the test case.  Liability protection between the individual series has also not been well tested, so you’re taking your chances here too.

Jeff

Mitch Kronowit · Answer

We have a separate insurance policy for each property with the exception of one, which is simply covered under an extension of our homeowner's policy. It's clear as mud to me, but my carrier explained that the one rental which we've had the longest was originally covered that way and that's how they prefer to keep it. All subsequent rentals received their own policy and each policy carries $1M in liability.

An LLC is NOT a substitute for insurance, but there are several misinformed individuals that believe that. An LLC is simply another layer of protection (think layers of an onion). In certain cases, such as negligence, your insurance policy may refuse to pay altogether, but your LLC can still afford you some measure of protection, especially if the negligence was caused by a third party and not yourself. We also enjoy the personal privacy and separation an LLC affords us from our business, e.g., all of our tenants understand the property they rent is owned by a company, not a person.

George Ramsay · Answer

One thing to add...

California is an expensive place to form a LLC. You can form your LLC in cheaper states like Nevada, so keep in mind you dont have to file your LLC your home state

Carole M. · Answer

Paul S

I personally woudn't own rental property without a LLC as the LLC provides asset protection.  If you have a partner, then an LLC is essential as the Operating Agreement spells out the terms and conditions.   If you can get a copy of an Operating Agreement you will see just how detailed it is.   A call to a CPA and an Attorney would be advisable.

Ann Bellamy · Answer

I have an umbrella policy that  provides extra coverage on auto, personal residence and one investment property that I still own from before I understood about LLC's.

I then put each rental property in an LLC.  They are in NH, which is only $100 per year, so it's cheap and well worth it.  When you buy something in an LLC, you need a commercial loan, not a residential loan, so keep that in mind.  Terms are quite different.

Some states are implementing "Series LLC's",  Delaware is one of them.  As I understand it, you have to form only one LLC, and each sub-LLC, or series could contain separate properties, which are protected from liability individually, but which require registration of only the whole series.   Legal opinions so far are divided on whether these series LLC's will be recognized in other states that don't have the same type of Series LLC's.

Jay Neaves · Answer

As I'm still in the planning stages, my 2 cents probably isn't worth much, but I am considering an LLC holding company.  For me it just adds an extra layer of protection.

When to start an LLC?

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