Upgrade to commercial property strategy

[Jack P.]

BPers,

I'm laying out my long-term strategy and need some advice/guidance.  My portfolio currently has a trio of 4-plex properties in the same neighborhood, for which I use a professional manager and oversee things from afar.  One of those are in my name, and the other two in both my wife and I.  Total value for those 3 properties is about $700k.  

We plan on entering active retirement in about 10 years, and would like to reinvest those properties into something bigger.

Here's my plan:

-In a couple years (once the dust has settled from the new purchases and rehab), form a LLC or S-corp (not sure which one), and group those three properties into a single commercial-type loan. Continue to operate the properties as an LLC or S-corp for a period of time (~5 years) to build some type of record and credit for the company.

-When we retire, 1031 exchange that portfolio to a larger property, probably in the $1.5-2M range, still run by the LLC/S-corp, but located wherever we decide to live, so I can self-manage.

My questions:

-Does the above sound feasible? Can I lump my current properties into a LLC/S-corp and get commercial financing for them if I have several years of tax records showing profit?

-Can you 1031 exchange a S-corp held property?  Or do I need to keep them in our names?

-As I understand 1031 exchanges, the names for the exchange need to be the same, so the two properties that have my wife's name on them can't be combined with the one with just my name on it for the new property, right? 

-Does the strategy work well to establish experience for purchasing the larger property with commercial lenders? Would they care if my experience is gained in passive management in a property in my name, or would they prefer to see tax returns for a LLC/S-corp?

Basically, my assumption is I need to build a paper trail (tax-returns, rent roll, etc) of my current portfolio for a couple years to shift things out of my name, and into a company.  My credit score is in the 800 range, but I'd like to start building credit for a company.  

Any advice helps.

Thanks.

[Brian Burke]

@Jack P. that's a well thought-out plan, but completely unnecessary.  It's my opinion that you'll spend a lot of time and brain damage but gain nothing.

The properties are 4-plexes, which qualify for residential financing.  The terms for residential 4-plex loans are quite likely to be superior to what you'll find from commercial lenders.  For example, let's say that you put 15 or 30 year fully-amortizing debt on each 4-plex at a low fixed interest rate.  Under the terms of most competitive residential debt, there would be no prepayment penalty.  In the commercial world, rates tend to be a bit higher, terms are shorter (not amortization necessarily, but balloons) and prepayment penalties are common.  If I were you, I'd leave the title and financing alone.  I'm sure that someone will say that you need to put them in LLCs or a Corp for asset protection, etc, but that's a whole separate (and occasionally heated) debate and, in my opinion, another unnecessary expense and headache given the scope of what you are doing.

I also understand your underlying motivation to build credit for the "company" so that you can get financing later for a larger property. That's another non-issue. If you later form an LLC or corp and acquire a smaller property (call it under $5MM but that's not a hard-and-fast rule) the company debt will most likely be recourse debt where you will be signing a personal guarantee and the lender will be underwriting both the real estate and you personally. Your personal credit will be the credit that the commercial lender is looking at, even if the borrower is your entity. If you are acquiring a larger property, you might find non-recourse debt, in which case the lender will be looking mostly at the real estate and your track record and experience. In larger non-recourse debt placements, lenders typically require you to form a single-purpose LLC to own the real estate and be the borrower, so again all of the calories burned on trying to establish corporate credit is for naught as this newly formed entity will not have benefitted from that previous work.

As for your other questions, in a 1031 the taxpayer buying and selling need to be the same.  You can 1031 S-corp property but the S-corp will be doing the 1031 and will be the buyer of the replacement property.  If you were to ignore my advice and deed the 4-plexes to a S-corp, the one owned by you and the two jointly would all be deeded to the corp, and thus the corp would be the seller and the buyer so the 1031 sticks.  And no, the future lenders don't care if your real estate experience resulted from properties held personally versus in an entity. 

I hope that helps!