Lend via LLC?

Question

To create an additional income stream, I have decided to privately lend (gap funds under $50k for my first) amongst other members of the REI flip method coaching program to which I belong.

I have already formed an LLC for my eco flip to sell / rent business.

My question to those more experienced is: should I lend as myself or should I have the LLC lend? The money I'll be lending is personal savings and not tied to an SD IRA or solo 401k. I do imagine if I lend it as the LLC, the loan amount and interest return would be considered a capital contribution...

Thank you in advance for your time and advice!

Doug Smith · Answer

Just a warning. I've seen a lot of private lenders that don't have a lending background lose big time lending out money. When I was a commercial banker for a community bank, one of the board members asked me to have the bank lend someone he knew over $1 million for a business venture. When I looked at the deal, there was no way I was going to sign that loan. I went to the bank president to ask him for his help as it was really going to tick off the board member. He completely agreed with me as we were both grisled lending vets who had seen it all. The board member was furious, but he reaching into his own pocket and gave the guy the $. He lost it all. Please be really careful when you're lending. I've seen a few "coaching" programs out there that teach "private lending", but the gurus don't have a lending background. They sure know how to sell a course though. I just don't want to see you make the same mistake that I've seen so many others make. We lend...but I've also got a formal credit background from two of the largest banks in the world and 32 yeard of this under my belt. Please be careful.

Jeff S. · Answer

Compared to real estate ownership, the liability risks of lending are relatively low, @Elizabeth Watmough. Whatever direction you decide, make sure your lending is separate and distinct from any real estate owned. There’s no reason to expose your lending portfolio to something that could happen in a rental. Separately, and not trying to divert, but I’d be super careful of anyone suggesting it’s ok to lend your (non-replaceable?) retirement money for gap funding. These are second-position loans and are easily wiped out in foreclosure or bankruptcy. Did your flip method coach explain this to you? Hmmm. There are much safer ways to lend retirement money for flips, such as first-position purchase money and even syndications. Of course, you’ll be using a professionally prepared loan document package that includes a personal guarantee. Right? I’d hate to see anyone get taken advantage of by a coach. Talk to some local hard money lenders and ask which lending attorney they use. This is not the same as a real estate attorney. He or she should be able to explain MA lending law to you, including usury and licensing as well as the risks if you must foreclose, if a borrower declares BK, or otherwise contests a loan. Lending attorneys will also provide a set of loan docs, written in your interest, that will protect you. A coach, perhaps someone who is also borrowing from you (???), might not be as knowledgeable or forthright. Sorry -- just reading between the lines.

Elizabeth Watmough · Answer

Thank you for your feedback.After leaving W-2 employment last fall for health reasons, my sole sources of income will be from investments and my small business. The original plan was to pursue S-Corp for tax election but I have not filed for the election change. I do need to reconnect with a tax advisor and attorney, preferably local or familiar with MA state specifics. I appreciate you taking the time to respond; best wishes.

Rodney Miller · Answer

Great answers here. I think a flow-through LLC is the best entity for lending money. I agree with Doug on being very careful when entering this business. The fact that you were going to go straight into 2nd lien position lending threw up red flags for me. I would suggest finding a legitimate coach or program to teach you the ins and outs of private lending/hard money lending. They're out there...you just have to find the one that's right for you and you might have to part with a little money. Either way...the education or lack thereof will cost you money. Good luck!

Angel Maldonado · Answer

Hi Elizabeth, Regarding your small business you will definitely want to speak with a tax professional before making an S-Corp election. Making the S-Corp election brings with it the requirement for additional administrative costs such as running payroll for yourself. Additionally, if you are a sole proprietorship or the only member of an LLC, your small business income is reported on your personal tax return. Making the S-Election means you will have to file a separate tax return for the business. Depending on the profitability of your business, the additional fees of running an S-Corp might cancel out any tax savings you are looking to keep. The S-Corp election can be a great tax strategy but it is not a one-size fits all. I hope this helps!

Chris Seveney · Answer

Interest from loan payments are ordinary income (confirm with your tax professional)I recommend you use your LLC, but you would make a capital contribution to your LLC, the LLC would lend the money and the interest income would pass through to your tax return since LLC is a pass through entity and you pay ordinary income. So if you are in the 27% tax bracket that income is taxed at 27% (you do not pay SS,medicare on it).