Single Member LLC and Limited Liability?

Question

Hi Folks,I am looking to purchase my first investment property (either a SF home or less than 5 MF units) and plan to hold it in an LLC, with myself the only member and the member-manager. A couple questions about the legal structure:1. Would it make the most sense (tax, legal, etc) in this scenario to hold the property in an LLC or an LLC classified as an S Corporation? I would segregate assets/keep funds separate in order to limit liability to the amount of investment in the LLC. But where I am also confused is on classifying this LLC setup. Would I want to avoid the LLC being classified as “single member” or “disregarded as separate” as this would remove the veil between personal and business funds? Or if the LLC is elected to be taxed as an S Corp, does being “single member” or not no longer apply?2. Is there a major disadvantage in purchasing a property and using a sole-proprietorship for the first six months or so, then creating the LLC and moving the property over? For example, if the property is deeded to the LLC after the LLC is formed, would the property then be considered as separate from the owner?Thank you very much.Alex

Jenifer Levini · Answer

Hi Alex, I'm a lawyer in California. I can explain these concepts pretty simply.In answer to your first question, dont worry about the terms 'single member' or 'disregarded entity.' Neither of those removes the veil that protects you from liability. The entity is disregarded for tax purposes. This means that the entity does not have to file separate taxes. The profits and losses flow directly to you and are included on a separate schedule in your personal tax return. The term 'single member' reflects that there is only one member and that member has 100% ownership, and the Articles of Organization are a lot less complicated.Since you will be using this property for residential investment purposes, assuming you'll be having tenants in the property, its better to form the entity before you buy. And then buy in the name of the entity. That way if a tenant has a slip and fall on day one, your personal assets are shielded. When you buy a bank may ask for a personal guarantee. That's fine. They need to be able to go after you in case of default. Your LLC isnt (usually) intended to shield you from your lender. The shield is important to protect your assets from tenants, workers on the property, and other things that can go wrong on the property. Those things dont wait for 6 months to go wrong.Good luck! And I suggest you hire a lawyer in your state to help you form the LLC, answer other legal question, and review your purchase agreement. A few thousand spent up front can prevent tens or hundreds of thousands if something were to go wrong.Jen

Jenifer Levini · Answer

@William Morrison makes a good point. The LLC veil is intended to protect the owner of the property from certain liabilities. This doesnt replace having insurance. If you have been sued its important that you seek legal advice ASAP. The fine details of each incident will make the difference.

Alex S. · Answer

Thank you all (David, Damian, Robert, Jenifer, Tom, William)You have all pointed out very helpful strategies and information. For the long term and passive approach it does seem like the LLC will be a good choice for me as a first timer.

William Morrison · Answer

Tom, you're correct to some extent. What I laid out on purpose were violations of code, negligence or both. Those are not hard to find and results as well. Check the threads here on BP for some of the work that has been done before the thread is started looking for help. Negligence or breaking law by violating code, some considered minor some not. It's not cleaning the gutters and your ladder fell over or watering the landscape and the sidewalk got wet and someone tripped. Your final point about talking to a corporate attorney (I did) is exactly why it's important at this level. Look at those that are just starting out here on BP, watch the threads for how much money they have or don't have to start out. Not a lot there for time with a lawyer. Look at the number that recommend Do It Yourself LLCs to save money. Those well funded would be less likely to start out without a lawyer.I have several Licenses and Registrations. I get the monthly list of hearings, law suits and settlements in those states. As I'm sure you know without credentials the one sued has to prove competence. An LLC is just not the panacea some selling them suggest. And I don't think you are suggesting that.

Tom Olszewski · Answer

William, I don't think anyone would say either of those cases are frivolous. The question will be which will be liable. It's easy to include both on the suit but the defense will try to remove the personal liabilty from the case as he was acting in his normal duties as the owner of the company. The plaintiff would have to prove the repairs were outside of the normal operation of the business and there should be personal liabilty. The other way would be to pierce the veil by proving the comingling of funds and/or the owner did keep business and personal separate. Those types of issues will be flushed out in the case but that does not preclude liabilty protection of the LLC. Those examples only go to prove that each case has a set of distinct facts that can turn a case. I would have a hard time telling anyone that an LLC is not worth having based on allegations of a plaintiff's case without knowing the final outcome (or if the issues were even raised, i.e., the defendant had a good attorney that brought up those defenses). In fact, I'd say it's a good reason to talk to a good corporate attorney to flush out what you should be doing and what you shouldn't be doing, i.e., the metes and bounds of what your company should and shouldn't be doing. It's all in the entity setup.Although I am an attorney, this is in no way legal advice but is merely a conversion to discuss potential merits of legal entities.

William Morrison · Answer

Jen, I liked your post. This site has many first time investors like the owner of this thread. One thing new investors seem have in common is they do one or more things to make their dollar go farther. They buy to fix, they do their own maintenance and repairs, they are their own property manager, etc. I think what can happen in any or all of those areas can remove the veil. I'll give a few example. I just bought a property from a landlord getting out. He did his own carpet replacement as well as some other things I had to have fixed. What could go wrong with that? He saw the video at Home Depot and used their tools. It was not stretched correctly and the ripples were a big tripping hazard. I had a carpet guy come re-stretch it.New investor replaces the gas hot water heater with one he bought from Lowe's. Seals the gap in the induced draft flue. CO issue in the rental and maybe fire. Real story.New investor replaces the front and back steps but the rise is not to code.Real examples are easy to find, just check some the do it yourself threads on BP. Who are you going to sue? The LLC alone or the investor as well. I don't know if I'm really asking because I got my answer from a lawyer who only takes non-frivolous tenant cases. He's suing both.The big difference is passive investors with property managers vs sweat equity investors.

Tom Olszewski · Answer

What Jen said. The only thing I would add is that LLCs are state legal entities and there may be some quirks from state to state but the whole idea of an LLC is to provide limited liabilty, after all, it's in the name. This is why they were made, to make it easier to form an entity to protect the little guy's assets. Very large companies are structured as LLCs also, such as Fiat Chrysler. Since the laws very from state to state, you should check with a local attorney and/or an accountant for tax info.This is not legal advice.

Robert Spencer · Answer

The process is a maze. There seem to many things to consider, and they vary from state to state. I live in Michigan and all my properties are in LLC's. As I understand it, at least in Michigan, the liability benefits of an LLC and an S Corp are comparable. One major difference, however, is for taxes. A financial advisor that works for my of the Landlords that belong to the association I am a member of, said that an S Corp has to pay its own taxes and then the member has to pay separate personal income tax. An LLC's money simply goes in a separate "schedule" on the member's personal income taxes. For me, this means it is beneficial to use an LLC. It does, however, present some challenges while trying to obtain financing. For instance, I've been told by bank after bank that they won't do a low down payment mortgage like FHA for an LLC. On the business side, I haven't had the required down payment and since the term of the loan is shorter, the payments are higher than an FHA loan, which changes the equation for cash flow. Also, they usually have a minimum loan size for business loans that is higher than I need or can afford for the houses in my market. So there is definitely advantages and disadvantages to any way you choose.

David Dachtera · Answer

@Damian S.,I'd modify that to say that conveying title to your entity without the full sale and transfer opens the possibility of the lender exercising their rights under Due-on-Sale. This is a very uncommon occurrence, however. By the reports I've seen, only one notorious lender has been known to do so with any regularity: Bank of America and their acquisitions.David J Dachtera"Success is not a destination. Failure is not an event. Success is a process, failure is a choice."- DJ Benedict

Damian S. · Answer

If you are planning on holding the property long term, you will need to create an LLC. The election for S Corp is only good if you will be using the entity to conduct active business. I would also need to point out that if you purchase it outright, DOS clause will prevent you from transferring title to the LLC without consequence.