Mom & Son buy rental properties, need business structure advice

[Aaron Roggensack]

In recent years my Mom (59) and I (36) have been partnering together to make our first moves into real estate investing. In this arrangement she is essentially a silent investor and I manage the properties. To date there has been no formal business established for any of the activity described below. But all profits and costs have been claimed on personal income taxes.

Here are the most relevant facts, followed by my questions...

1) Between the two of us, we own 4 properties:

a) I own (via bank financed mortgage) my primary residence, a condo in Austin, Texas. Mom rents her primary residence, in another state.

b) Mom owns (via bank financed mortgage) an investment condo in Austin, Texas.

I operate this condo as AirBNB rental and retain a percentage of gross income for my management services each month. Remaining funds go into dedicated bank account owned by Mom.

c) Mom and I own (via co-signed bank financed mortgages) two houses in San Antonio, Texas.

Both houses are occupied by renters on year long leases.

I retain a percentage of gross rental income for management services each month. Remaining funds go into dedicated bank account owned by both of us.

2) We plan to both buy more real estate, both independently and together. Intended plan for all properties is to hold and rent them out for the long term.

3) It is somewhat likely that I, or she, may independently both be interested in changing status of certain properties in the future, from investments to primary residences. and vice versa. Both for personal and tax reasons.

4) I am now fielding inquiries to manage AirBNB rentals for others, and considering doing this (in conjunction with income listed above) as full time business.

Questions

A) Should our currently owned rental properties be put into LLC(s) and if so what are the primary reasons? Can strong insurance on the properties work just as well?

B) If you recommend LLC, do you recommend one for all properties or one for each individual property?

C) Will placing the current properties in LLC's have any affect, positively or negatively, toward obtaining more financing for future purchases?

D) Should we start buying properties with only one of us listed on the mortgage/title, to avoid difficulty in future financing (too many mortgages)?

E) What would be the best method/schedule of distributing funds from these LLC's to us as owners?

F) Should I setup an LLC or S Corp for Property Management Business?

G) Are there any concerns with paying My Management Company, for managing properties co-owned by me?

Your expertise and advice is much appreciated. Thank you!

[Scott Smith]

I am going to address your questions in a separate post, but I want to explain asset protection from a birds-eye view, first. When I sit down with clients, I always discuss (1) their personal assets, and (2) what their current investments portfolio and other business ventures are before discussing (3) their future goals. Each of these variables will dramatically change the advice I give the individual asking me this question. Generally though, I break it down into the "five pillars" of protecting your assets.

The first pillar is avoiding unnecessary and risky activities (don't drink and drive, insurance generally won’t cover your poor decisions) and take good care of your investments(maintain your property, etc) - these simple steps will help you prevent lawsuits before they even occur.

The second pillar is a good insurance policy as that cover the majority of your exposure. However, insurance is limited because it only protects you from one type of liability: accidents/negligence. Insurance doesn’t protect you from any part of the sale or acquisition of a property (e.x. Somebody wanting to sue for you backing out of a bad deal or accusing you of selling them a property with defects like unknown termite damage). Insurance also doesn’t protect you from misunderstandings, especially those made in writing and email. What happens in these misunderstandings is that something goes wrong either in the sale or after, and then they sue you for some statement you made that they “misunderstood”. That lawsuit is a claim for fraud, and that’s what fraud typically is...a misunderstanding and someone being “injured” and wanting to hold the other responsible for it. Insurance never protects you from these kinds of claims and they happen all the time.

The third pillar applies after you have good insurance You need to protect yourself from what insurance doesn't cover by compartmentalizing your assets. Compartmentalization means that if something happens to one property, people suing can't touch you or the other properties. You should use either LLC's (the old and expensive way) or a Series LLC (the new and more cost/time effective way). No matter where you live or where you own assets, I personally recommend the Series LLC to be a great tool for the individual investor who is planning to expand their operation, as it allows for you to scale infinitely for FREE. If you're interested in using an LLC, this article also further explains the advantages of a Series.

The fourth pillar is somewhat similar - you want to separate your operations from your assets. One company owns everything and does nothing (this is your SLLC a/k/a "asset holding company") and a completely separate company handles all of your operations (this is a traditional LLC a/k/a "operating company") For the operating company which serves as your face to the world and through which you do all your business, you establish a Traditional LLC to carry out the operations of your investments. The operating company takes on all of the liability that would otherwise blow back on you including: paying property management, paying contractors, collecting rent, marketing, etc.

The fifth pillar is owning everything anonymously. If people don't know that you have assets, then they are less likely to sue because there's no use in suing people that qualify for food stamps. This anonymity can be accomplished for free by using land trusts to own your companies as well as the assets. Trusts create this anonymity by removing your name from public record. Even if they can see you used to own a property, when properly transferred it will look like it was sold to investors. If they somehow guess you are the owner though, it still doesn't matter because you would not be the owner. The land trust and the LLC are the owner of the asset/real estate, so even in the scenario that potential litigants guess, they would guess wrong.