Forming an LLC for an owner occupied?

Question

Patrick L. · Answer

You will put yourself in the commercial category for loans and insurance, rates will be higher for both.  No clue as to why you think you need to put it in an LLC,  maybe you should look into putting it into a trust if you're looking for asset protection.

Jeffrey Gignac · Answer

As backlground, I am a CPA formerly in public practice but now focusing mainly on trust administration and strategy. For your situation and many others like you just starting out, there will be little no advantage of having your property under and LLC at closing. Trust is another story entirely and really won't come into play until longer down the line.

As stated by @Edward B., financing and insurance rates will be less favorable when done as a commercial entity as opposed to in your own name. Also, for tax reporting purposes, a single-member LLC is classified as in individual person anyway, so not looked at any differently by the IRS. As you stack properties, umbrella policy would be the way to go and they can always be retitled to a business entity at a later date if you so choose.

Edward B. · Answer

@Kory Lutes,

You absolutely will not be able to get favorable financing if you close under the LLC. You will have to put down at least 20% and more likely 25%-30%. You can transfer the property into an LLC after you close but risk having the loan accelerated. Search "due on sale" here for a plethora of interesting arguments on that little gem.

Insurance cannot protect you as well as a properly established and maintained LLC but whether or not you need that level of protection is highly dependent on your situation. The reality is that the vast majority will never need that level of protection. It is good to have if you will be in this business for long but I would not let it stop you from moving forward.

Corey Woodruff · Answer

I know my uncle buys all of his properties under his own name and transfers them into an LLC before people get moved into the properties. This is the best way to bypass the financing issues and the issue of getting sued for everything you have when a sue leach decides they took a hard "fall" on your property. Make sure you are protected no matter how you go about doing this whether that is by insurance and an umbrella policy or protected by a LLC.

Jeffrey Gignac · Answer

@Zach Winner, I agree with everything that @Edward B. mentioned. I would use an LLC or series of LLC's based upon risk tolerance or similarity of investments. If you had a collection of properties that were all in one city or partcular part of a city, they could be grouped together. How you personally organize your information may also dictate which properties you put into which LLC's. It is essential to treat these businesses as separate from you personally, as that is the only way to keep personal and corporate liability separate from each other. Stack an umbrella policy on top of these corporate structures and you should be secure.

@Steve Vaughan, The IRS ruling that you are referring to only applies if you have lived and used the piece of property as an occupant for a minimum amount of time during your period of ownership. The idea behind this preferential tax treatment is to not penalize an individual with higher taxes if they had to sell their home to move for a job or other outstanding circumstances. Does not apply for investors so placing homes in an entity (LLC, S-Corp, etc.) is ideal once you have accumulated a critical mass of properties.

Zach Winner · Answer

Thanks @Edward B. for the very helpful response. The maximum percentage of net for any single LLC is a new wrinkle that makes a lot of sense.

Steve Vaughan · Answer

I have read that owning your primary in an entity disallows you from the tax-free gain on sale exclusion.  That's up to $250k if single, $500k if married in tax free gain that would have been.  Talk to a tax pro before getting all sophisticated with your primary residence @Kory Lutes!

Edward B. · Answer

@Zach Winner,

It really depends on you and your level of risk tolerance, but I will tell you what I like to do.

I would establish your level of risk tolerance based off the cost to set up and maintain an LLC, which happen to be particularly expensive in CA. You can do it based off a dollar amount or percentage of your net worth (i.e. $50k, $100k, 250k, or 5%, 10%, 25%) and only put that much equity into any given LLC. To use round numbers, if you have a net worth of $1M and don't want more than 10% at risk from any set of investments then only put $100k of equity into each LLC. Make sense? I would also try to separate out any properties that might have a particularly litigious tenant base from ones I considered safer.

Regardless, it is all a cost benefit analysis. Even if LLCs are cheap they are kind of a pain to maintain because you have to have separate checking accounts for each one at a minimum and it really is a good idea to document everything properly just to strengthen the argument that it is a separate entity and not an alter ego. If it is costing you $800/yr like in CA, then you need to decide if it is worth it, but it is just like any insurance decision. A properly set up and run LLC is better in my opinion than just umbrella insurance. You have to decide if the protection is worth the cost, though, and at what level.

As for umbrella insurance I would definitely get it if you have any assets at all. It is relatively cheap in comparison and it gives you definite peace of mind. It can make you kind of a target but in reality your insurance is not a matter of public record so an opposing attorney can only speculate if you have it. If they think you might though, say because you have a lot of assets, then it is good to have. Moreover, you can be sued for any reason, especially if you have rental property, and if you have plenty of insurance, the costs of defending yourself shouldn't come out of pocket.

That is kind of a down and dirty that just scratched the surface, but to answer your question, I personally would go with a variation of option 3. I would definitely get umbrella insurance and I would transfer properties into not just one but multiple LLCs based off of the amount of equity in each and their ability to support the LLC's costs.

Ed

Zach Winner · Answer

@Edward

@Edward B. and @Jeffrey Gignac, I am a little further along in building an investment portfolio than @Kory Lutes, but have a similar question.

I've got 5 SFR investment properties, and am looking to add 12-15 units (in 2 to 4 unit properties) this year. I formed an LLC, but only have one of my investment properties in it (transferred to it after the close, with no due on sale issues).

The question I have is do you think I am at the point where:

1. I should continue to maintain the LLC and transfer all the properties to it, (and continue to pay the annual fees associated with keeping the LLC);

2. I should get an umbrella policy for added liability protection, and don't really need the LLC; or,

3. I should transfer all properties to the LLC and take out an umbrella policy that covers all units?

I understand you're not attorneys, and aren't giving legal advice. Just trying to get some advice from more experienced investors.

Thanks very much!

Zach

Forming an LLC for an owner occupied?

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