Form a LLC to start real estate investing?

Question

Hello!

Thank you for taking the time to read my question. I am currently a beginner in real estate investing, but trying to learn as much as I can to increase my knowledge in this area.

I have acquired one property previously (primary residence, now a rental). I am hoping to slowly acquire more properties in the near future. My question is, should I form an LLC to do so? This will provide me with liability protection.

Thank you!

Dave Toelkes · Answer

@Wen Wu

If you are thinking that the LLC makes you immune to a lawsuit, then you need to have a serious discussion with an experienced attorney to get the best informed answer to your question.  You may not have a complete understanding about the extent of liability protection (if any) an LLC offers.  Also, the LLC is not a replacement for liability insurance.  You will still need insurance, even if you form an LLC.

For many years, I have suggested that if you are going to be a landlord, you don't really need an LLC until your net worth is greater than the total liability coverage offered by your property hazard insurance and the maximum limit for an umbrella policy offered by your insurance carrier.  For most, this threshold is usually a number in the mid- to high seven figures.

Since you are just starting out, and most likely don't have a high net worth to shield with an LLC, give the landlording business a try before resolving to form a business entity.  You may discover that your heart is not really in the landlording business and sell your property -- eliminating any future need for an LLC.

Brandt Smith · Answer

@Wen Wu whether or not you need an llc depends on your investment type. MF always should be in an LLC. SF (including duplexes and quads) don't need it. It doesn't add much protection (use insurance and good landlording for protection) and you can only get non-recourse loans. Fannie Mae (recourse) loans typically have better terms and can't be called.

Gord Stevenson · Answer

An LLC should provide a measure of protection for your other investments or personal assets...from liability that occurs related to assets held by the LLC.  For example, a tenant of a property held by the LLC sues you.  If you are doing business in the name of the LLC they would have to sue the LLC.  A couple of caveats and things to consider:

1) you need do do bisiness related to that/those properties under the name of the LLC consistently.  Eg.  Rental agreement in the name of the LLC.  Rent income goes into a bank account in the name of the LLC.  Expenses for the property paid for by the LLC.  Search on "piercing the veil" for discussion about it, but do not necessarily believe everything.  You will get the idea.

2) An LLC does complicate administration of the property.  You would file a tax form for the LLC...then the resulting profit goes on a K1 form to inform your personal tax form.  In my opinion the extra tax forms is the biggest additional workload over holding the property in your own name.  Depending on the state the LLC is set up in, there may be an annual or bi-annual form to file to keep the LLC in good standing, but that is easy.

3) if you are a resident of Canada as I am, and setting up a US entity to hold a property in the US, a US LLC is not a good choice.  I use an LLP (Limited Liability Partnership) instead.  An LLP has the same liability protection but is set up with the State's Secretary of State instead of the Corporations Commission.  The reason that an LLC is not good for Canadian residents is that we do not have the same LLC construct in Canada...so our tax authority would just hear "blah blah Company"..."Oh that must be a Corporation" and potentially disallow the credit for tax paid to the IRS for the LLC against tax due in Canada.  Double taxation...not good.  One disadvantage of an LLP is that there has to be at least two people to form a partnership.

4) if you don't want the complexity of an LLC or LLP to hold your property, another option is to buy more liability insurance.  That won't provide true isolation of liability, but it will provide more coverage to pay for liability.

The bottom line for LLCs or LLPs is that they provide liability protection but do not affect taxation rates.  The mechanics of taxation change because there is another tax form to complete, but the tax rates etc are the same as if holding the property personally.  That's the difference with a Corporation.  A Corporation provides liability protection but the tax rates for rental income and capital gains are higher in most cases.

Kurt K. · Answer

In addition to an LLC and insurance, I would recommend having additional coverage such as an umbrella policy. Currently we have it for 1 Mil, but you can have additional coverage.

For additional asset protection, you can also have your LLC into a Living Trust. This is much more complicated and would need a lawyer to set up. But if you have a number of properties this is another option.

Kurt K. · Answer

Account Closed I never said it would protect you 100%. I'm just saying there are other ways to help protect your assets.

Steven Davis · Answer

Wen,  I just went through this. You may find my blog post helpful.

https://www.biggerpockets.com/blogs/8891/52079-llcs-mortgages-and-covering-your-assets

Gord Stevenson · Answer

One other thought that occurred to me:  I use a property manager because I don't live near the properties so that may also reduce risk of being sued for something I might have done or not done as a "manager" of the LLP/C.

Gord Stevenson · Answer

Only the judge in a court case can settle the question of liability for sure.  Unfortunately we live in a world with complicated legal systems.  Dave, I agree that an LLC won't take personal liability risk down to zero, but if it is properly used to avoid "piercing the veil" issues, I think it will dramatically reduce personal liability risk.   Not to zero, but a major reduction...probably to the point where an opportunist looks at it and concludes it is not worth the legal fees to try to get you personally.

You then get to a point of diminishing returns where the extra complexity and cost of managing additional layers of protection exceeds the value.  Implementing and maintaining a trust for example is not trivial.

For the LLP (similar to LLC) approach I use, I am able to set it up and maintain it including filing US and Canadian income taxes without professional assistance.  I think I would need legal and maybe accounting help ($$$) to add a trust or other layers.

My preference is to rely on the LLP/C backed by a decent amount of liability insurance.  For me, if I was going to do something different it might be to do less...further increase liability insurance and hold the property in my own name to avoid the complexity of maintaining the LLP/C...mostly filing taxes for the entity.  Having said that, my opinion could change if my estate was in the millions and therefore I was a more juicy target for opportunists.  It's about probabilities and risk management.

David Dachtera · Answer

@Dave Toelkes,

That's why you build your business entity structure such that none of the entities is owned by a human person. They're owned by each other and a trust you set up with you as the beneficiary.

Dave Toelkes · Answer

@David Dachtera,

If you are the manager of the LLC then any lawsuit arising out of your LLC activities will name you personally as well.  If the basis of the lawsuit is for something you did or failed to do but should have done, even though you are acting as the manager of the LLC, you can also be held personally liable.  As I suggested earlier, the LLC may not offer the level of lawsuit protection many believe it does, and that is why a conversation with an experienced attorney should be the first thing to do when considering forming an LLC.

Form a LLC to start real estate investing?

Most Popular Reply