When and Why to start an LLC?

7 Replies

Hey everyone!

I'm currently looking into the pros of an LLC because I'm going into Real Estate with two other people financially. I know that falls into an attorneys hands as well with legal binding documentation. Does the LLC help? Should I do a deal or two first before doing so?

Depending on where you’re getting your funding, the finance company may require you to close under a LLC anyways.

Generally commercial lenders do not lend to owner occupied property and because of that they don’t need to abide by federal lending laws for consumers. To make sure there was no lending “gray area”, the LLC is required.

As @Kevin Dureiko stated, LLC's play a large role in your business if you're trying to obtain commercial financing vs personal financing. Lots of people have the discussion about tax and legal implications, which there are many and should be discussed with an accountant and attorney, but you'd want the LLC if you want to buy properties directly in the name of the business without having to do quit claim deeds and run the risk of having the loan called due.

If you're buying little houses with debt, you are probably better off buying as TIC - tenants in common - and having a JV agreement. Especially on your first house.

If you're buying commercial assets and/or seeking commercial financing (which is a higher risk, higher cost PITA), then do the LLC.

Verify with legal/tax professionals of course @Kevin Dureiko

@Christian Drake keep in mind your loans are going to be recourse loans (personally signed) even as a LLC. Your partners included in the LLC formation will almost always be required to sign on any finance agreement as well.

Your tax implications likely won’t be at the LLC level as most states see LLCs as a pass though, any profits are personally reported.

I don’t know your particular states rules, but I have yet to see anything different. Consult with tax/legal for sure.

Thanks everyone this is helpful. We are looking to get into residential for the foreseeable future and I understand each city/area is specific to itself. Never heard of a TIC @Steve Vaughan . We have funds to most likely close one our first and maybe second properties without getting into residual debt if we can BRRRR correctly. If we come across some cheap flip opportunities that would be very beneficial.

@Christian Drake I would strongly suggest you establishing a Corporate Entity such as a S Corp or a LLC depending on your REI Endeavors. This is a relatively inexpensive process. I invite you to Google "Creating a LLC or S Corp in _____," "Division of Corporations in _____," or another phrase. You can go to http://www.sunbiz.org and see how Florida does things, to give you and idea what to look for, in a website. I invite you to please consider the following, from a Federal Income Tax Filing Perspective. I cannot stress the importance of finding a very good Investor Friendly CPA. Below are some things you may wish to consider, as to which Corporate Enity is best, for your Business Model as well as your REI Goals and objectives.

Flipping Properties

If the primary objective of your real estate business, or one of your real estate businesses, is to buy, potentially fix up an existing property and resell it within one year, the Internal Revenue Service can consider that to be an active trade or business. Unlike passive rental income, the income from an active trade or business is subject to self employment tax (a nasty 15% tax commonly referred to a "social security and medicare" by working folks). If your goal is to reduce that self-employment tax to a minimum, an S Corporation is the best entity to use. Why?

It is the only entity structure whose rules allow the business owner to take a “reasonable salary” (subject to social security and medicare) and then take the remaining profit (often as much as 50% of the remaining income) out as distributions not subject to self-employment taxes. Correspondingly, all business income taken from an LLC under similar circumstances is subject to self-employment taxes. For a business owner with $100,000 taxable annual income, the net tax savings for using an S Corporation instead of an LLC in taxes paid every year can be as high as $7,500.

Holding Properties

When holding properties as a cash flow investor, the LLC (or LP) is generally the better choice because an LLC has more liberal distribution rules. The key here is flexibility. LLC distributions come out of the LLC at cost basis. The members of an LLC are issued K-1 Form and have to pay taxes on all profits as though it were income, which could expose the owners to high employment taxes. Also, an LLC can elect to be taxed like an S Corporation.

While there is never only one answer that is correct for all circumstances, there is a general rule that is almost always the correct choice. So remember, for legal and tax planning, a good CPA will recommend that clients hold their properties in an LLC or Limited Partnership and run their businesses as S Corporations to avoid self-employment taxes.

Originally posted by @Christian Drake :

Thanks everyone this is helpful. We are looking to get into residential for the foreseeable future and I understand each city/area is specific to itself. Never heard of a TIC @Steve Vaughan. We have funds to most likely close one our first and maybe second properties without getting into residual debt if we can BRRRR correctly. If we come across some cheap flip opportunities that would be very beneficial.

Refinancing inside an LLC is going to suck. Search 'I am having a hard time brrrrr-ing because my house is in an LLC'.

or 'All I can get is crappy short-term adjustable rate commercial financing on my house because I own the house inside an LLC.'

Those 2 searches alone will keep you reading for a while, Christian.

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