It seems that the question of whether or not to set up an entity for real estate comes up a lot, and the answer probably varies depending on who you ask.
If you ask an attorney, they’ll probably all tell you that you absolutely need one to own investment property in.
Usually, they’re thinking about liability protection, which is definitely a consideration, but whether or not setting up an entity makes sense really depends on your own situation and investment strategy.
At first, it seems like the perfect strategy for any real estate investor is to put each property in its own LLC, but the only problem is that we live in an imperfect world.
When an Entity May Not Make Sense
There are many variables to consider when evaluating an entity to hold real estate. Sure, liability protection is an important one, but you need to put that in context, too. How much overall exposure does the investor really have? Can some of this exposure be reduced through things like an insurance umbrella or mortgage debt against the property?
You should also consider the financial implications. For example, if you’re just starting out in real estate, maybe it makes sense to buy properties in your own name in order to utilize residential loans, which have lower down payments, lower interest rates, and lower insurance premiums than commercial loans. This is a strategy that I utilized when starting out, and it enabled me to build up my real estate portfolio that much more quickly.
Once you’re past the bank limits for owning real estate in your own name, then it starts to make much more sense to start owning real estate going forward in an entity, like an LLC or trust.
For me, I’ve kept those first few properties leveraged with mortgage debt. With a HELOC (Home Equity Line of Credit), I was able to quickly recapitalize and continue building my portfolio.
Another strategy of mine was how I took title to those properties with my spouse through “Tenants by the Entireties.” An advantage of taking title this way (in a state like Pennsylvania) is that if a judgement is obtained against one of the spouses, the sale of that piece of real estate can’t be forced.
As one’s portfolio grows, it may be a good strategy to have more buckets or silos of assets. After a while, the number of entities I had quickly grew. From land, mobile homes, storage centers, office condos, apartments, and notes, the number of commercial entities seem to accumulate substantially. Of course, so do the number of tax returns you have to do.
That being said, you could set them up as pass-through entities, which could enable the LLC or trust to be taxed at a lower rate. For example, LLCs are taxed at the owner’s rate, and trusts are taxed at the beneficiary’s rate. So, if you were to own an LLC with your son who’s in a lower tax bracket, half of the LLC would be taxed at his rate.
Control vs. Ownership
The other factor to think about as you accumulate more assets is how to preserve and then eventually pass them on to your heirs. Does it always make sense to own everything, or is control really the most important aspect? Maybe some entities could be owned with future heirs now. Estate planning trusts may be wise to consider as well.
You can also have your trust own your LLC to give you some additional anonymity and to limit some of the frivolous types of exposures. There can also be some disadvantages to owning assets in a trust, especially if you need to get financing or you encounter transfer tax.
As you can see, entity selection can quickly become a complex decision depending on the exposure, domicile, and exit strategies of the investor. This is where it really pays to have a good team of accountants, attorneys, and financial planners to really help you strategize. But for me, the decision to start using LLCs was mostly a financial one.
So, for those of you on BiggerPockets, when did it make the most sense for you to set up an entity for your investments?
Leave your comments below!