Should husband & wife investors form an LLC?

Question

Hello, my wife and I are beginner RE investor, we just bought our first duplex in Sacramento this year (with existing tenants). We are planning to buy another duplex this year, and maybe more properties in the years to come. We are filing taxes jointly, both have W2 jobs and I have an S-corp and my wife has a sole proprietorship store boutique. I came across articles that suggest doing RE investments under LLC to limit the personal exposure. So, I have a few questions:

- Given our plans and circumstances, does it makes sense to form an LLC for RE investments?

- Does it make sense to transfer our existing duplex into LLC (not sure if Wells Fargo, our lender, even allows it)

- Should we consider buying our next duplex under LLC?

Any feedback is much appreciated. Thank you.

Dave Foster · Answer

Asking an accountant about a liability protection strategy is like asking  an attorney about creating a depreciation schedule - it's not their expertise or concern.  If you want to understand the tax implications of LLCs then your CPA gave you his best advice - the tax benefits from a pass through single member LLC is not worth his additional fees for registering the LLC in CA.

If you're looking for liability protection approach an attorney who can help you plan.  Then you can compare the cost/benefit of what they craft for you based on the additional costs for things like accounting.

One thing to consider which they will guide you on - not every LLC is created equal.  The tax election you make, the way membership and equity is structured, and the nuance of the particular state filed in all work together to create the umbrella you want.

@John Thedford is correct - ownership in an LLC does not necessarily restrict the use of 1031 exchanges.

John Thedford · Answer

I would consult with your CPA and an attorney knowledgeable in real estate. As far as an LLC, that does not inhibit doing a 1031. The replacement property must be titled the same as the relinquished property whether it be in both your names, a LLC, or S Corp.

Travis Sperr · Answer

@Lenny B. any accountant that suggests doing business in "an informal partnership" needs to be replaced.

Cameron Skinner · Answer

Yes the compliance cost of a LLC is some what of a burdon, but a @Jerry W. it is an insurance policy, especially if you and your wife have assets and future earnings to protect.  You can form an LLC, and as long as you and your wife are the only members, it can be treated as a "disregarded entity" for IRS purposes which allows you to report on your schedule E instead of paying for an additional partnership or s-corp return. My wife was sued when one tenants dog bit another.  All our other properties split up in about a dozen separate LLCs,  being careful not to have too much equity in any one LLC.  Our Lawyer says don't worry you set everything up correct once they realize they can't easily go after your other properties they will drop the suit, after some discovery they dropped the suit.  Hope this helps, Good luck!

Pat G. · Answer

Lenny:

When I was RE investing with my now ex-wife we placed no more than 5 homes - valued at around $150K each into LLC and then we had a S-Corp that was the management firm which took payments and all the admin stuff.  Now, is that the best way - need to ask your Real Estate(investor) lawyer and a Real Estate (investor) accountant.

The largest reason I placed each house into a LLC that on public record I owned nothing, but controlled it all. Now, yes with a little digging you can find out who owns an LLC, but 99% of the population doesn't know how to do that.

Even an LLC, C or S corp in the eyes of the courts is a separate entity from you and your wife, plus I love all the things you can write off against an entity that you can't against your W-2 wages. I am not a lawyer, broker, or giving any legal or accounting advice, only 20 + years experience and know how in the RE business.

- Given our plans and circumstances, does it makes sense to form an LLC for RE investments?  YES

- Does it make sense to transfer our existing duplex into LLC (not sure if Wells Fargo, our lender, even allows it) - I am not familiar with how a duplex is coded for taxes - I am assuming non-homesteaded so transferring it into an LLC would not be a problem. Wells fargo won't care - they already have your names on the mortgage anyway.

- Should we consider buying our next duplex under LLC? - Seeing that a duplex is seen as residential the mortgage company may not let you buy it up front in an LLC unless your LLC has a credit history and a Duns number. (more info than you need now). Definitely buy it and then transfer it at the closing table into you LLC - just have your closing agent create a Quit claim or Deed from you personally to your LLC.

Later

Pat Gage

Chris E. · Answer

I will be doing an LLC for the rentals we are planning to purchase real soon now. I know I have to cough the $800 per year every year for the wonderful state of California, but hopefully it will get spread out over a lot or rentals....

Dave Toelkes · Answer

@Lenny B.

For a rental that you will manage yourself, you as the manager of the LLC are also personally liable for anything you did and screwed up as well as anything you did not do but should have.  If an accident in or on your rental property is in any way due to your actions as the manager/owner of the LLC, then you are personally liable.  In this respect, the LLC does not give you the liability shield that you alluded to, and therefore, the LLC offers you no real protection.

Since you are planning to use the LLC for your rental activity, the LLC will be tax neutral.  All the legitimate rental expenses that you can deduct are available whether the LLC is in place or not.  Since you are in CA, a community property state, you and your wife can elect to have your LLC treated (for federal income tax purposes) as a disregarded entity (a sole proprietorship) which will avoid a separate income tax filing.

I am not against using the LLC as you describe, but if your net worth is less than the limit of liability on your rental dwelling insurance policy plus any umbrella policy you may choose to put in place, then I don't see that the LLC offers you any benefit at all for rental property that you manage yourself.   When your net worth (that is what is left over after you sell everything you own and pay all your creditors) is greater than the limits of your liability insurance, then may be the time to consider an entity structure that does whatever you need.

The decision to put an entity in place, and the type of entity, needs to be made in consultation with your attorney, your accountant, your tax adviser, and your estate planner.  Preferably, with all of them in the room at the same time.

Just my 2¢

Jerry W. · Answer

Hey @Lenny B..  Let me respond to your accountants statements.  First the $1,500 fee is a genuine concern.  It can cut cash flow significantly, plus you have a separate tax return and annual filings as well as business minutes etc.  If it is just you and your wife I do not object strongly to an informal partnership, but it makes me uncomfortable.  If you were to do an informal partnership with with anyone other than your spouse I would say advice of that sort is malpractice and you need your license revoked.  Now your accountant did not say that, but I want to make it clear how dangerous an informal partnership is.  Any business related activity of a partner creates an UNLIMITED liability for every partner of all of their assets except those exempt under bankruptcy law.  LLCs or corporations do create real liability benefits for investing, but there is a dollar cost.  Every major business uses them for dam good reasons.  You can buy a lot of insurance for the $2K a year you might spend in CA to keep one up.  To say they are useless is grossly wrong.  They are the same thing as buying automotive insurance.  You hope to never use it, but you dam sure need it when you need it.  If you get multiple units, then it is like owning a fleet of cars without insurance.  You will need it at some point and won't have it and the question is whether or not you can afford the cost of not having one.  There are also tax benefits your accountant should be aware of.  those will be few if you own one rental and pay $2K to maintain an LLC.  If you own 15 rentals you dam sure need one, no questions asked and the cost will be tiny when spread out over that many.  I have over 30 units and only 3 are not in a corporation.  There are special reasons why those 3 are not, and I have a special insurance policy on those 3.  They are not mandatory but they are an important tool that you should not ignore.  Ask any of the professional real estate investors on this site and all of them will tell you they do business in corporations of some form.  You may get smaller investors or those holding day jobs who say otherwise, but never the true professionals.  You may not need a power roofing nailer to put shingles on a house.  You can pound them in by hand.  I have done it.  If you plan to do 5 roofs in a summer you are an absolute moron not to buy one and use it.  I hope this helps.  there are a lot of folks who are nice and take time to give advice on this site.  Not all of them know what they are doing.  Good luck in your investing.

Marylynn Caruso · Answer

My husband and I were in a similar situation.  We put our first rental in an LLC and when we got a second one we added it.  We also have a sub S for a different business.  We were advised to structure this way for protection as we all know.  It also made it easier and cheaper to insure the properties.  Good Luck!

Jo-Ann Lapin · Answer

Firstly, I am not an attorney. The LLC is I am told by most investors easier to manage on the whole versus a corp. The LLC is an added layer of protection but can be pierced. Check into the compliance on that. The best advice my Mom who is an insurance agent has been to  get as much insurance on a rental as you can for that cushion of insulation.

Lastly, congrats on your purchase and all the best for the next one.

Regards;

Jo-Ann Lapin

Should husband & wife investors form an LLC?

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