LLC To Manage House Hack
I am interested in getting into rental investments via house hacking. My eventual goal is to own a portfolio of properties outside of my personal residence, but the first two properties I buy will likely be house hack duplexes to get the ball rolling with low down payments.
I understand that in house hacking and FHA loans, I will need to own the property in my own name. I understand the implications of that--not a problem. My question here is whether it's worthwhile to establish an LLC to manage (but not own) my house hack(s).
I want to do this for a few primary reasons. First, I want to have some separation between myself and my tenant. Presenting the property for rent from Property Management, LLC allows me to hold myself out as the "property manager" who happens to live next door rather than the owner of the building that lives on-site. I know there is no legitimate legal separation here since the property would be titled in my name, but it does provide a bit of social distance between myself and my tenant. The tenant's lease would say Property Management, LLC, not my own name, which would mitigate some social awkwardness of the tenant knowing that I am also the owner of the property.
Likewise, if Property Management, LLC is the entity collecting rent and dealing with the tenant, it may provide asset protection benefits in addition to the privacy benefits. If a tenant sues Property Management, LLC, but not myself personally, Property Management, LLC would have very few assets. I know any competent lawyer would search and see that I own the property, but you never know. This is a marginal benefit that gives the outward appearance of separation.
Finally, the last reason I am interested in doing this is to scale it later. My goal is to buy probably two house hack duplexes, then move into a single family residence and keep the two duplexes on the side. I will then scale up my rental portfolio over time with rental properties that will be owned in (most likely) a series LLC. Once I am able, the two original duplexes will also be moved into the series LLC. However, all the while, the properties (both the house hacks and any new investment properties) will be managed by the same Property Management, LLC. No matter if the properties are re-titled, owned by me personally, or owned by a series LLC I control, they all appear the same to my tenants: "Managed by Property Management, LLC." This allows Property Management, LLC to establish brand equity as a landlord from my very first house hack, and it also simplifies some of the accounting / rent collection / etc since I will, for a time, have some properties owned by me personally and some not, but they will all be managed by the same management LLC.
Has anyone pursued this strategy? Is it worthwhile? Keep in mind my intentions to scale later into a more robust network of rentals. The house hacking component will be only the first ~6 years or so. After that I will stop house hacking and start buying rental units with investment property mortgages rather than FHA loans.
Most Popular Reply
Ian:
Thank you for having really thought through this issue. I see so many people here say thing about LLCs that make no sense. "I'm broke, and want to become a real estate investor, so how do I form an LLC?" (BTW, I'm not a lawyer.)
It is easier to hold SF rentals in your name since you don't have to worry about due on sale clause and you can refi without having to move title back and forth. Just be sure to get good liability insurance and consider an umbrella policy. Most importantly, run the property well in a legal and safe manner.
I have formed LLCs to manage my properties too. Just draw up a contract between you and the LLC for managing the property. One other benefit of this is that you can now write-off reasonable expenses toward managing your property through the LLC. For example, stamps, paper, toner, and the like can be purchased by the LLC as a business expense. As you grow, more and more of those things are legitimately deductible. My wife and I go to dinner every Friday and discuss business. Some of those dinners are inexpensive and some very nice but all are deductible. Talk with your CPA about it.
Ian:
Thank you for having really thought through this issue. I see so many people here say thing about LLCs that make no sense. "I'm broke, and want to become a real estate investor, so how do I form an LLC?" (BTW, I'm not a lawyer.)
It is easier to hold SF rentals in your name since you don't have to worry about due on sale clause and you can refi without having to move title back and forth. Just be sure to get good liability insurance and consider an umbrella policy. Most importantly, run the property well in a legal and safe manner.
I have formed LLCs to manage my properties too. Just draw up a contract between you and the LLC for managing the property. One other benefit of this is that you can now write-off reasonable expenses toward managing your property through the LLC. For example, stamps, paper, toner, and the like can be purchased by the LLC as a business expense. As you grow, more and more of those things are legitimately deductible. My wife and I go to dinner every Friday and discuss business. Some of those dinners are inexpensive and some very nice but all are deductible. Talk with your CPA about it.
Thank you, Greg.
In terms of the accounting logistics, does the management LLC have to write a check to me for disbursement of the rental income or does any income the LLC has from collecting rent just flow through to my schedule E either way?
For instance, let's say the management LLC collects $2,000 per month in rent. Does the LLC have to withhold a fee for "property management" and then disburse the difference (say, $1,800) to me personally as rent? Or can the LLC just report the entire $2,000 on my tax return as rental income, even though the LLC itself does not own the asset being rented?
@Account Closed
While I'm not a lawyer or accountant, I think we need to clear somethings up. First, here are just a couple of prior threads that you might find useful. BP has many of them, pretty much daily:
https://www.biggerpockets.com/...
https://www.biggerpockets.com/...
For real estate purposes, the LLC doesn't provide any tax benefits unless you are investing with a non-spousal partner. The whole moving Title back and forth, while "everybody" seems to do it, really looks to be a "bad practice." Not just the alter-ego aspect I've brought up, the split between the LLC holding Title but you personally giving the mortgage. Everything isn't under the umbrella of the LLC so you don't fully gain the limited liability protection.
The below thread might help give you some perspective on your last question:
https://www.biggerpockets.com/...
But, in your case where you are personally holding Title and the mortgage, I don't think it really matters. You would need a legal document between yourself personally and the LLC where the latter is in effect your property manager (consult a qualified professional or two, of course). This lets the LLC lease out the property for you.
As for accounting for the funds, remember that LLC's are pass through entities for tax purposes unless you elect to be taxed as a C Corp. By default, a single member LLC is a disregarded entity and a multi-member LLC is a partnership from the IRS' perspective. Both tax status' are pass through entities. You are still using SchE --- remember, the LLC doesn't provide additional tax benefits. You'll still want to move the funds from the LLC's bank account to your personal account before making any/most payments (if you need to hire a contractor, I'm not sure if you want to hire them or if you want your LLC to hire them) to avoid co-mingling your funds. This is just an "owner's draw."
Does that help? Good luck.
Thank you, @David M. I looked at the other threads to which you linked here. I appreciate the additional info, but it does not apply to my situation. I know that if I hold the title/mortgage in my personal name, transferring title alone to an LLC (while continuing to hold mortgage personally) is utterly pointless because it will pierce the corporate veil. I am not intending to do that.
Rather, my question was regarding the financial logistics if I hold the property/mortgage personally, but contract with my management LLC to manage the property (i.e., advertise, collect rent, etc).
Let's say I have a duplex wherein both the property and the mortgage are owned by me personally. I draw up a contract with my single-member LLC (Property Management, LLC) to manage the property for me. This obviously changes nothing regarding the title or mortgage; they're still owned by me personally. However, it is now Property Management, LLC that is dealing with and leasing to the tenant, collecting rent, hiring contractors, etc.
Property Management, LLC collects $2,000 a month in rent. Should Property Management, LLC then transfer that $2,000 straight to me personally as an owner's draw? Or should Property Management, LLC retain some kind of "management fee" for itself so that the management agreement is more legitimate?
My question above was simply: does it make a difference either way? Will the entire $2,000 flow through to my Schedule E as rental income regardless of whether I 1) leave it sit in Property Management, LLC's bank account all year; 2) transfer the entire $2,000 to my personal bank account every month as rental income; or 3) transfer some portion of the $2,000 to my personal bank account every month as rental income (say, $1,800) and retain a portion for Property Management, LLC as a management fee? The question is: does it make a difference for tax purposes whether one does option (1), (2), or (3)? Or does the income show up on one's Schedule E as $2,000 in rental income regardless of the internal transfers?
I think if Property Management, LLC were an S-Corp or C-Corp it would change the dynamics, but the question is for an LLC, which are disregarded by the IRS. If you are familiar with how it would be structured as an S-Corp or C-Corp, I'd be interested to compare.
@Account Closed
Oh sorry...
It seems like you understand the elements, but maybe its just a matter of putting it all together. Since the default LLC is pass through entity, how much money is in the bank doesn't matter on your tax returns. You will still just be filing as a SchE for the rental and perhaps a SchC for the Property Management function (if it rises to be more than just passive). You know a single member LLC is disregarded so for tax purposes just imagine as if its not there...
For legal purposes, you just need to have the legal agreement between yourself and the LLC. rents goto the LLC and you keep taking owner's draws when you like to. You make the mortgage and tax payments from your personal account. Depending your intra-agreement, either you or your LLC hires any trades for repairs, etc.
I wouldn't take a management fee because that just converts your passive income into active income, a less advantageous tax situation.
Does that answer your 1,2 3 question?
S Corp or C Corp could be useful, but its a more "advanced" technique. The former requires more periodic paperwork and filings (i.e. operating costs) as well as a "reasonable salary." Again, you are converting passive income to active, ordinary income, not usually what one wants. However, if you want to or need to create a W2 income (perhaps for health or retirement benefits) this is one way to go about it. You can save on SE taxes because everything over the "reasonable salary" you take as a distribution (usually miscalled as a dividend, but that is how its taxed). Again, you are only saving the self employment taxes, but you need to making a significant amount to cover the costs incurred by the S Corp. The C Corp is not a pass through entity. Right now, you can try to take advantage of the low corporate tax rate. However, getting the money out of the C Corp will generally incur additional tax on your return. This is a much, much more advanced technique.
Does this help? It'd you want, I'd be happy to chat instead of typing out lectures --- just send me a direct message.
Thank you @David M. I think that answers the (1), (2), (3) question. My goal would be to have 100% of the income taxed as passive rental income; I do not want to convert some of it to ordinary income. I was just not sure of the internal logistics of how to manage the payments once they're in the management LLC's account.
To the question of scaling it later, let's say I own the following properties:
- House Hack Duplex 1 (owned/mortgaged personally)
- House Hack Duplex 2 (owned/mortgaged personally)
- Apartment Building 1 (owned/mortgaged by my single-member LLC 123 Main Street, LLC)
In this scenario, assuming that my same management LLC has contracts to manage each property, Property Management, LLC would collect the rent for each property, then Property Management, LLC would transfer the rent from House Hack Duplex 1 and House Hack Duplex 2 to me personally, but it would transfer the rent from Apartment Building 1 first to 123 Main Street, LLC, then I can take an owner's draw from 123 Main Street, LLC's bank account once the funds are in there? Am I understanding that correctly?
In the situation where I use an S-Corp or C-Corp as the management entity, it is my understanding that only the amount collected as a "management fee" becomes ordinary income, correct? The amount that I transfer to myself as the "rent" portion is still passive rental income on Schedule E? From this amount I'd have to pay myself a reasonable salary and take the rest as a distribution. Do I understand correctly that a C-Corp does not have the "reasonable salary" requirement? Doing the Corp. route seems to give me more control over how I want income to be reported. If the management fee is low, then I am converting hardly any of the income to ordinary.
@Account Closed
i see we are getting there...
Yes, that flow of funds would seem to work. I've heard that you could simplify it a bit further. Depending on how the agreement between the two llc's is structured, you could have the Mgt LLC pay the mortgage directly. In this way, the property LLC bank account would be quite stale. You'd have to consult a professional, but your first instincts is the cleanest.
The S Corp requires the "reasonable salary." One thing I've never figure out is what happens when its income isn't sufficient to support the "reasonable salary." I assume the IRS will let you do payroll for the "reasonable salary" only up to the business' income. I'm pretty sure the remaining rents and deductions would stay passive since its a pass through entity. However, your statement: "From this amount I'd have to pay myself a reasonable salary and take the rest as a distribution" note quite correct.
Lets say you get $1000 in rent. Then, you have $750 in operating expenses which should include your management fee which lets just say is $100. So, now you have payroll of $100 to yourself. Your SchE will show $1000 in rental income and the $750 in operating deductions as well as non-cash deductions such as depreciation. That will be your passive profit/loss. If you want to take a distribution, that should be ANOTHER expense of some sort. You are now converting more passive income to ordinary income by taking a distribution.
C Corp does not have a reasonable salary requirement. However, it is the only NON-pass-through entity. Corporations have their own tax filings and effectively tax code section as I understand. Just enough for me to stay away from it. First, the rents would be its income. Anything it pays for is a deductions. I have no idea if corporations have the same ordinary vs capitcal gains vs passive income. They just have the two tax rates I thought. Either way, the profit/loss gets taxed. Now the Corporation has 'corporate post-tax' funds. Oh, you want some of the funds? You could take a payment, i.e. payroll, in which case you are paying full taxes. You could take a dividend subject to your marginal tax rate. If anything, Corporation has the least control, especially since the funds start out as passive, one of the more tax advantaged categories.
Does that help?
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#1 Personal Finance Contributor
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This is what I do. My mgt co (s-corp in my case) has mgt agreements with the owner of each property. Paying out an owmer draw or keeping as retained earnings doesn't matter I don't think, especially if a SMLLC, disregarded entity.
But I stopped commenting on anything tax or legal less the pros come take my head off.
So, how does your S Corp handle the "reasonable salary" requirement? You should be taking a payroll action from your S Corp as its no longer a single member LLC for tax purposes.
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I do take a reasonable salary as a % of earned income. What do you mean how do i?
Actually nevermind. I'm only here because the OP requested me to comment and I've done so.
@Account Closed This is a way better solution than people who try and purchase in a LLC. One of my clients here in Connecticut does this for the reason you mentioned, to have a little separation between them and the tenants.
Hey @Account Closed, If your long-term goal is to invest in more properties it is worth it to invest in a solid property manager.
Your time as an investor is infinitely better spent analyzing markets and deals. You want to move up the 80/20 leverage curve from technician to investor/entrepreneur.In Bridgeport, CT the investment is about 10% of rents collected. This frees you up from taking resident phone calls, coordinating maintenance, leasing vacancies, accounting P&L's, conducting inspections and making property payments to focus on higher leverage activities.
-Craig
@Steve Vaughan Most investors use LLCs. If you choose to make your LLC a pass-through entity you aren't forced to pay yourself a salary and avoid all the salary-related taxes.
@Account Closed If your LLC is a pass-through entity, the discussion on whether or not it shows a profit, is like saying "which pocket do I want to put this dollar in?" Whether you personally have more income or your LLC has more income (which then passes on to you) is irrelevant as the net effect is the exact same.
@Craig Bellot I agree that property management is a difficult, time-consuming job. You can still have an LLC that manages the business even if you hire a third-party management company to manage the day-to-day issues at the property.