Should You Buy Rentals in an LLC?

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Should you buy rentals in an LLC? Here are four reasons why I don't think you need to. So as a disclaimer, I'm not a lawyer, I'm not a CPA. So as you're making this decision, make sure you consult with your professionals.

Liability

First, why do we even need to buy in an LLC in the first place? The main considerations are liability and tax implications. So in terms of liability, if you were to own a rental property in an LLC and you were to get sued, the most that you can lose is what you have in the LLC, whatever assets you have, and the equity you have. That's the only thing that's at risk. If you were to hold rental property in your personal name, not only is that property at risk, all of your other assets could potentially be at risk.

How do you mitigate that risk? In terms of holding a property in your personal name, which a lot of people do, the main thing that you want to do is have a good lease. And then you want to have a good system in place to prevent lawsuits.

Make sure you're doing home inspections and have a good property manager that is not violating any fair housing laws. Once you have a good lease and a good system, that should handle a bulk of your issues and potential lawsuits.

The one thing you want to have in place is liability insurance. And that's going to be required by your mortgage company anyway when you buy a property. But, you want to make sure you have enough coverage in your liability insurance so if you do get sued, they go after your insurance policy. If that's maxed out, then it could roll over and they could come after your personal assets.

To prevent that from happening, you can get an umbrella policy where it covers everything else if the individual property's policy doesn't cover the lawsuit. So, that's something that you could talk to your insurance agent about. For a fairly small sum, you can get a substantial amount of coverage to protect yourself. But with those few things, you can mitigate the risk of a lawsuit when you're holding property in your personal name.

Tax Implications

So the next thing that's under consideration is the tax implications. When you're doing business in another entity, it's so that it's beneficial for taxes. But in real estate most of the time, you're generating tax losses. So when you're generating tax losses, you really want those losses to float to your personal tax return so it can offset some other income so you can get a tax refund. In the case of an LLC, more likely than not, you will need to set it up as a sole proprietorship that acts as a disregarded entity, and it flows into your personal tax return or you're going to set up as a partnership if you have more than one person. And again, that's going to flow into your personal tax return. So for tax purposes, getting an LLC doesn't really make a difference.

Piercing the Corporate Veil

So the third reason you don't need an LLC, piercing the corporate veil. LLC is a separate entity. So that basically means it's another person. So it's going to need its own bank account, credit card, its own set of books. So if you don't have that setup, if you ever were to get sued and a bank determines that there everything's blended together between the LLC and your personal financials, they could say, Hey, this entity isn't really a separate entity. It's actually you. So they're going to say, you know what? Instead of just suing the LLC, can get sued as well.

Another way this can get confused or you can get the corporate veil pierced is if you're managing the property in your personal name, even though it's the LLC and you don't distinguish between the fact that, Hey, it's the LLC that owns it, but you're, but you're using your own name. So that's another way you can get in trouble with this. So most people from what I see when they do have an LLC, they have, they have trouble doing this. It takes a lot more work to keep the entity separate from yourself. So keep that in mind when you're thinking about buying in an LLC or setting up an LLC.

Financing

Finally, one of the most compelling reasons not to buy in an LLC is going to be financing. If you buy in an LLC, you generally need to get a commercial loan to finance the property. Banks will not lend to you in your personal name if you're going to be buying in an LLC. What that means is you're not going to get the best rates. You're not going to be able to take advantage of the 3.5% FHA loans or the 5% down conventional loans. In the commercial world, that almost doesn't exist.

You're probably going to be looking at best, the 20% down on your loan, but on average, you're probably looking at 25 to 30% down on commercial loans and typically, they don't have 30 year fixed loans. You're looking at a five-year adjustable-rate mortgage when it comes to commercial loans or five-year mortgages with a balloon payment. So that's the most compelling reason you're not going to get great loans when you're buying in an LLC. They're going to be commercial and the terms aren't going to be as favorable as getting a personal loan.

Conclusion

So should you buy a rental in an LLC? Unless you max out the loans that you have in your personal name, I really don't think you need to buy in an LLC. Once you max it out and you can go ahead and put an LLC because you're probably going to need to go the commercial route anyway.

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