Rental Investment Units Purchase - LLC's & Bank Accounts
Good morning everyone, I am a new investor in the state of Maryland and anxious to purchase my first rental property. I have selected a realtor thru Bigger Pockets, I am currently analyzing deals and will soon be placing an offer on a property. As I embark on this journey and based on recent discussions held with both financial advisors and estate planners, it was explained to me that each unit I purchase should be placed under its own LLC for both asset protection, liability coverage, taxes and estate planning purposes. I understand these recommendations and will follow thru once a property is acquired. The few questions I have pertain to the accounting and tracking of both rental income and expenses associated with said rental properties:
1 - I use a small office at home for purposes of investing - should I create an LLC now for tracking of general business related expenses I have and will incur moving forward?
2- Once a rental unit is purchased and set under its own LLC, should a new savings and checking account be created to track income and expenses specific to that property?
3- If answer to #2 above is "YES", is that the norm for each property I purchase moving forward? Or can income and expenses from multiple properties be tracked via the same accounts? I would think all combined would be acceptable as long as specific unit information is included on the "Memo" line of each deposit received or check written.
Thank you all in advance for your valuable feedback. Lots of questions as I get started but anxious and ambitious to get going.
Regards!
Please only take this kind of advice from lawyers and not from random people on forums.
If you want, I can connect you with my lawyer.
Quote from @Julien Bartolo:
I'll start with bank account information, then follow up with my take on LLCs.
You need two accounts: checking and savings. If the properties are split into more than one LLC, then each LLC will need its own accounts.
Checking: collect all income here, then use it to pay bills. Pay the mortgage. Pay for maintenance. If you are setting aside funds for capex, taxes, insurance, or other expenses that don't occur monthly, transfer those funds to Savings each month and hold them there until it's time to spend them. You will receive the security deposit in Checking but then transfer it to Savings.
Savings: Hold the deposit here so it's separate from operating funds. You can also hold money for maintenance, capex, taxes, insurance, or other projected expenses. When a tenant moves out, transfer the deposit back to Checking so it's ready to apply towards expenses or to refund to the Tenant.
If you end up with excess funds in the Checking account, I recommend you transfer it to a third account that is specifically designated for future investments. That ensures you don't spend it on other things and that you know exactly how much you have available to spend on the next purchase. If it's mixed in with your deposits and reserve funds, you may accidentally spend money you shouldn't have.
An LLC is useful for two things: anonymity and legal protection. In most cases, neither is warranted.
Warning: I am not an attorney and this can be a complicated topic. Please note the information provided below is a layman's definition designed to provide a basic understanding for the general audience. You should consult an attorney or CPA for your specific situation.
ANONYMITY: When you create the LLC, your name is recorded on the documents and published on the Secretary of State website for all to see. So you're not completely anonymous. If you want to be completely anonymous, you can use a Registered Agent. The Registered Agent will record the documents on your behalf so only their name and information appears on the documents. I've done this with my properties because I'm well known in my small town and don't want people to know what I own.
LEGAL PROTECTION: By placing your assets in an LLC, you are legally separating them from your personal assets. If someone injures themselves and sues, they will be suing the LLC and not you personally. If your insurance coverage isn't enough, they could seize the LLC assets, but not your personal assets.
Additional thoughts:
1. An LLC is not free. You can spend as little as $100 to form an LLC, or you could use an attorney and spend $1,000 or more. There are also additional costs of operating and maintaining an LLC, like separate bank accounts, annual report filings, tax filings, etc.
2. There are rules to follow! If you fail to follow the rules, you may open your personal assets to a lawsuit. An example of this would be mixing your personal money and LLC money in the same bank account.
3. You do not need a separate LLC for each property or a series LLC! Don't make your life more complicated than it has to be. Most professionals will recommend a separate LLC for every $1 million in assets but I don't think that's necessary. In my case, I have residential rentals in one LLC, commercial properties in another, self storage in a third, and my real estate company operates in a fourth. Some have more than $1 million in equity while others have less.
4. The need for an LLC is grossly exaggerated on BiggerPockets and other websites. Have you ever heard of a Landlord being sued by a Tenant and losing property? I've been on this board since 2010 and haven't found an example yet. You've probably heard of big Landlords losing property, but only because they were flagrantly violating Fair Housing, running a slum, or otherwise violating the law in an egregious manner. You are more likely to be struck by lightning twice. The vast majority of lawsuits against Landlords are for wrongful eviction, security deposit disputes, and Fair Housing Violations. Your basic insurance policy with $300,000 in liability coverage should be sufficient in 99.999% of all lawsuits.
5. The best protection for you and your investments? Know and obey the law. I manage around 400 rentals with 12 years experience and have never been sued once. Even if I were sued, I document everything and obey the law, so I won't be found guilty. Even if I were found guilty, the cost would be in the thousands, not in the millions. Insurance would cover it, I would pay the deductible, and no assets would be lost.
If you are in an area like San Diego where people are more likely to sue, a judge is more likely to find you guilty, and the payout is likely to be higher, then you may consider an umbrella insurance policy. This policy will provide additional coverage above what your existing policy covers. It's easy to obtain, costs very little, and doesn't require additional, on-going effort to maintain.
@Ruchit Patel - Thank you for the advise, I would appreciate it if you could in fact share a contact so I can ask a few simple questions as i try to get my journey started. I want to try my best to ensure I have a proper understanding on how to move forward based on my long term goals. Thanks again
@Nathan Gesner - Thank you so much for taking the time to share this general information. I have already held discussions with an attorney who will assist me with this overall setup so all will be done properly as I move forward. It does help to have a general understanding on how others in the investment community operate. I really appreciate the feedback. Have a great day.
Quote from @Nathan Gesner:
Quote from @Julien Bartolo:
I'll start with bank account information, then follow up with my take on LLCs.
You need two accounts: checking and savings. If the properties are split into more than one LLC, then each LLC will need its own accounts.
Checking: collect all income here, then use it to pay bills. Pay the mortgage. Pay for maintenance. If you are setting aside funds for capex, taxes, insurance, or other expenses that don't occur monthly, transfer those funds to Savings each month and hold them there until it's time to spend them. You will receive the security deposit in Checking but then transfer it to Savings.
Savings: Hold the deposit here so it's separate from operating funds. You can also hold money for maintenance, capex, taxes, insurance, or other projected expenses. When a tenant moves out, transfer the deposit back to Checking so it's ready to apply towards expenses or to refund to the Tenant.
If you end up with excess funds in the Checking account, I recommend you transfer it to a third account that is specifically designated for future investments. That ensures you don't spend it on other things and that you know exactly how much you have available to spend on the next purchase. If it's mixed in with your deposits and reserve funds, you may accidentally spend money you shouldn't have.
An LLC is useful for two things: anonymity and legal protection. In most cases, neither is warranted.
Warning: I am not an attorney and this can be a complicated topic. Please note the information provided below is a layman's definition designed to provide a basic understanding for the general audience. You should consult an attorney or CPA for your specific situation.
ANONYMITY: When you create the LLC, your name is recorded on the documents and published on the Secretary of State website for all to see. So you're not completely anonymous. If you want to be completely anonymous, you can use a Registered Agent. The Registered Agent will record the documents on your behalf so only their name and information appears on the documents. I've done this with my properties because I'm well known in my small town and don't want people to know what I own.
LEGAL PROTECTION: By placing your assets in an LLC, you are legally separating them from your personal assets. If someone injures themselves and sues, they will be suing the LLC and not you personally. If your insurance coverage isn't enough, they could seize the LLC assets, but not your personal assets.
Additional thoughts:
1. An LLC is not free. You can spend as little as $100 to form an LLC, or you could use an attorney and spend $1,000 or more. There are also additional costs of operating and maintaining an LLC, like separate bank accounts, annual report filings, tax filings, etc.
2. There are rules to follow! If you fail to follow the rules, you may open your personal assets to a lawsuit. An example of this would be mixing your personal money and LLC money in the same bank account.
3. You do not need a separate LLC for each property or a series LLC! Don't make your life more complicated than it has to be. Most professionals will recommend a separate LLC for every $1 million in assets but I don't think that's necessary. In my case, I have residential rentals in one LLC, commercial properties in another, self storage in a third, and my real estate company operates in a fourth. Some have more than $1 million in equity while others have less.
4. The need for an LLC is grossly exaggerated on BiggerPockets and other websites. Have you ever heard of a Landlord being sued by a Tenant and losing property? I've been on this board since 2010 and haven't found an example yet. You've probably heard of big Landlords losing property, but only because they were flagrantly violating Fair Housing, running a slum, or otherwise violating the law in an egregious manner. You are more likely to be struck by lightning twice. The vast majority of lawsuits against Landlords are for wrongful eviction, security deposit disputes, and Fair Housing Violations. Your basic insurance policy with $300,000 in liability coverage should be sufficient in 99.999% of all lawsuits.
5. The best protection for you and your investments? Know and obey the law. I manage around 400 rentals with 12 years experience and have never been sued once. Even if I were sued, I document everything and obey the law, so I won't be found guilty. Even if I were found guilty, the cost would be in the thousands, not in the millions. Insurance would cover it, I would pay the deductible, and no assets would be lost.
If you are in an area like San Diego where people are more likely to sue, a judge is more likely to find you guilty, and the payout is likely to be higher, then you may consider an umbrella insurance policy. This policy will provide additional coverage above what your existing policy covers. It's easy to obtain, costs very little, and doesn't require additional, on-going effort to maintain.
This is so helpful. Thank you, Nathan. On your point of anonymity (use a Registered Agent") - is this applied to all states, or only a few states (eg. Nevada, Vermont, Wyoming)? I'm in Maryland. Would using a registered agent basically suffice for anonymity? Thanks.
Quote from @Remi Nguyen:I've only created LLCs in Wyoming but I would assume the other states are the same. You will just have to check
Thanks, Nathan.
In other States in general, the Registered Agent wouldn't suffice for anonymity as the owner's information would be public. WY just happens to be the "favorite" for anonymity LLC's. So, you'd have to first form a LLC in WY or similar state (I believe DE or perhaps NV??), then form your next LLC in the state in which you are doing business as the WY LLC as the owner /member.
Lets face it, they are just trying to sell you something. Legal entities have their place. However, they aren't always necessary for real estate investing, especially with residential properties.
As we keep saying, legal entities don't provide any tax or accounting benefits unless you are investing with a non-spousal partner.
Reference this post about LLC Misconceptions: https://www.biggerpockets.com/...
Remember, the LLC is legally a separate entity. So you have to keep your accounting and funds separate. You can't co-mingle funds and you can't use it as your alter-ego. This is all in addition to what you would do anyway if you owned it personally. You'd still have to have insurance... And your loans would be more expensive since legal entities such as LLC's are not eligble for conforming residential loans. You have to use commercial loans. The lender advised quit claim deeding (N.B. lenders don't have a fiduciary respnosiblity to you) only pierces your corporate veil in my layman's opinion since you are using it as your alter-ego. Besides, now the mortgage is in your name.
Yes, each LLC needs its own bank account and perhaps credit cards. Remember, it is its own entity: for example, you could NOT do business out of my personal checking account, right?
The best/better part about NOT using the LLC is that you can still take all the same deductions. So you can still take the home office deduction as a sole proprietor. Don't fall into the trap of trying to track your expenses by account. This is a bookkeeping issue. As you incur expenses for different rental properties, you just account for them in your bookkeeping. No need for additional bank accounts, credit cards, etc. All this accounting/bookkeeping was done before credit cards, computers, etc. No need to reinvent the wheel.
Quote from @Julien Bartolo:
@Ruchit Patel - Thank you for the advise, I would appreciate it if you could in fact share a contact so I can ask a few simple questions as i try to get my journey started. I want to try my best to ensure I have a proper understanding on how to move forward based on my long term goals. Thanks again
Be careful asking questions of an attorney that is not familiar and practicing real estate / tax law in your state. From my experience asking attorneys general questions gets the most strict interpretation of the law - they are not inclined to give you general advice and definitely not their opinion (until you have built a cordial mutual trust relationship).
Setting up a separate LLC for each property is probably overkill, but it will depend on your own personal financial situation and risk tolerance. I personally have a few LLCs and group properties in them - in one I have a commercial plaza, in another I have a portfolio of four homes and in another I have a couple more. I have a separate one for flips. Putting each property in its own LLC would require a lot of extra expenses and bookkeeping hassles that just are not necessary. As Nathan pointed out, when was the last time you heard of a landlord losing everything because of something that happened on their property? I actually worry more about the opposite - getting sued personally over a car accident or something else crazy because then from my understanding all of my LLCs (and hence property) would potentially be in play for the suer.
@Julien Bartolo Please remember too, most conventional lenders do not lend directly to LLC's. So you'll eliminate a huge chunk of your financing options right away. You can transfer title to the LLC afterwards, but that will violate the "due on sale" clause.
Right, legal entities such as LLC's are not eligble for conforming residential loans. You will have to rely on commercial financing. Mentioned that before..