Sole Proprietor - Llc. - ?

Question

We are currently operating as a sole proprietorship and are now ready to create an LLC.

What are some of my main concerns, what questions do I need to be asking our accountant, and should I be considering for the future.

I realize you may need to know our plan.
In a nutshell:

We would like to create some liability protection for our business as well as protect our profits within the tax code(isn't everybody?). Our profits right now are staying in the business until we go totally self employed, we have W2 jobs at the moment. We will be building our rental portfolio and also working on other projects with exit strategies for flips and owner financed deals.

Have read about this, I still am not sure what is best, I am at a crossroads. We are not a very complex business at the moment. Any help is greatly appreciated.

Thanks in advance all.

Dave Toelkes · Answer

Mat,

First, recognize that an LLC is treated for federal income tax purposes as a corporation, as a partnership, or as a sole proprietorship.  If you and your spouse will be the only members of the LLC, then the tax treatment for your LLC will default to partnership unless you elect to be treated as a corporation.  A sole proprietorship LLC can not have multiple members.

As a general rule, you do not want corporate ownership of rental property, so use the partnership LLC for your rental activities.  For your active income activity (property flips), suggest the LLC treated as an S-corp.

Leaving profits in the business to reinvest does not avoid taxes.  Your net business income is taxable whether retained in the business or distributed to the LLC members.

Please understand that your business assets are exposed in the event your business is sued.  Your hope is that your business entity shields your personally owned assets when the business is sued.

This is a significant risk when you self-manage your rental property as a sole proprietor, or, you as a managing member of the LLC also manage the rentals.  Hands on property management does create personal liability for you and exposes your personal assets when your business is sued.

Make sure you thoroughly discuss this point with your CPA and your attorney.

Bryan Hancock · Answer

First...I agree with pretty much everything written in this thread.  You have received some top-notch advice.

The only part I would nitpick about is the passage above.  In many cases it is unnecessary to segregate rentals all into separate LLCs.  It really depends on the equity position in each property, how long you intend to hold them, what all you are trying to protect, etc.

For most newer investors two entities are plenty.  The LLC taxed as a S-corp can be a passthrough entity you use for branding and for your flip business.  It can also shield your LLC that holds rentals from liability.  If you have a ton of rentals you could consider segregating them into different LLCs, but I wouldn't go nuts with it.  You have to file a separate tax return for each of these entities, keep minutes, etc.  It is a pain to maintain and overkill in many instances.

A series LLC for your rentals is another option to consider which addresses some of these issues.  The case law is skinny for these entities so there is definitely a tradeoff using them.

Bobby Casey · Answer

I prefer to segregate assets by holding the property (or any other type of asset) in separate LLC's thus limiting the risk to each property and to me personally.

Then use the LLC (taxed as Scorp) for your operating business.  This keeps your assets (the property) free of liability associated with the operation of the business.

I prefer the LLC because of the liability protection it offers from both inside and outside creditors (if properly structured) and the Scorp tax election because of the ability to minimize your social taxes (15.3%) and also the ability to pass through any losses to you personally.

If the business becomes large enough, switch to Ccorp tax status.  I recommend to my clients to do this when you anticipate EBIT to exceed $1m.

Account Closed · Answer

You will have some asset protection in the single member LLC though it is not the same as having a multi-member LLC.

There are many issues that can come over the life of a business.  Adopting am operating agreement from the start that covers issues like adding members, how profits and losses are shared,  how non-monetary contributions will be valued, etc.

It is good to find a CPA or attorney that is familiar with entity formations and contract law.  They will review a host of different situations with you to help insure that your business needs are met.  You can set up an LLC on your own, but usually these are very inflexible and can hurt future growth.

As far as tax issues go, basically the LLC is a non recognized entity for federal tax purposes.  The business would still be treated as a sole prop unless you elected to have treated as a corp.

Bobby Casey · Answer

Mat,
For your operating business, yes, you need to register in your home state.

I would recommend an LLC taxed as an Scorp.

For any RE owned, they should be registered out of state as mentioned.

Bobby Casey · Answer

There are 2 main considerations when registering an LLC; the state of registration and the operating agreement.

For RE purposes, it is register the LLC in states like NV, WY or DE.  These states offer the best asset protection as they recognize charging order's by statute (as well as other various benefits).

It is not necessary, or even preferred, to register an LLC for RE ownership in your home state for privacy reasons.  You only need to have an LLC registered in your home state if it is an operating business with employees.

And in this case, I would still register the LLC to own the property out of state, and have an in state Scorp or LLC for operational reasons.

The other consideration is the operating agreement.  This is basically the contract between you and your business.  In absence of a solid operating agreement, you can be at the mercy of the court.

Someone previously mentioned SMLLC (single member).  This is only a concern in certain states and only when you don't have a solid operating agreement.

I hope this helps.  If you have any further questions, let me know.

Mat Lewczenko · Answer

Thank you all for passing on your experience. Very much appreciated. Now lets see what my guys comes up with.

Mat Lewczenko · Answer

Thanks Bobby, could you share your perspective on why S corp over C corp?

Mat Lewczenko · Answer

Thanks everyone, I think that helps us out a good bit. At least gives me some great questions to ask my CPA next week.

I feel like we would set up our LLC in the state that we are in, for the main entity that we do buisness in. There will be two of us as managing members (wife). Then our portfolio would be under spearate LLC's.

As far as the main entity that we will be running, I keep getting stuck on the taxation issue. C or S? I have read through article after article and am still not clear on the advantages of one over the other.

Will keep reading though. We will also see what my CPA has to say about it as well.

Account Closed · Answer

Bobby, I tend to agree that the operating agreement is a very important document when setting up any LLC.

The need to register with any particular state will vary.  Many states have unchallenged laws or in some cases case law that expands the generally accepted definition of doing business.  The commerce clause limits the powers of states, but many states have redefined the meaning of doing business in their state.

Anyone choosing to using an out-of-state (foreign entity) should consult with an attorney or at the very least review how the state defines "doing business" in their state.  This is becoming more of a sticking point and eventually their will be a supreme court challenge.

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