Setting up an LLC for first rental?

[Dustin G.]

I am looking at purchasing my first long term rental property and was wondering if setting up an LLC would be beneficial before purchasing the rental home?

[PJ M.]

Ask yourself what you want to accomplish.  What is it that you are trying to do.  Once you know what you want to do, then ask yourself is it needed.

For me, I have good insurance. I self manage and have a few properties. My tenants know who I am, pay to me, call me when there's a problem, etc. My properties are leveraged so there isn't much equity. If someone sues me there's not a lot they're going to be able to get....and to get what I have they're going to have to get through the million dollar plus insurance policy I have. For what I wanted to do, insurance got me there. Now if I get a larger number of properties, which I may get someday, I'll re-evaluate that what to I want to accomplish and if I need it and it might be time for an LLC, series LLC, land trust, or something else. For now, what I have works.

Below is an excerpt from @Scott Smith on his direction.  It gives some good direction on each of the layers that you could get.  I think it is solid advice.

When explaining the function of LLCs to new investors I try give them a pretty solid understanding of the purpose of asset protection and LLCs in specific. When meeting with clients the first order is to discuss (A) their personal assets, (B) break down their current investments portfolio and other business ventures before discussing any (C) future goals. Each of these variables will dramatically change the advice for the individual asking this question. I often break it down into the "five pillars" of protecting your assets.

1st 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 - these simple steps will help you prevent lawsuits before they even occur.

2nd 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.

3rd 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 they can't touch you or the other properties. You should use either check out this article to learn more.

4th 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.

5th pillar is owning everything anonymously. If people don't know what you own, then they are less likely to sue. People don't sue people that qualify for food stamps. This anonymity can be accomplished for free by using 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 still, it doesn't matter because you are not the owner. The trust and the LLC are the owner of the asset/real estate, so even in the scenario that they guess, they guess wrong.

Setting up an LLC is only one step. You will want to ensure that it is set up correctly as well as operate it right. I often encourage investors looking to form their first LLC to have an experiences attorney draw it up, so they can learn the ideal way and ensure their property is protected while also learning how to operate the LLC correctly, After that most investors will decide whether they want to go through the hassle of creating the LLC personally, or just outsourcing it from then on.