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Is Incorporating Worth It?

by Kevin Perk on March 25, 2013 · 35 comments

  
Is Incorporating Worth It?

Every year about this time as I do my taxes, I think about my LLC.  I incorporated my landlording business about 10 years ago.  I recall that I was at a real estate seminar listening to one of the gurus talking about how you had to incorporate to protect your anonymity and your assets.  This year I was pondering if incorporating my business was worth it.  Do the costs of incorporating outweigh the benefits?

Here is a Brief Rundown of the Benefits.

  • It makes my business appear more legitimate.  People just like to see that LLC.
  • It makes us appear more professional.  As we have developed our business over the years, banks and others have liked the fact that we have an LLC.  This despite the fact that no bank would make a loan to the LLC in the first two years of existence so none of the properties we bought could be put in the LLC.
  • The LLC does provide a liability shield.  Thankfully we have not been sued yet and hopefully never will be.  But it is nice to know that there is a level of protection there.
  • The LLC does provide a bit of anonymity, but a few clicks on the internet will quickly clear that away.

And Here Are the Costs.

  • The LLC costs me money.  There are annual filing fees and additional taxes.  Here in Tennessee for example, there are franchise and excise taxes that sometimes have to be paid.
  • The LLC costs me time.  There is more paperwork to keep up with.  You have annual meetings, corporate minutes and other items that have to be done and kept up with every year.  In addition the taxes are more complicated.  Not only do I file a 1040, but now I have to file a form 1065.
  • There is more complication.  You have to be careful about not co-mingling funds.  In other words, do not mix your personal funds with corporate funds.

Would I Do It Again?

Is looking more professional and legitimate worth the extra time and expense?  I would have to say no.  And over the years I have met many investors who never incorporated and seem to be doing well.  But with 10 years invested in the name, I will keep it for now.  Does this mean LLC’s and other business entities do not have their place?  No, not in the least.  But for the smaller, less complicated buy and hold business the costs seem to outweigh any supposed benefit. 

What are your thoughts?  Please share in the comments section.

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{ 35 comments… read them below or add one }

Paul Ling March 25, 2013 at 10:50 am

I agree with you comments. The cost far outweight the benefits for most of us. If one needs extra protection, I suggest one buys an umbrella which is far cheaper than paying all these various taxes. I only use an LLC if I only have too because of the lender’s requirement. Generally, I don’t like to use an LLC because of all the reasons you stated. Thank you.

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Kevin Perk March 25, 2013 at 9:46 pm

Thank you Paul.

I think as you do a large liability policy might have accomplished the same thing as incorporating without as much hassle.

Kevin

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Paul March 25, 2013 at 10:54 am

This is a good question and I have asked this question to many people! It is my opinion that the biggest benefit to moving properties into a LLC is the “liability shield.” I think one could argue that all the other benefits listed may not be all that beneficial. To combat this I have taken out a large insurance liability policy which is relatively inexpensive. I agree with the author that in general it’s not worth incorporating.

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Alejandro Saenz March 25, 2013 at 12:10 pm

I don’t have an LLC so I don’t know much about it, but wouldn’t an LLC help shield some of your earnings from taxes as well?

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Paul March 25, 2013 at 12:47 pm

I don’t think there are any tax advantages to an LLC. If there are I’d like to hear them.

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Ryan Ferguson March 25, 2013 at 6:49 pm

Paul – An LLC can have tax advantages depending on your situation. I’ll use my own situation as an example. My partner and I each hold full time jobs, which is where the initial seed money came from. We have no intentions of withdrawing money from the LLC in the first 10 years and want to plow all earnings back into the business. As an LLC we can choose to be taxed as a corporation instead of passing that income through to our personal income. Because we are each in fairly high tax brackets, and the LLC is in an exceptionally low one (due to revenues being low as a start-up), we are taxed less on the revenue that we intend to reinvest anyway. If we were taxed as individuals, the income would be taxed at a higher rate and we’d have less money to reinvest. Eventually, yes, we’ll be taxed twice (once for corporate earnings and again when we pay out dividends), but the hope is that the increased retained earnings will result in faster business growth in the early years and a greater pay-out in the long term.

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Kevin Perk March 25, 2013 at 10:03 pm

Thanks for sharing your knowledge and experience here Ryan,

Kevin

Paul March 26, 2013 at 6:23 am

I own 2 properties in an LLC . I created the LLC since these are shared with a partner. When we file our taxes the gains from the LLC flow through to our personal taxes. I asked my CPA if there was a way to defer these and he told me that I could not do this with an LLC. It may be possible to do this with a general corp or a S-corp but I didn’t think it was possible to do this with a LLC.

Ryan Ferguson March 26, 2013 at 6:48 am

Paul -

Google “LLC Tax Election” and you’ll find a few articles indicating how this is done. This is a good place to start: http://mashable.com/2012/03/31/tax-llc/ . #3 details the situation I’m referring to.

— Ryan

Paul March 26, 2013 at 7:18 am

Ryan – thanks for the link!

Lance April 6, 2013 at 6:52 pm

For the reasons you’ve stated that is why I like the LLC. If set up correctly for realestate it has many advantages that make the cost worthwhile. The tax savings alone make it worth it for me. As it stands right now if you set your LLC up as a RE partnership taxed as a C corp you can keep Uncle Sam out of your pockets by avoiding schedule C’s and E’s.

Kevin Perk March 25, 2013 at 10:02 pm

Alejandro,

I can only speak of my experience, others may be able to give more details.

The LLC acts only as a pass through entity. The income reported on the 1065 just “passes through” to my 1040 and is reported with all of my other income. So I am not taxed twice on any income, but in my business I do not see any tax benefit with having an LLC.

Others can offer different experience and advice. Talk to a trusted and knowledgeable professional about this subject.

Kevin

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Tim Hawkins March 25, 2013 at 1:37 pm

Note: you should never comingle you personal funds with your business regardless of entity type…. The IRS makes that very clear. This holds true for your Social Security direct deposit account as well oddly enough.

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Kevin Perk March 25, 2013 at 10:04 pm

Very true Tim,

Thanks for reading and commenting,

Kevin

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Damien Shoemake March 25, 2013 at 3:24 pm

You don’t have to be an Incorporated C or S Corp, the LLC is all you need…

LLC’s are great tools… paperwork wise you file a 1065 and give Sch K1’s for each member which in turn gives them personal pass-through taxation. *TAX-ADVANTAGES* (Pass-through income on your Sch E can enable you to bring losses into your personal return to help off-set other taxable wages and may help reduce your own personal tax bill)

The LLC is like a person, it can have its own bank account, c/cards, Tax ID #, mailbox, etc… plus its own credit rating, just set up the acct with Dun&Brad. *For a c/card, you may need to sign a personal guarantee in the beginning.*

The LLC can partner with SD-IRA’s and also be a member or part owner of other LLC’s or Trusts. You can also have a Master LLC / Holding Company with individual Series LLC’s for each individual property you own for an even greater layer of protection from liabilities arising from one property to the next.

For anonymity, you can always change your registered agent to an official registered agent company like CT Corp and pay them an annual fee. They can also be your RA across multiple states if you expand out of your own and the official name and address of the RA will be them, not you.

And don’t forget probate, estate taxes & inheritance tax (Death Taxes) in case you pass away… If you have assets in your own name, your loved ones may be looking at a nice tax bill… Just address the death of a member in your LLC’s operating agreement and articles of organization during set up.

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Kevin Perk March 25, 2013 at 10:11 pm

All very true Damien and well said.

But I still contend that it may not be worth the time and trouble for the smaller investor, heck even the larger investor.

It all depends on what the investor wants and how they want to structure their business.

I do agree with you though, LLC’s are the way to go for a buy and hold business and are a tool worth thinking about.

Thanks for reading and taking the time to comment,

Kevin

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Terry P March 25, 2013 at 3:27 pm

I think A LOT of people create LLC’s that do more harm than good since they run them as sole propriety leaving them easy to pierce. Also, that a lot of people are under the false impression that liability insurance protects 100% from anything, most people don’t understand the exemptions in those policies including the ones the underwriter has not disclosed (just because it is expensive means nothing!). Insurance laws including disclosures and policies are written just as vaguely and ambiguous as LLCs, including subrogation laws, etc. If a LLC is ran as a legal entity it can offer another layer of protection a liability policy does not guarantee. That is why you create them as asset protection, not tax or accounting reasons. I just read a BP thread a guy wants to created a SLLC to get around having to register his investments often at his place of employment, a investment firm. I had to chuckle, what will they think of next. Attorney’s got to love it!

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Kevin Perk March 25, 2013 at 10:13 pm

Terry,

There are ways around everything in this world :) If someone wants to pierce that corporate shield bad enough, I think they will find a way to do it. Plus, I think you are right, lots of folks do not keep up with all of the paperwork to keep the shield properly in place.

Thanks for reading and commenting,

Kevin

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Rick March 28, 2013 at 10:32 am

I am in TN as well and I created an LLC because I have a partner and I did not think there was any other legal way for two people to share ownership in a house. Is that not true?

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Ryan Ferguson March 28, 2013 at 11:25 am

Rick – I’m fairly certain that’s inaccurate. You could create a simple “Partnership”, which is a business without the paperwork or benefits essentially. Furthermore, you could simply both co-sign the relevant documents the same way a husband & wife would share ownership in a personal house. I guess TN may have something unusual going on, so you’d want to consult a lawyer for a definitive answer.

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Kevin Perk March 28, 2013 at 3:25 pm

Rick,

Ryan is correct. There is no need to incorporate. A partnership agreement will do. Just be sure you have a partnership agreement spelling out the duties of the partners, the details of who does what and how to split things up.

Thanks for reading and commenting,

Kevin

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Ryan List March 28, 2013 at 12:23 pm

What about the benefit of not tying up your own credit in your rentals? If you have your properties in an LLC and have multiple mortgages under that company, shouldn’t your personal credit line stay fresh?

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Ryan Ferguson March 28, 2013 at 1:30 pm

Now there’s a thought. Good idea. It won’t work in the first couple of years (You have to personally guarantee any loan for new businesses since they don’t have any history) but after you’re established and have been in business for some time, yeah, I imagine that could be an advantage. Moreover, ownership of the business actually increases your net worth, which makes you a more attractive credit target.

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Kevin Perk March 28, 2013 at 3:28 pm

It might,

But like Ryan said it will not work for the first couple of years as generally no one will lend to a newly created corporation, so you have to sign as a guarantor of the corporation.

Kevin

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John Slocum March 28, 2013 at 4:38 pm

Here in Washington State, setting up and maintaining the LLC is rather easy and not overly expensive. When using a Registered Agent other than yourself, you can maintain some degree of anonymity. No State income tax, as well.

Many of the investors I’ve known have a master LLC, and run every project as a LLC under the master.

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Kevin Perk March 28, 2013 at 8:36 pm

John,

Pretty much the same here in Tennessee. We also can set up a master LLC and have sub LLC’s.

It is not really that difficult, but i think I could have gotten by without it.

Thanks for reading and commenting,

Kevin

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Tim Hawkins March 28, 2013 at 7:44 pm

Interesting that I haven’t seen any comments in this thread regarding the not so long ago restriction by Freddie Mac that the prior owner could not have been a LLC for the prior 6 months. It was silly rule in my mind, but you never know when these federal puppets might re-instate the insanity. Issues like this affect your ability to dispose of the property in a timely manner. It’s a risk that must be taken into account.

The article starts
Lender Guideline Changes That Effect All Investors
by TROY SCHURICHT on JUNE 5, 2008

There are two major player in the lending industry right now, Freddie Mac and Fannie Mae, both of these companies are very important because they more or less dictate the rules and guidelines for lender and banks across the USA.

Freddie Mac recently released a guideline change – “We are revising our requirements for Investment Property Mortgages to reduce the number of financed properties in which a Borrower who owns more than one financed Investment Property may have an individual or joint ownership interest (including the subject property) from 10 to 4. Also, effective for Mortgages with Freddie Mac Settlement dates on or after August 1, 2008, the borrower on a cash-out refinance mortgage must have owned the subject property for at least six months prior to the note date of the new refinanced mortgage.”

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Kevin Perk March 28, 2013 at 8:38 pm

Tim,

Was not aware of that rule. That would surly be a limitation if I was not just a buy and hold guy.

Thanks for passing the information along and thanks for reading,

Kevin

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Shaun April 8, 2013 at 1:32 pm

Hey Tim
Did the article go more into the items you are talking about?
Nothing in that introduction gave the impression you couldn’t sell out of an LLC.
The 6 month thing was about doing a cash out refinance.
The other part was limiting the number of loans you can be involved in.
This 2nd part could be an issue if it extended to commercial loans held by the LLC and regular loans you have personally or recorded private loans etc.

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Tim Hawkins April 8, 2013 at 2:58 pm

Kevin, The article is here biggerpockets.com/renewsblog/2008/06/05/lender-guideline-changes-that-effect-all-investors/

The article is challenging to find using Google because the author didn’t know when to use Affect vs Effect — Google properly uses Affect, suppressing the article.

Did the article go more into the items you are talking about?
th — yes, the full article provides way more information (see the link)

Nothing in that introduction gave the impression you couldn’t sell out of an LLC.
th — I missed the copy-paste on that paragraph.

The 6 month thing was about doing a cash out refinance.
th — I’m not sure since I can’t find the original bulletin.

The other part was limiting the number of loans you can be involved in.
th — yup, saw those.at freddiemac.com/sell/guide/bulletins/archive.html

This 2nd part could be an issue if it extended to commercial loans held by the LLC and regular loans you have personally or recorded private loans etc.
th — Sounds correct, but I have no basis.

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Shaun April 8, 2013 at 3:17 pm

Thanks for the link.

Still only says that if you quit claim yourself a deed from your LLC, presumably to get a residential refi, that you have to do it 6 months ahead of actually doing the loan.

Still stupid and a burden on the buy and hold investor, but quite different than not being able to sell a property that is owned by an LLC.

Tim Hawkins March 28, 2013 at 9:04 pm

Even if you were a buy and hold — rules like this inhibit your ability to sell your property quickly if you needed to for whatever reason. Like if you were on the run from the mob! Gotta get outta dodge, but have to sit on my thumb for six months… hummm. Shoulda used a big, cheap, umbrella policy…. We have both FWIW. We also run the LLC fairly strictly to assure veil integrity. The best defense is a layered defense. The top layer is the one where we try to treat our tenants with honesty and integrity, and hope they respond in kind. Unfortunately, that’s not usually not the case. But, at least we try to avoid legal entanglements by always doing the right thing. Never perfect though.

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Kevin Perk March 31, 2013 at 11:01 pm

Tim,

“The top layer is the one where we try to treat our tenants with honesty and integrity,” well said. This goes a long way. If tenants feel they were treated with respect they will often respond in kind. But not always as you point out. So yes, some layers (LLC or Liability Policy) are also needed.

Thanks for reading and commenting,

Kevin

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Kevin March 30, 2013 at 10:04 am

Good thread here. We borrowed from a credit union who keeps there own mortgages. They even financed in our name and at closing transferred title back to LLC for us. We been in business over two yers and found no bank will touch us for a loan. Plus we had to o through hoops when we took out a HELOC on our second propery through Hell Fargo. Took 3 month for the loan and we had to have two appraisals because they couldn’t believe property increased 30% in value even though both appraisals were spot on
The other thing if ypu are able to get a loan throgh LLC your terms will not as good, most are 7-20 year loans.
From an accounting pov it’s easier to have llc, but greater cost for this.
No one easy answer overall. What works for one perspn not the other

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Kevin Perk March 31, 2013 at 11:05 pm

Kevin,

Good points all around. It was 2 years before we could even think about getting a loan in the LLC. And even then we had to guarantee the loans personally, so what was the point?

It all depends on what you want to do in your business and how much risk and exposure you are willing to have. No one size fits all as you say.

Thanks for reading and commenting,

Kevin

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