LLC - Should I form one or not?
(The attorney in me needs to take over for a second.) I don't believe in LLC's for the average single family investor. There I said it. Why you ask?
- If you just have one or two houses, it is not cost effective. It costs about $300 just to form an LLC in Texas. This is the fee payable to the Secretary of State. Attorneys fees will run several hundred to a few thousand on top of this depending on the complexity of the documents.
- You can achieve liability protection through an umbrella policy much cheaper. (You should have this coverage regardless of whether you have a LLC).
- It is difficult for a LLC to get financing before it has established credit. (If you are going to utilize a LLC you should oftentimes finance the property first and drop it into the LLC after closing.)
So when would you want to use a LLC?
- If you have a partner other than your spouse.
- If you are investing in larger multifamily properties.
- If you own 100 single family houses, it may make sense to drop a few into one or more LLC's to protect the equity in each LLC from a lawsuit from a property in a different LLC.
Moral of the story - Don't knock on my door (or any other attorney's door) to form a LLC for you unless you really need it.
[Insert standard language about this not being specific legal advice here. This is general guidance and you should consult your own attorney about the specifics of your own case.]
Comments (10)
@Deidra Hubenak
Thanks for the clear and concise information about the LLC. What information do you have about a Land Trust as a means of protecting assets? Thanks.
Anne James, over 9 years ago
Thanks Deidra,
I just discovered your blogs and really enjoy your posts. This was especially pertinent as I am a new REI and have been feeling like I should pursue an LLC at some point in the nearer future. This makes perfect sense and thanks @Sharon Tzib, @Leigh Ann Smith and @Chris Simmons for your insightful additions to the discussion.
Christopher Covell, over 9 years ago
For your first question about why should you go see an attorney, the simple answer would be that you need some specialized legal service that you are not able or willing to provide for yourself. Ok ok...I'm not trying to be rude, rather just proving a point. I am reminded of myself in how I used to buy specialty power tools, grown up toys, and then try and figure out what I would do with it. Similar to your question about why should you see an attorney, if you don't have a valid purpose or concern in your head, then it would be logical to think that you don't need to and in my case, should not waste the money.
Now, I have read some of your posts and even responded to one about financing I think. From what I am reading, you are simply a beginner that is trying to figure out what you need to know and you can gain knowledge by spending some time with an attorney as well as with other investors. I assume you have purchased and or sold at least one house in the past. Did you retain counsel for that? People always recommend using an attorney for large, complicated transactions but in my opinion, single family residential real estate does not always qualify for a few reasons.
1) You commonly work with a realtor as does the seller. That affords you some level of protection since both sides are "supposed" to follow the rules. Also, in this scenario, the contract that you use is likely the standard, templated, used thousands of times per year, Realtor's association contract for sale of real estate. This thing is pretty much tried and true with not much mystery to it....but of course, if you have questions with ANY contract, seek legal help.
2) Assuming that you will utilize a legitimate title company to close the transaction, then you will in fact have an attorney involved in the transaction behind the scenes. The attorney will not specifically be representing you or the other party in terms of what is fair, but they will do their part to make sure that any title issues are resolved and properly transferred into the buyers name. That should be sufficient to let you be comfortable feeling you will end up owing the property you bought. Just in case, I always buy title insurance.
So lets's assume that you are now comfortable with buying or selling a house without direct legal representation. You can stand to gain some knowledge by proactively developing a relationship with a real estate attorney now. Since you plan to be a landlord like me, start looking for one that is familiar with landlord tenant law, evictions, judgments, liability etc. You certainly don't want to wait until there is an issue to go run to the yellow pages. Are you comfortable with leases you can download from the internet? I paid an attorney to draft one for me and I modify it as needed for each lease. Are you familiar with the landlord responsibilities in your jurisdiction? After reading some books specific to your area and meeting with other investors, some time talking to an attorney can answer some questions for you. There are certain actions you can take with tenants depending on issue, there are certain things you can ask during the screening process. Consider forming a relationship with an attorney and use your questions as a way to interview attorneys as you look for the one you want. In my area, you can call the local Bar Association and pay $20 to get referred to an attorney that specializes in the area of law you want to discuss and you get 45 minutes with that attorney. This gets you out of the simple free but very limited initial consult. At the end of the 45 minutes, the attorney advises you of the rate should you continue with him and you can decide from there, no questions asked. You will likely have better luck picking one attorney and sticking with him rather than just going to the yellow pages every time you need something.
Now, regarding your insurance matter. Your rider that you have on your farm is likely specific to that business use and you may not be able to replace that with any type of coverage. You will need to discuss this with your insurance agent to be sure. An umbrella policy is a supplemental policy that covers you as a person. It kicks in after your auto policy or homeowners policy or any other policy has been exhausted. In order to by an umbrella policy, you have to have fairly high liability limits on your other policies to begin with. The umbrella policy acts like its name. It shelters you from claims against you personally, whether you cause a large pile up during the morning commute or someone breaks a leg on your property. Since this is personal coverage, it likely won't replace and might even exclude your for profit farm activities. Your insurance agent will be able to advise you. I have a large umbrella policy that covers my wife and I from personal liability with our cars, personal home and all three rentals.
In the event I get sued, yes, I will call my own attorney but guess what. He will likely make a phone call or two but depending on what I am getting sued for, he may likely sit back and let my insurance companies attorney handle it. That's right, my insurance company. That's part of the coverage. The insurance company won't just roll over and beg to settle. They will fight back and protect their interests since they will be the one to pay damages. By protecting themselves, they are generally protecting you.
Now, these rentals are in my name. If they were in an LLC, they would not be covered because they would be a separate entity and would require a separate and much more expensive insurance policy. With these properties in my name, or in a land trust where my wife and or I are the beneficiary, I have landlord protection policies with the same carrier that insures my house. In fact, I can't get coverage for my rentals without a homeowners policy. It covers the structure only so your tenants need a rental policy to protect their belongings and even provide a first layer of liability defense in the event they have dogs or a guest slips and breaks a leg.
Keep reading, asking questions and talking to investors. At the end of the day, you are buying a house and letting someone else pay you to live there. It really can be that simple. Get some insurance coverage, have an attorney and a handyman you like on speed dial in the unlikely event you have a problem and you can just let the rent checks roll in monthly. If you follow the rules, act in good faith and lease good, safe homes, there really is not that much liability out there....and for the liability that's out there....that's why you are well covered with a high quality insurance company and maintain sufficient cash reserves to pay your own personal attorney.
Chris Simmons, almost 10 years ago
Okay, I already dropped the $300 for the LLC prior to purchasing our first property. Perhaps you can help me avoid wasting even more money. I keep hearing over and over on Biggerpockets that you need to see an attorney. I asked about making a first visit to see an attorney on the forums yesterday but have no replies so far. My question is "See an attorney for what?". What is it I need him to do for me if I am looking to purchase a few SFR's to buy and hold?
I should add that we have a choose & cut Christmas tree farm in a sole proprietorship. We have a recreational land use rider on our insurance for that. It's probably significantly higher liability risk than REI (think kids riding hay rides, people carrying saws around, and employees securing trees to the top of customers' vehicles).
Maybe we should drop the rider and just get an umbrella policy for that and the REI business?
Leigh Ann Smith, almost 10 years ago
Very informative! I am new to RE investing and was wondering if I should start a LLC first before I make my first purchase. This helped answer my question! Maybe down the road but not right away! Thanks!
Ryan Billingsley, almost 10 years ago
Great post on the 1031/LLC issue, Deidra. Thought it might be nice to provide the link here for people that want to follow the conversation: http://www.biggerpockets.com/blogs/5070/blog_posts/37244-1031-exchanges-using-llcs
Sharon Tzib, almost 10 years ago
Thanks for clarifying, Deidra! I will check that post out now so I make sure I understand it correctly. Appreciate your valuable advice!
Sharon Tzib, almost 10 years ago
Hi Sharon. Thanks for your comments as always. You are absolutely right about the Due on Sale Clause issue. I thought I might write another post to clarify what I believe Jeff Brown was saying. See Question #3 on my May 11th post. In summary, you can buy a property, drop it into an LLC and then do a 1031 exchange. The key is that the party that starts the 1031 exchange must be the same party to complete the 1031 exchange. There are several potential issues with using LLCs that I outlined in that post.
Deidra Hubenak, almost 10 years ago
Hi, Read your comment on BiggerPockets and since your from Katy I wanted your opinion if it's not too much trouble. I'm retiring soon from NYC and I'm considering moving my family to Katy (cane islands). What's your opinion of Cane Island living and would you recommend? Also, if I do decide to move I would continue real estate investment in the Houston area... how's the market for multi family and do you recommend investing in Houston? I know I'm asking a lot here, but any advice is appreciated. Thanks, Ed
Edwin Gutierrez, almost 7 years ago
I wish everyone on the forums would read this, Deidra! I can't tell you how many people, mostly newbies, I see setting up LLC's before they've even purchased one property under the misguided belief that they will get more tax deductions or be bullet proof from a lawsuit or because maybe they think having a company is "cool" and they'll look more professional to a bank when getting a loan. Little do they know, as you say, most banks will never give them a loan in the LLC's name, which means they will have to re-title the property to the LLC post-close. The act of doing this can have a couple of effects as well: 1. Trigger the Due on Sale Clause - not a huge chance a lender will come after you, but legally, they can. 2. 1031 Tax Exchange - according to Jeff Brown who writes articles for BP and has been involved in REI since birth, I think :), if the same entity which purchased a property is not the same entity trying to procure a 1031 tax exchange, it will be denied!! In plain English, if you buy a property as an individual, then re-title it to your LLC, and then try to 1031 the property later, you will be denied (and don't think about re-titling it back to your name, they'll catch that). So folks, listen to Deidra! She knows of which she speaks. LLCs are the last thing you should be worrying about when you decide to become a REI.
Sharon Tzib, almost 10 years ago