All Forum Posts by: Ryan Coon

Hi John,

From a legal perspective it would probably be a good idea to cross a few t's and dot a few i's as you prepare to convert a portion of your current home into a rental. First, you may want to sit down with a family law attorney in your area to confirm that you're thinking through the division of assets issue correctly. Especially in a community property state like WA, it's often not as simple as who's name is on the asset. It would be unfortunate to put the work into this property and then subsequently lose it to the divorce.

Second, you will want to do your homework on zoning and other possible restrictions on you renting a portion of the property, including any possible HOA restrictions. I've seen too many investors acquire or reno a property for a purpose that is not actually allowed by local zoning or other rules or by HOA restrictions so it would be a good idea to make sure your ducks are all in a row here before getting to far into the planning process.

Note: This information is for educational and informational purposes only and does not constitute legal, tax, or financial advice. No attorney-client, fiduciary, or professional relationship is established through this communication.

Hi Luis,

As an attorney I have reviewed many of these "template" contracts and forms and while the quality can vary quite substantially, I will say that I rarely see any that don't need at least some adjusting or revising, whether to better protect your interest, or just to fit the template to your specific needs and circumstances. Consequently, I strongly recommend having an attorney on your team who can at least review these and offer pointers and recommendations. I think you would be surprised how much grief and money it can save you to have someone with the experience and expertise to help ensure that you aren't painting yourself into a corner with a poorly drafted or adapted contract.

Hy Felicia, this is a great question! The answer in part depends on whether you are living on a portion of the property (e.g. in one the units) or you are renting out the entire property.

If you are living in part of the property then placing the property into an LLC probably wouldn't have been a great idea anyway. Doing so could jeopardize your ability to use the 121 exclusion (capital gains tax exclusion for your primary home) and your states homestead exemption/protections. It's also unlikely that the LLC would provide any real asset protection anyway given your personal/mixed used of the property. However, it would likely be worth creating an LLC to which you could lease the portion of the portion of the property that you are going to lease out, then sublease from the LLC to the end-tenant. This can help create some separation between you personally and the tenant. The asset protection for this setup is not as robust as if the LLC owned the property directly, however, it may be better than nothing.

If you are not living on the property (which is unlikely given NACA's owner-occupancy requirement). Then you could start with the above strategy (lease to an LLC then sublease to tenant), then transfer to an LLC if/when you are allowed to do so, although, this may require you to refinance with a different lender.

I would also advise that you carefully review your mortgage and/or have an attorney review for you to ensure that leasing directly to a tenant or to an LLC are not themselves violations of your mortgage terms.

Note: This information is for educational and informational purposes only and does not constitute legal, tax, or financial advice. No attorney-client, fiduciary, or professional relationship is established through this communication.

Great question Jorge, let me see if I can help.

There are several benefits to using an LLC or other business entity to flip homes. The two biggest are asset protection and tax mitigation.

As to asset protection, using an LLC or other business entity can help separate your business (flipping) activities and assets from your personal activities and assets. Why does this matter? Well, lets say you're not using an LLC/business entity and your currently rehabbing a couple of homes to get them ready to sell. These homes are titled in your name. Now lets say that during the rehabs you get into a car accident that is your fault and you get sued. Because the rehab properties are sitting in your own name, they are exposed to this lawsuit for what amounts to a personal liability. Conversely, any liabilities created by the rehabbing will expose any personal assets such as your personal home, financial accounts, etc.

If instead, you do your rehabbing through a business entity such as an LLC you can effectively create a barrier between your business or flipping activities and assets and your personal activities an assets. The idea is to separate these parts of your life in order to limit your exposure to any single liability incident. I've seen too many cases where investors have lost everything because they did not have an appropriate business structure to protect them. All it takes is one contractor working on your rehab to get severely injured or disabled, or worse, die, while working on your property for you to lose your life's work to one lawsuit.

As to taxes, there are a couple of issues here. First, rehabbing is an active income generating activity, which means you are going to get hit with both ordinary income taxes and with self-employment/FICA taxes (~15.3%). A corporation such as an S-corp or C-corp (or an LLC taxed as an S-corp or C-corp) can help you mitigate your overall tax liability depending upon how much your bringing in from your flipping activities and whether your primarily living off of this income or reinvesting it back into flipping.

Second, if your planning on or are already investing into long-term hold real estate, then a corporation or an LLC taxed as a corporation has the added bonus of preventing you from getting personally tagged by the IRS as a real estate dealer. This is important because real estate dealers cannot use some of the most powerful tax tools available to real estate investors including 1031 exchanges and accelerated/bonus depreciation (via a cost segregation). This is because these tools are available to "investment real estate" but when you get tagged as a dealer, your real estate no longer qualifies as "investment" but rather is now classified as "inventory".

In summary, it is generally wise to use a business entity such as an LLC for just about any business, especially one that holds significant assets and/or creates significant liability exposure. Additional, you may want to consider a corporation or an LLC taxed as a corporation for the tax benefits and to avoid getting personally tagged as a real estate dealer.

Note: This information is for educational and informational purposes only and does not constitute legal, tax, or financial advice. No attorney-client, fiduciary, or professional relationship is established through this communication.

Seller Financing means that the intent is for the seller to loan the buyer the money to close, rather than using a traditional mortgage lender. Thus, at the close of the transaction, the buyer has the property and owes the seller for the difference between the purchase price and the down payment.

Seller financing can be beneficial for the seller if they are looking to come away from the sale with a passive income stream (monthly loan payments) and it allows them to make some extra money via the interest on the loan.

The buyer can also benefit from seller financed deals because the buyer is much more likely to be able to negotiate terms they may not be able to get with a traditional lender. It can also allow buyers with low or bad credit to purchase where a traditional lender wouldn't be willing to lend due to their less than ideal credit.

Seller financed deals are typically structured with a Promissory Note to outline the terms of the loan and a Deed of Trust or Mortgage to give the seller/lender a security interest in the property which can allow the seller/lender to foreclose on the home to recover the balance due if the buyer/borrower defaults.

I've worked with a number of real estate investors who started with wholesaling properties when starting with minimal capital. Wholesaling generally involves going under contract to purchase real estate that may be undervalued, then finding an end-buyer who will purchase at a higher price than you are under contract to purchase for. You can often get into the market for a pretty minimal investment because you simply need enough for a deposit on the purchase contract and then may have some marketing and/or legal costs (e.g. to setup business entities, draft and/or review contracts, etc.).

Wholesaling can be a bit more complex than a rental property or house hacking, so it can be very helpful to find a mentor to help you though your first transaction or two but it can be less cost prohibitive than purchasing a rental property.

You can wholesale real estate just using a DBA, however, this is almost certainly not an ideal setup. DBA's provide no separation between you personally and the business of wholesaling and at best it provides you little flexibility in tax planning, at worst it can create really substantial obstacles to long-term real estate investing plans or goals, especially if your long-term goals involve long-term hold investment and/or rental properties.

First, on the separation element, having a business entity such as an LLC or Corporation provides legal separation between you and the business (here wholesaling). This separation creates barriers to prevent creditors of the business from going after your personal assets and vice versa. This creditor or asset protection can significantly decrease your exposure to lawsuits or other creditors and is important when engaging in just about any business.

Second, having a business entity can help you with tax planning and mitigation. For one, if your long-term goals include the possibility of investing into long-term hold real estate like rentals, then it is important that you start right as you begin in wholesaling (or flipping). This is because there are some extremely powerful tax tools available to real estate investors such as 1031 exchanges (allows you to defer capital gains taxes when selling an investment property) and Cost Segregations (accelerates depreciation of your real estate to generate losses on your taxes to offset income and decrease tax liability). However, if you engage in flipping or wholesaling real estate, then the IRS can classify you as a "real estate dealer". This means the real estate that you own will now be classified as "inventory" rather than as "investment" which means you now lose the ability to utilize these tax tools exclusive to real estate investors like the 1031 exchange. You can prevent this by engaging in wholesaling and flipping through a corporation such as a C-corp or an S-corp (which are separate taxable entities from yourself). This will cause the corporation to be tagged as a real estate dealer, not your, that way you personally are still considered a real estate investor and have access to these tax tools.

Additionally, as your income from wholesaling/flipping grows, a corporation will provide you better options to mitigate your taxation of this income because income from these activities is considered active income.

Hopefully that is helpful and best of luck as you get started in real estate investing!

As a general rule, you should avoid mixing your tech contract work and your real estate investing under a single entity. Combining these under a single business entity not only complicates your taxes for these different activities, but it also creates more exposure from a liability or asset protection perspective.

First, as to the tax element, your tax contracting work will be taxed as active income which means you're going to get hit with both ordinary income taxes and with self-employment/FICA taxes (about 15.3%). If your making a substantial amount of money via this contract work then you may benefit from an S-corp to help mitigate your self-employment taxes. Real estate investing, on the other hand, may be producing passive income, in particular if you are engaged in mid to long term rentals, in which case using an S-corp would actually increase your tax liability. An LLC disregarded for tax purposes would likely be better for this passive income. Thus, optimal tax mitigation would likely involve separate business entities for these different activities.

Second, if you engage in both activities through a single business entity, especially if you hold real estate in the business that you are doing contract work through, then the real estate will be exposed to any possible liabilities or lawsuits involving the contract work. If, instead, you hold real estate in a different business entity, then you can dramatically decrease the liability exposure of the real estate and largely prevent creditors of the contracting business from going after the real estate.

Commonly you can draw up separate leases for portions of your property such as the basement, however, this will often depend upon local zoning and permitting. Sometimes, all you need to do is simply have lease agreements that adequately identify the portion of the property being leased. However, many times local laws or regulations will require that the basement qualify as a separate "unit" by having things like it's own separate entrance. Thus, it is always a good idea to familiarize yourself with local rules and/or to contact a local attorney to help you navigate the rules in your area. 

It's also worth noting that if the property is in an HOA, you will want to review the HOA rules (e.g. covenants and restrictions) to ensure that you are not running afoul of any HOA rules or approval procedures.

I regularly review property management agreements for both landlords and property managers (PMs) and it is quite common for property management agreements to include additional fees for specific services or items on top of the flat property management fees. For example, many PMs will charge a "placement fee" (e.g. 50% + of the monthly rent) each time they obtain a new tenant. This can help compensate the PM for a property that has high turnover. Other similar fees that I often see include things like eviction fees, maintenance fees, vacancy fees, etc., all of which are aimed at providing additional fees to the PM for circumstances that increase the PM's costs and that may be outside the PM's control.

There is an argument, however, for the PM to be responsible for incurring at least some of these costs, especially when the PM has significant control over the vetting of the potential tenants. While we all know that tenants can at times be unpredictable, it is arguably one of the jobs of the PM to have adequate vetting procedures aimed at finding ideal tenants and mitigating the amount of turnover and "problem tenants". Thus, the PM generally has at least some role in mitigating problems and costs associated with the tenants on the property.

In the end, what additional fees you charge as the PM is up to you, you just need to make sure that such fee schedules are explicit in your property management agreement. It is certainly reasonable and not uncommon to include additional fees, but it is also important to note that getting too carried away with such fees may make you less competitive as compared to other PMs in your market so it may be wise to do some market research to get a good idea of what other PMs in your market are charging.