Is Filing Your Real Estate Business As An LLC Your Best Option?

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I’ll be honest with you – I’m a busy guy.

In fact, two weeks ago I was forced to record a video because there simply wasn’t time to write an article.  And last week I skipped all together.  Brandon begged and begged (as in nobody is going to read the blog if you don’t write…please, please Ben).  Alas, I was busy!

This week – still busy as all get up.  I may write about what’s keeping me busy later on.  But, seeing as I just can’t risk giving Brandon a heart attack by skipping yet another week, today I’ve decided to write an article of no more than 800 words.  This will likely be one of the shortest contributions I’ve ever written for BP, and I’ll go over if content quality demands it.  But, time is money and I don’t have enough since I don’t have a job.  Besides, the mental exercise of packaging solid information into 800 words sorta appeals to me.

It’s 5 AM.  I give myself 30 minutes to put 800 words on the page.  Here we go:

Should I Use An LLC?

This question comes up in the forums with some regularity.  I think I can answer this question within 800 words, inside of 30 minutes.

Question: Why do we use LLCs?

Answer: LLC is what we call a flow-through entity relative to taxation.  This means that income is not taxed at the LLC level; all of the income flows through and is taxed on the member’s personal income statement.  Thus, an LLC has no impact on our taxes whatsoever.

With this in mind, the only benefit of an LLC is relative to Asset Protection, which is why this vehicle was created.  In other words, people figure that by taking possession of property inside of an LLC, they can limit the liability exposure to the asset base inside that LLC, and free them personally from any liability.

Few Thoughts

First of all, it’s appropriate to remember that if criminality and/or negligence on your part is proven in court, no LLC will save you.  An attorney will crack that baby faster than I can slap Brandon Turner’s behind :)

Related: Top 3 Real Estate LLC Myths: Busted!

Secondly – I want to ask you a question: How Much Wealth Do You Own?  I mean seriously, what the hell are you so worried about exposing and/or losing?  If this is your first, second, or third house (all of which you’ve bought for $30,000), then how much Net Worth do you really have at risk that can be attacked?

I am not an attorney, so take everything I say in this piece with a grain of salt.  But, from knowing lots of attorneys (I know lots of attorneys – or should I say they know me) I can tell you with some level of confidence that most do not particularly take pleasure in working for free.

To make the determination relative to their advice to their client about whether to pursue a law suit against you or not, the first thing they’ll do is check to see what you’ve got that could be taken from you.  With this in mind, not having wealth is the best deterrent to law-suites that there is…is it not?

Leverage

Yep – that works better than an LLC.

Say you buy a 4-plx for $120,000.  If you put down 20%, which would mean that you’re stupid and don’t know how to play this game the right way, your equity position would be $24,000.  If you were ordered to liquidate to cover damages, how much would they get after RE commissions, property taxes, escrow… $10,000 tops?  And this would have to be split between the client and attorney?  Is this worth their time to sue?

Now – if you’re like me, in other words not stupid, and instead of making a 20% down-payment and buying this building for $120,000, you paid $90,000 and financed every last cent, then 3 things will have been true:

  1. Very likely, nobody would think to challenge the value as anything higher than $90,000…
  2. If so, they would note that there is no available equity to be had since the building is financed up the wazoo…
  3. Even if you were ordered to liquidate, how much would you loose – all you’ve put in – $0?   Good luck on that math…hahaha

Final Thought 

I am not saying do not have LLCs.

I do, and so should you.  But, in the beginning, while you can still qualify for Fannie/Freddie conforming Notes, for a lot of you it might make sense to at least consider buying in your name.  Fannie/Freddie will not let you buy inside an LLC, and smaller properties cash flow much better at the 30-year amortization and lower interest rate which is part and parcel with conforming Notes.

Related: Should You Put Your Rental Properties in an LLC?

I know what you’re thinking – I’ll just buy in my name, and then move it to my LLC.  OK, whipper-snapper; just  remember that in doing so you will be triggering the Due on Sale Clause in any modern conforming loan, which in turn triggers the Acceleration Clause.

Make sure you get it in writing from the bank if this is your plan.  Some banks will let you move assets into a Single-member LLC – others will not.  I highly advise that you do not do it behind their backs, though…but it’s your call, since you obviously know much more about this business than I do!

I’m done.  I encourage you to comment; this is an important subject to talk about.  And in case you’ve been counting – about 850 words…

BAM!  Am I good, or what?  And I did this from 5 to 5:36 AM on Thursday morning (a few more minutes to load it into the WP and review).  Now that’s commitment. Josh Dorkin – it’s time for a freaking raise, man!

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About Author

Ben Leybovich has been investing in multifamily residential real estate since 2006. His area of expertise is creative finance. Ben works extensively with private as well as institutional financing. Ben is a licensed Realtor with YOCUM Realty in Lima, Ohio. He is also the author of Cash Flow Freedom University and creator of a cash flow analysis software CFFU Cash Flow Analyzer.

51 Comments

  1. Konrad Lightner on

    Great Article!

    One thing that concerns me, is that you suggest that having money down is a bad idea( I have not heard of this). Do you mind sending info/ links or for your next article to talk how to achieve no money down loans ( conventional or otherwise). Do you then not pay down the loan at all when you have the property, or just interest? Thanks!

  2. So Ben , By not having any equity, the lawyers will be discouraged from coming after you. Please correct me if I’m wrong.

    • Nothing is full-proof; besides – some attorneys work strictly hourly and don’t care about logic or wisdom, nor their client’s $$. But, by and large this would make sense…no?!

  3. @Author — you missed the role of good insurance (base and umbrella) that any organization should have (non-business entity and business entity alike). We protect ourselves using an LLC (managing), LP (owning), property insurance and an umbrella insurance policy…

    Most solutions are not unidimensional (from a programmer).

    • Hey, Tom!

      @Author’s name is Ben Leybovich – pleased to make your quintessence indeed.

      You are right. A good umbrella policy should be part of the asset protection strategy.

      Thanks so much for reading and commenting, Tom!

  4. Brandon is right – you need to publish your articles weekly because they always make me think! I’m a new real estate investor and during start-up I evaluated my risk position. As a result, I began my business as a sole prop and will periodically evaluate that decision as my circumstances change. A sole prop made sense to me for a couple of reasons.

    1. I’ve been working in corporate America for the last 15 years, and like all good corporate soliders, most of my net worth is tied up in 401(k) plans. These are effectively judgment proof. My next greatest asset is my personal residence, which I could also protect if sued.

    2. Given the current nature of my assets, an umbrella policy is more than sufficient to protect me from litigation. As you said, the attorney will contrast the value of my umbrella policy vs. my attachable assets and decide to walk with the insurance money.

    3. In Tennessee, the franchise/excise taxes are cost prohibitive on an LLC. I can avoid these taxes via my sole prop.

    I do expect that I will need to form an LLC once my investment assets grow. But what I understand from your article is that it’s not as simple as – “form an LLC.” Rather, we must evaluate our position and let that analysis determine our entity structure.

    • Haha – nice, Jeff. Actually, I’ve published almost 80 articles on this blog, and I do publish most weeks. Once in a while, lately, I find myself just slammed. But, this doesn’t happen regularly :)

      But, if you are compelled to shoot Brandon a message telling him that Ben Leybovich is the greatest thing happening to BP since sliced bread, that would be awesome! :)

      • Ha! I’m sure Brandon and Josh both already know that. Seriously, I do appreciate the thought you put into your posts – even the ones limited to 850 words! I’ve read quite a few of your articles and have listened to both of your podcasts with Brandon and Josh a couple of times. I’m a new investor, and I intend to be a serious student of this business. As such, I enjoy both the breadth and depth of your articles. So I just want to say thanks because I know you don’t have to do it.

  5. Ben,
    Great post, as always. But you didn’t mention that the pros and cons discussed are relative to single owner buy and hold. Beyond that, there are other issues and considerations. Especially for multiple partner fix and flips. Yeah, I know, you don’t consider that investing, but it can be the cash generating arm of the business. And it needs to be isolated exactly for the purposes of taxes, if no other reason.

    • Sure – no argument here, Walt. I guess, I did not mean this article for advanced players or complex syndicated deals. This was aimed at the beginner, since only a relative beginner would ask the question to begin with…

      Thanks so much, Walt!

  6. My favorite issue that gets overlooked constantly re this topic is what is your tax strategy and exit plan?

    – wholesaling and flipping (when your gross per year is >$90k) then your entity might be LLC taxed as an S corp. Where if you wholesale or flip and your annual gross is less than $90k then the cost of setting up and running the S-corp may not be worth it, then take title in your LLC taxed as a pass through.

    – Rent for long term hold. Your entity needs to be a pass through regardless, either held in your name because you bought with bank mortgage and they don’t like title held in an LLC, or hold in your LLC taxed as a pass through so your 1040 W2 income can be reduced by the deductions and depreciation…

    Your #1 defense is keep the house safe, no loose stair treads, GFI’s where needed etc etc. #2 have a great relationship with the renter. #3 have great liability insurance. #4 entities..

  7. Hello Ben, and thanks for this post. For a complete newbie to REI like myself, treating this endeavor like a business rather than hobby is something I’m focusing on as I formulate my business plan and try to project costs associated with the business even before my first offer is made. That said, I’ve been considering ways to protect my personal assets from litigation exposure. I currently own the home I reside in, but I also have rather substantial equity holdings in three trust accounts inherited from grandparents. Perhaps my question is outside your sphere of expertise, but are personal trust holdings vulnerable to litigation? Thanks again!

    Jesse Vipond

    • Jesse, If you drove your car and ran over and maimed a bicyclist who happened to be a medical Dr, (high life time earning potential), then all of your personal assets (all) are at risk. This is not a real estate only topic. You need legal advice. Trusts just hide, they don’t limit access. Under oath you WILL disclose.

    • Into more property!!!

      Remember, Paul – stripping equity for the sole purpose of asset proptection and taking the money unto Bahamas, or something, is illegal. They actually have a name for it – Equity Stripping. Don’t do it. Use equity to grow your empire! :)

      • Ben, I don’t understand. It is illegal to take my own equity and spend it as I see fit? I am trying to understand how to protect myself from lawsuits, and it appears that the best way is to avoid having equity or cash that is easy for legal predators to see. Is it really illegal for me to keep my money somewhere that cash-strapped attorneys cannot easily obtain it?

        • It’s not illegal to spend it. It can be illegal to bleed your property if you know the law suit is coming and “make the money disappear” to an off-shore bank…you’ll have a fun time splaining that :)

          Might as well make bridging of equity part of your plan…

  8. The logic here is a bit backward. If you have that $120,000 fourplex investment property, leveraged or not, the purpose of placing it in the LLC is not to protect the fourplex or any asset placed in the LLC. The purpose of placing the fourplex in the LLC, opening the bank account in the LLC and properly maintaining the corporate veil is to protect your personal assets from liability incurred by the business. You want to protect the equity in your personal home, your IRA, your 401k, your life savings and your other business assets that can accessed because of personal liability through the back door.

    Yeah, maybe some of us don’t have a huge sum in assets but if those 100K in assets is all you have it is a good thing to cover your ass….I mean assets.

    • And if you think that a good attorney won’t crack that, you are kidding yourself :) People – No Excessive Equity ANYWHERE – period!

      This game is about Cash Flow – build it and live on it…

  9. Hi Ben:

    You seem to be an expert!

    Can you please clarify how stupid the people are who put down 20%?

    Can you please clarify how smart the people are who lend you 100% of the value of a property when you have such a public, cavalier “I’ll just walk away” attitude?

    Do you know that many states tax LLC’s separately so you are plainly wrong to say that owning an LLC has no impact on one’s personal taxes? $800 per year minimum in California.

    Can you please clarify how having such strongly voiced ignorant opinions helps grow your business?

    Phil

    • Hey, Phil – I did not know that they tax LLCs in Cali. But, I am not surprised since they tax everything in sight out there…lol

      LLC can be set up as an S Crop, in which case it does get taxed. This is not typically how we do it if the intent is to hold property.

      I guess you don’t like me much – that’s OK. There’s a lot I don’t know and learning every day. I like you. Most people, when leaving an inflammatory remark such as you have, would not attach a real name (I’m assuming Phil is your real name). I appreciate that you did. Perhaps you will like my future articles better than this one…

      • Hi Ben,

        I don’t dislike you. I simply asked some questions.

        You asserted that people who put down 20% equity are stupid. Can you please clarify what you mean?

        You suggest that the ‘smart’ way to buy property was to use 100% financing. In the event something goes wrong (a lawsuit) you argue that your threat of ‘walking away’ will deter a lawsuit. This would leave your lender holding the bag. Adopting this stance makes you in my eyes, a very non-creditworthy borrower. So, I would like to know if you have a different way of thinking about the situation such that the people lending your money are actually smart, given that your ‘strategy’ is to walk away if things go sideways?

        Finally, you are posting fairly strong opinions in a public forum and holding yourself out as having an informed opinion. Is calling some people who do business differently than you, “stupid” a wise approach? Maybe this is part of a larger strategy I don’t understand.

        I know there are many ways to skin a cat, and I would be very hesitant to call other people, ‘stupid.’ Buying high yield assets with a ton of debt is as new and thoughtful a strategy as having an undercooked lunch. People have been doing it for thousands of years and it always works well until it doesn’t.

        • Phil,

          No offense taken. A couple of points:

          1. I know what I know, and most people on this forum, and others, value my opinion. I am not in the running for miss. congeniality. I am an investor first, and teacher second. I am honest with what I believe, and I let the marketplace decide if I am a nice enough guy…

          2. Relative to the DP, there is a difference between buying CF and creating it. I do the latter – this is the way of sophisticated investing. Most people use DP to alleviate insufficient equity. If you read between the lines, all that I am saying and have always said is that if the deal doesn’t CF well under 100% financing, then it’s just not a good enough deal. Don’t put money down just to buy CF.

          3. The previous paragraph also applies to equity. We don’t buy it – we force it. and if we can’t then there’s no deal!

          4. People giving me money, both institutional and private, are very happy. They’ve never lost money. They’ve always made considerable money with me. They always end up with collateral that is stronger and more valuable than that on which they lent or partnered…

          But, I don’t make DPs. I let others do that. I only take the deals which don’t need it :)

          I hope this helps to clarify my perspective. Although, I’ve written books and a course stating my case and it is certainly not possible to truly illuminate my perspective in this answer. Hope it helps, though…

        • Ben –

          How did your strategy fare between 2005 and 2008? Were you investing at that time?

          Can you give us an example (address to lookup on zillow etc.) of a house that you bought, ‘forced equity appreciation’, and sold within 6 months?

          If the answer is that your strategy is buy-and-hold, how can you prove you are ‘creating equity’ and not merely ‘creating spreadsheets’?

          Thanks.

        • Haha – nice, Phil :)

          1. I started buying in 2006, and every year has been getting better and stronger.
          2. I don’t buy houses. I am in it for the cash flow, and in my marketplace houses do not offer stable nor substantive CF. I buy strictly apartments…
          3. Our methods of placing value seem to be a bit different. You look to Zillo to determine how much something is worth. I derive value in not having to work – going on 3 years now :)

          Why should I sell an apartment building that keeps me home with my kids? I didn’t always do this right, and in the beginning bought a few houses. I may sell those sooner rather than later, but not the apartments – it takes time to force appreciation. And in the mean time, that cash flow is fine by me…

          The least thing I bought was this 10-plex:

          http://www.biggerpockets.com/renewsblog/2013/05/07/10-plex-case-study/

          OK – it wasn’t quite 100% financed, but really close :)

          Be careful with Zillow – it’s often very wrong

        • Hi Ben,

          I totally agree Zestimates are a poor way to value single family homes. However, Zillow and the other major web sites offer (at least for the communities in which I invest) a good way to observe historic transaction prices for properties, which is why I asked. If you provided an address I could see where you bought and sold.

          It seems you are indeed performing spreadsheet calculations to demonstrate that you have ‘forced appreciation.’ If you want to call it that, fine. I would say that you bought a distressed property and fixed it up and got higher rents and a higher NOI. You expended time/money/effort to improve the property. That’s great. Good for you. But it’s not a magic bean or a special technique, and it’s not ‘forced appreciation,’ except that the force=your effort expended.

          I have done the same trade and own some formerly distressed multi-family properties. I bought them from a bank, who got them back from a guy like you, leveraged to his ears… He was doing the same tricks – collateralizing one loan with other better capitalized projects. When one domino tipped his debt-funded empire collapsed and people like me were waiting. With 100% down payments….

          Real Properties are not like stocks and bonds. The mark-to-market process can be very flawed and subjective. Unless you have realized gains on the actual sale of a property, all of the appreciation you believe you have is hypothetical.

          If you don’t control your debt, your debt will eventually control you… If you have multiple layers of financing on cross-collateralized properties, you can be sure that you are not the one in control.

          Good luck to all.

        • You speak truths, Phil. I can not and will not disagree with a single aspect of over-leveraging. Those guys that foreclose on the buildings you buy – I buy the same buildings (sometimes).

          Am I going to be one of them? I hope not, but the jury is still out. On the one hand, I am a young guy at 38, and there is a lot I don’t know. On the other hand, for a young guy I do know quite a bit and surround myself with advisers who’ve pretty well seen all that there is. Hopefully, the fact that I am quite aware of the things you speak of will help me navigate – it has thus far. My techniques, my checks and balances to hopefully prevent over-averaging both in terms of equity and CF are the essence of my method, if there is such a thing…

          I assure you, Phil, that while the jury is indeed still out on me, I am not one of those guys – I know much too much, and respect the beast much too much…

          It’s a pleasure to converse with you. Continued success to you and feel free to reach out on BP!

        • Phil,

          What do you mean by collateralizing one loan with better capitalized projects? Is that meaning taking the equity out of a home and refinancing it and then putting that pulled equity into buying a new property? Your comment seemed like this was a bad idea? If so could you explain further? I’m still trying to learn everything so I hope to hear from you or anyone that can flesh this out!

  10. Good post, Ben. I agree 100% with you. We hold all our properties in our own name, and see to it that we run a tight-ship as to avoid any negligence or give reasons for people to sue us. I know, anything can happen, but who cares – it’s only money. The one thing they can never take away from us is the experience. I also look at LLC’s as a distraction. I meet so many investor’s talking about setting up a “series LLC” as if it will bring them a deal…? Get a deal first, learn how to fix, manage the property, build some net worth, THEN worry about protecting your ASSet. Some people I know have been in this business for 30 years with over 100 units and hold all in their name with not a single legal problem. Run your business properly, and you’ll be A-OK.

  11. Good morning Ben,

    Good article with good information(limited as it was at 5am). As a Real Estate Broker, I get to see both sides and have watched for 8 years now while others did the investing and flipping. It is now my turn…I have my business under an S-Corp for the tax break which also carries over to my personal; would it not make sense to run the investments-whether flip or keep-through an S-Corp to not only protect your assets, both personal and business, but also to reduce the amount of tax liability? No matter what you do, there is always going to be risk if someone chooses to sue you, I get that, especially as a Realtor having E & O. I saw an earlier comment about it being expensive to run an S-Corp but I have not seem any additional cost to having this since I created them.

    Your thoughts?

  12. Good though provoking article in 30 minutes!

    A couple of points:

    1 – You provided some good reasons that you might not need an LLC, but there’s still a chance that it will help you. So why not have leverage AND hold properties in an LLC? And if you are broke now, but your financial situation changes later, you wouldn’t have to re-do things.

    In some states having LLCs is expensive, so that would be a good reason to consider an alternative. But in Arizona where I am, LLCs are essentially free (no annual fees), so it would be silly not to hold properties is an LLC and add that extra layer of protection.

    2 – Technically LLCs are not pass-through entities. In the eyes of the IRS, LLCs do not exist. You have to select what taxation you want for the LLC, which can be either sole proprietor (if single member), partnership, S-corp, C-corp. Since most investors select one of the first 3, which are pass through options, then the LLC ends up being taxed as a pass through. But you can have an LLC that is not pass through, if you select C-corp taxation.

    • Hey Nate!

      Yes – I have LLCs, but they are not necessarily the answer for everyone. I’m just showcasing some other perspective.

      And yes, as I mentioned in another answer, an LLC set up as a corp is indeed taxable. You are right. Most of us, however, do not set it up in such a way. There are times, though, when this is appropriate.

      Thanks so much!

  13. Read this a few days ago and something has bugged me ever since. First rule of educating, don’t insinuate students are “stupid.”

    They can be wrong, misguided or foolish. Point is, there are better ways to say stuff. Using words like stupid, dumb or idiot turns people off. I like reading your stuff, but this turned me off.

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