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Stop! DON’T Put Your Investment Property in an LLC If…

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LLCs are a hot topic with new investors.

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If you’ve been investing for a while, you probably invest with an LLC. But the question is: Is an LLC worth it for a new investor?

Maybe you haven’t done a deal yet, and you’re about to do one. Should you start an LLC?

Or maybe you have a few deals already, then the question might be: When should you start your LLC?

Here I’ll address both things—when to start one and if it’s even worth it at all.

Related: The Traditional LLC vs. the Series LLC: Which is Better for Real Estate Investors?

I’ll nip one thing in the bud right now. Is an LLC worth it? Yes, absolutely.

I know no one who owns a large portfolio and doesn’t own it in some sort of corporate structure. So if you’re planning on building a reasonable investment portfolio, you need an LLC. You just do.

Here’s why.

Why You Should Invest in Real Estate Using an LLC

1. Protection from liabilities.

LLCs protect you from liability claims. Anything that’s a claim against a property—like, “Hey, I slipped and fell”—an LLC is an entity that can stand between you and that. The party will come after the LLC, not you personally.

Full transparency: there are ways around this. The most important one to mention is liability insurance. Now, I’m not saying insurance takes the place of an LLC—but you are not fully exposed if you don’t have an LLC but you do have insurance.

2. Provides tax write-offs.

Because it’s an entity with its own tax return, LLCs allow you to write things off (i.e., business-related expenses like your cell phone bill). You can try to write them off on your personal tax return, but it looks a little squirrelly to the IRS that it’s not a company claiming those business expenses. It makes things cleaner from a financing and tax perspective to write them off under an LLC.

3. Allows you to sell shares of the company.

An LLC operates as a business entity. As long as it’s registered properly with the SEC, you can sell shares of the company to other investors who want to invest with you. You can sell shares as a security as you grow. Or you can sell the LLC altogether as a business that owns things.

There are times when an LLC is not appropriate though. So, when exactly shouldn’t you form one?

Related: Top 3 Real Estate LLC Myths: Busted!

When NOT to Use an LLC

1. Don’t use an LLC if you’re house hacking.

Don’t use an LLC when house hacking, because it may prevent you from getting the financing you want. If you’re looking for low money down, Fannie Mae- or FHA-backed mortgages, this property can’t be in an LLC.

For these purposes, banks can only lend you that money under your personal name. Just get a really good insurance policy.

2. Don’t use an LLC if you don’t have 20 to 25% for a down payment.

If you’re buying a property for $100K, if you’ve got $20 to $25K to lay down plus some for closing costs, there’s no reason why you would not go out and start up an LLC. You can get commercial financing on these properties or financing from some other lender. If you encounter lenders who won’t do it, find another one, look on BiggerPockets, or walk into a small community bank.

More LLC Pro Tips

Here are a few final thoughts on the topic.

Avoid setting up your LLC online (unless you’ve been doing it for a while). Instead have a lawyer help you.

And absolutely have a lawyer help you create an operating agreement with the LLC. You can do this online, too, but I highly recommend NOT going that route—especially if you have partners.

A good lawyer can set up an operating agreement for you for less than $1,000. It’s worth it.

Bottom line, if you’re going to build a business around real estate investing, run it as a business. An LLC is a company.

If you’re looking to make this a side hustle or just something you do a little bit, then do it in your personal name and own one or two properties. That’s OK.

But, if in the future, you intend to build a big portfolio, set up an LLC. Operate as a business. Do it now—five years before you get to that point. I promise you, moving properties out of your personal name and into an LLC is not easy—it’s doable but difficult.

One last thing, set up the LLC where the property is. Don’t favor Nevada or some other state over others. The LLCs that own certain properties should be set up in the state the property physically exists in.

You’re going to have to pay a tax return in that state. So just set it up there.

The reason people talk about state-based LLCs is because they believe specific types of LLCs will prevent certain claims from jumping over the LLC and getting to you personally.

However, I’ve never seen any state-based LLC prevent anyone from getting ahold of a person specifically if that’s what they’re trying to do. Plus, that’s what insurance is for. Avoid the tax headache of setting up an LLC outside of the state the property is actually in.

I’m not a lawyer or CPA—neither is BiggerPockets. You should absolutely consult a lawyer or CPA about this subject. A lot of the information that I’ve gone through here today is my opinion, so it’s important to consult a professional.

Watch the video above, where I go into even more detail about this subject, and let’s talk about everything in the comment section below.

I’d love to hear your opinion! What do you think about LLCs? Do you favor a certain state over others? 

Leave a comment below!

 

Matt Faircloth, co-founder and president of the DeRosa Group, is a seasoned real estate investor. The DeRosa Group, based in historic Trenton, New Jersey, is a developer and owner of commercial and residential property with a mission to “transform lives through real estate." Matt, along with his wife Liz, started investing in real estate in 2004 with the purchase of a duplex outside of Philadelphia with a $30,000 private loan. They founded DeRosa Group in 2005 and have since grown the company to owning and managing over 370 units of residential and commercial assets throughout the east coast. DeRosa has completed over $30 million in real estate transactions involving private capital including fix and flips, single family home rentals, mixed use buildings, apartment buildings, office buildings, and tax lien investments. Matt Faircloth is the author of Raising Private Capital, has been featured on the BiggerPockets Podcast, and regularly contributes to BiggerPockets’s Facebook Live sessions and educational webinars.

    Dave Mays Investor from Madison, Wisconsin
    Replied 5 months ago
    Matt, I’ve heard both side of the argument of establishing an LLC for each property. In your opinion, if I have a small portfolio of 6 properties, should each have their own LLC?
    Derik Lewis
    Replied 5 months ago
    Sorry, didn’t see your comment while I was watching the video and adding my comment … same question here!
    Derik Lewis
    Replied 5 months ago
    Great information! What are your thoughts on putting each property owned into a separate LLC? In California, it becomes a problem becuase of the $800 minimal annual tax on each LCC, but if we could do some type of DE series LLC (and register it in CA), it might be possible to avoid that tax while keeping liability separate for each property. Just curious on your opinion. Thanks!
    Dave Rav from Summerville, SC
    Replied 5 months ago
    @Derik Lewis – I wonder if you established the LLC in another state? Maybe Delaware or Nevada – they are tax and biz friendly. You may not necessarily need to form the company in your home state..
    Jon Cunningham
    Replied 5 months ago
    LLC members will have to follow the tax requirements of the state(s) where the PROPERTIES are located regardless of where the LLC is formed. Typically, unless you need anonymity, an out of state LLC just adds cost and complexity with little or no upside.
    Jon Cunningham
    Replied 5 months ago
    Completely agree. And you need the insurance anyway, while the LLC will protect your personal assets the assets inside the LLC could be wiped out by a large uninsured claim within the LLC. Also, LLC members will have to follow the tax requirements of the state(s) where the PROPERTIES are located regardless of where the LLC is formed. Typically, unless you need anonymity, an out of state LLC just adds cost and complexity with little or no upside.
    Leonard Smith
    Replied 5 months ago
    Hi Derik, Unfortunately, CA will charge the $800 minimum tax regardless if your LLC is based in CA or not! As long as you have a LLC that operates in CA, you have to pay the tax. Hope this helps!
    Brian Levredge Investor from Chattanooga, Tennessee
    Replied 5 months ago
    You’ll probably want to skip the series llc. I had initially set up two series llc’s for different entities and quickly came to the realization they weren’t needed and were in fact costing me money. I was required to set up bank accounts for each series, which had it’s own EIN per series as well. In the end the compliance costs far outweigh the benefits, imo. Btw, the reason people do DE, NV, and a couple other states is also because some of those states don’t treat them as community property for marriage purposes and they have additional layers that makes getting to the assets that much more difficult. Probably not necessary for 95% of the people here but a distinction nonetheless.
    Dave Rav from Summerville, SC
    Replied 5 months ago
    @Brian Levredge I completely agree with you. Vast majority of folks don’t need some of these things. Especially newbies. Sophistication may just end up complicating your business and cost you money, when in the end it’s overkill. If your portfolio is small or lacks complexity, a degree of simplicity likely is appropriate. If you only own say two properties, then 1 LLC and a liability policy likely is good enough. There is no way to fully mitigate 100% of the risks out there.
    Jared Friedman Investor from Studio City, California
    Replied 5 months ago
    Insurance is always your first and best defense against a lawsuit. An umbrella policy for several million is cheap and a must for all real estate investors. This is what will protect you from slip and fall and all Peronal liability. I have yet to hear of a single example where an LLC saved someone from a major lawsuit when that person had sufficient insurance. Also- regarding taxes it makes zero difference if you have an LLC or not. You get to write off everything the same way. They are both “clean”. LLCs have their place but they create a false sense of security. I’d rather spend my money on a crapload of insurance so if and when you have a lawsuit the insurance company will send out their army of lawyers on my behalf.
    Jon Cunningham
    Replied 5 months ago
    Completely agree. And you need the insurance anyway, while the LLC will protect your personal assets the assets inside the LLC could be wiped out by a large uninsured claim within the LLC.
    Michael Klugmann
    Replied 5 months ago
    You cannot sell “shares” of an LLC. You’d have to have an incorporation to sell shares in the traditional sense. LLCs are based on percentage ownership and not comprised of shares. This is true for both single member and multiple member LLCs.
    Dave Rav from Summerville, SC
    Replied 5 months ago
    Good post. I believe LLCs, or establishment of some type of entity is important. There are many others that may prove helpful too (S-corp, LLP, etc). Forming an LLC online is actually doable. I do not believe you need to consult an attorney (unless you have multiple partners and a complex structure); you just need to know what you’re doing. Research the topic. I actually took a corporate law class during my undergrad studies, which prepared me (years later – who knew!!). I’ve formed two LLCs in my home state of SC – no problem. Cost was 1/8th that of attorney. However, if you are looking at 3+ partners, with unequal responsibilities, a silent partner, or other complexity I highly recommend consulting an attorney.
    Tarun Patel from Lansdale, PA
    Replied 5 months ago
    For small multi family (1-4 unit) I’ve heard setting up an LLC prevents you from obtaining the better residential financing rates (you have to pursue commercial financing). Is this true? Thanks
    Tal Morgenstern from Sydney, Australia
    Replied 4 months ago
    It would greatly depend on your personal circumstances but an alternative would be a quit-claim deed by which you close the property under your name and mmediately is transferred onto the LLC's
    Mark Sandvig Rental Property Investor from St. Louis, MO
    Replied 4 months ago
    Purchasing as a non-occupant (whether through an LLC or not) will yield inferior rates (usually .5-1% worse). Doesn’t matter if you’re in an LLC or not if you never plan to occupy. If you are house-hacking, you can always purchase it in your name and then drop it into an LLC later (via quit claim deed). This is how we are doing it.
    Mike Conner from Tallahassee, Florida
    Replied 4 months ago
    Tarun, Mark’s right that you will get inferior rates, but at least in my area all the commercial loans are amortized over 20 years as opposed to the residential that are 30 years. That will make quite a difference in your payment/cashflow.
    Tarun Patel from Lansdale, PA
    Replied 4 months ago
    Thanks guys. In my area (outside Philadelphia, PA) I have been quoted rates of 4.375% amortized over 30 years for small multifamily (1-4 units) with 75% LTV. However, as you mentioned, commercial lending doesn’t typically provide the beneficial amortization terms (typically 20-25 years), and rates are higher (typically ~ 5% is what I have been seeing, both big banks and portfolio lenders). Higher rates obviously eats into your cashflow. As I have been looking at small MF properties in my area, I’ve been hence debating internally whether or not I should form an LLC when I do make my initial purchase knowing that at the end of the day cashflow might be affected. Maybe the best approach is to purchase as self proprietorship and obtain the liability insurance (umbrella policy) as suggested by others on this thread. Thoughts?
    Jeffrey Grieshop from Coldwater, OH
    Replied 4 months ago
    I am in the same boat. Read three posts down. I really started veering to “own in your own name” with the umbrella policy. My main reason is that forming the LLC will cost $ and I am yet to form one, it’s only holding me back. What Jon Cunningham said is assuring. I know it’s not the only time I have read about what he stated, that the tax benefits run the same either way(single member llc vs your own name).
    Wave Taylor from Baltimore, MD
    Replied 5 months ago
    Great stuff here. Should you set up a separate LLC for each property?
    Drew Ander
    Replied 5 months ago
    I am also curious about setting up a new LLC for each new property. I was advised from some really jerky laywer here in Cleveland to always set up a new LLC for every new property. He made it seem like if something happens, you can just ditch the LLC and not taint the business name. He also mentioned not tieing your personal name to the company name. So for me, don’t make it Anderson LLC but rather something random like “all homes are fixable LLC”
    Jon Cunningham
    Replied 5 months ago
    Really you will not get any additional business tax deductions by forming an LLC. In fact. unless the LLC has more than 1 owner it will be entirely disregarded for income tax purposes. A single member LLC and an individual tax payer will both report income using 1040 Schedule E (and state equivalents). If you do form an LLC you will most likely NOT be required to register with the SEC to take in additional investors. (There are many safe harbor exceptions to registration requirements). Most of my clients find it more efficient to start off owning real estate directly and form an LLC down the road when they add partners or equity investors. It is easy and typically a nontaxable event to move rentals into an LLC. However you should evaluate implications of your specific situation including possible property tax re-assessments, especially in California where such a transfer may cost you Prop 13 benefits. As the OP suggested, if you have any questions contact a CPA specializing in real estate. Most of us will gladly give a free consultation regarding your specific situation.
    Terry Lowe
    Replied 5 months ago
    We have an LLC for each property in Colorado. That way, if someone gets hurt, they can only sue that one property. We also carry liability insurance for each property. Book keeping is more difficult, as you have to have an account for each property. Also you cannot mix funds between your properties. I advise a good attorney, because there are different laws in different states. Getting your LLC set up correctly is the only way it will protect you.
    LEONID ORLOV Investor from Hermosa Beach, California
    Replied 5 months ago
    “LLC Provides Asset Protection” – only in theory .. If a tenant injury is caused by what is found to be “gross negligence”, corporate veil will be pierced and one will be responsible directly. Much better, and more reliable asset protection and a maximum liability limit your insurer allows and an Umbrella Insurance. Other negatives: double taxation. In CA you have to pay, I think $800.00 no matter if you lose or make money in your LLC. My 2c on the subject
    Joanna Ling Real Estate Agent from Arcadia, California
    Replied 5 months ago
    What is gross negligence? We purchased a commercial property under LLC which was rented to a fast food chain. Although it is a NNN, we still purchased a liability insurance. There were some findings in the inspection report that needs attention, I requested the tenant to correct them, but they just ignored it. If it actual cause any lawsuit from it, are we still liable to it or tenant is 100% responsible since I already inform the to correct them?
    Talisa Rafferty
    Replied 4 months ago
    You are the owner. Safety violations fall on you.
    Terry Lowe
    Replied 5 months ago
    I agree with gross negligence. We have a great property manager, but we are still active in making sure our properties are to code, and that there is nothing that could be considered gross negligence. I do not believe being a rental owner should be “passive”. Be involved!!
    Edward Granville
    Replied 4 months ago
    Hi I’m based in Curacao (Dutch Caribbean), And the dutch are smart about taxes. So here we pay an incremental tax percentage on owned capital. This might be true and handy for other countries too. Or other countries might change from a flat fee to an incremental fee in the future: In Curacao the thresholds are like this: 0,4 % up to $175k; 0,5 % between $175k and en $300k, and 0,6 % for $300k and higher. So here we try to maximise each holding LLC to about $175k. For $1.2M in real estate that would easily earn back all the administrative cost to separate and protect properties in their own LLC. There will also be a holding company for all the LLC daughters and a special daughter that does all the high risk stuff. Gains and losses can also be moved between daughters to minimise taxes.
    Shama Lightwala
    Replied 4 months ago
    Thanks for the LLC insights, Matt. I am new to the real estate investing world, and have just setup an LLC. I don't have any investments yet, but looking to make it a long term business (starting with research on auction buys in GA). This was helpful, thanks again!
    Jim Demartini Investor from Moorestown, New Jersey
    Replied 4 months ago
    Matt, fellow NJ investor here. I have moved two properties from personal name to LLCs, and in both cases it was pretty easy and only a few hundred in legal and filing fees. These were in Burlington County though, which may be different from Mercer, where I believe you own properties. I (and my attorney, and my insurance agent) believe LLCs are worth it, in fact each property should be in its own LLC. You should also have enough insurance to cover all of your personal assets and you should let your insurer know about your rentals. In my case my umbrella rate went down when I put the rentals into LLCs. Your mileage may vary. But as in all business decisions, consult with your attorney and follow his/her counsel. They are the one who is going to help you should anything untoward happen at your rentals.
    Reid Kane from Pittsburgh, PA
    Replied 4 months ago
    Which is better and why: 1 property. C Corp with bearer shares, 1 shareholder, sell corp as an entity with the single property as its sole asset vs LLC
    Don Taylor from Raleigh, NC
    Replied 4 months ago
    I'll start off with getting my 1st property in my name, then set up an LLC for non FHA properties