LLC vs corporation vs individual buyer

15 Replies

Hi BP community,

I have been going over the different forums here trying to get the hang of breaking ground on REI. We just opened escrow on an income property in Los Angeles and wanted to get everyone's opinion/input. It's a 4 unit rental property solely for income with 25% down and has a monthly gross income (after paying Taxes, P&I, and insurance) would be 800/month. We (me and my wife) already pay a lot of income tax due to relatively higher income bracket, since we do have full time jobs; I wanted to find out if it's good idea to form an LLC to help with saving on taxes vs forming a corporation vs leaving it the way it is? We don't really have any other assets so will most likely not need any protection on that front. We are using a real estate manager who will be paid a portion of the total rent collected as well as a handyman who will be paid per service episodes. Any input will be greatly appreciated.

Thanks

@Talha K. - Well it depends on what type of loan you are getting. If your loan is through a residential mortgage broker and you used your personal income to qualify then you have to buy the house and hold title in your personal name. You can always form a LLC/Corp later and transfer ownership to it but understand that it could trigger the "due on sale" clause

As far as a LLC vs a corp the vast majority of investors I talk to do a LLC. I have a LLC because I did not want to be subject to the double taxation of a Corp. This link explains the different tax benefits and reasons for choosing an entity

http://www.mycorporation.com/learningcenter/corpor...

Medium second city real estate logo   white close upBrie Schmidt, Second City Real Estate | [email protected] | http://www.SecondCity-RE.com | IL Agent # 471.018287, WI Agent # 57846-90 | Podcast Guest on Show #132

1. Whether it's an LLC or not will have no impact on your taxes. An LLC would just flow any profit or losses through to you on a K1, anyway.

2. The reason to use an LLC is for liability protection. If you hold the property in an LLC and (this is important) actually use the LLC (have a bank account, have tenants check written to LLC, etc.), then, in the event of something going wrong with the property, the LLC gets sued, not you.

3. You will not be able to use an LLC to close the deal, because your lender will require the property to be in your name. However, you can quickly and easily move the property into an LLC immediately after closing... cost will be in the range of $500-1500.

4. The way you are describing the property makes me nervous. "Gross income" is the rent before any expenses. If you let me know the following information, I will tell you whether it is a good deal: Price, total annual rent, sq ft of structure, year built, and sq ft of lot. (I've brokered / renovated / managed a ton of 4plex deals in LA).

*I'm not a lawyer and the foregoing is not legal advice.

Thanks @Brie Schmidt  for the response.

It is a loan through residential loan broker and we will have to transfer the title in case we decide to start an LLC. How often does the "due on sale" clause get triggered in such situations? Is it very common these days?

Thanks again.

Thanks for the input @Moses Kagan  

Here is the info:

Price: 530K

Annual rent: 50.4K

SQ foot: 2600

lot :6700 sq ft

@Talha K. - I am not sure how often it is triggered. I have some properties in my personal name and some in an LLC and it is really only because I have some with residential loans and some with commercial loans.

Medium second city real estate logo   white close upBrie Schmidt, Second City Real Estate | [email protected] | http://www.SecondCity-RE.com | IL Agent # 471.018287, WI Agent # 57846-90 | Podcast Guest on Show #132

@Talha K.: You're at 10.5x grm, meaning you'll have a pretty decent yield. And you're at $204 / sq ft, which is about what it would cost to build a building brand new if someone gave you the land for free.

Obviously I don't know the address or the condition of the property, but this looks like a sensible deal to me. 

Bravo!

Originally posted by @Talha K. :

Thanks @Brie Schmidt  for the response.

It is a loan through residential loan broker and we will have to transfer the title in case we decide to start an LLC. How often does the "due on sale" clause get triggered in such situations? Is it very common these days?

Thanks again.

 I have heard from many sources over a period of time that, while lenders could pursue exercizing the due on sale clause if they wanted to, is almost never done.  

Regarding "If your loan is through a residential mortgage broker and you used your personal income to qualify then you have to buy the house and hold title in your personal name." I don't think there is a requirement to "hold title in your personal name". Yes, it must be originated in your name, and any transfer must be approved in writing, but that doesn't mean you can't hold the property in an LLC.

@Talha K.   you could ask your closing attorney to draft a second deed as part of the closing package. The second deed will be recorded immediately after the first deed. The First deed is from the seller to you (personally) and the second deed is from you (personally) to your LLC. Make sure your attorney knows that when underwriting balks and says "we can't do that" that the closing attorney (not you) insists it was his idea to move the property to the LLC. If more 'no's follow, let the attorney may ask the underwriter to quote the the guideline where this is not allowed. Note that the closing documents all have you (personally) signing the loan. The deed tacked on the end is not material to the loan.

Regarding DOS... in this scenario it's not an issue. The closing attorney my LLC uses correctly says that the transfer is agreed to by the lender, since it is part of the closing package and they agreed to close. We have done this several times without issue. The loans (correctly) show up on our member's credit reports. The assets are (correctly) considered a capital contribution to the LLC by members, who get a credit for P/L and Capital contribution percentages.

The above is my experience, and my experience only along with my observations and it's not advice. Your mileage may vary. Discuss with your legal and accounting professionals, because those people are the only ones who matter for your personal and company affairs.

@Talha K. welcome to BP. you have been given some good advice here and some bad advice. There are many things to consider in forming a holding company. One is cost, my understanding is that in CA they charge $900 per year just to register a company. There are many types of companies, C Corps, Sub S Corps, LLCs, lots of partnerships, and personal. For strictly rental income LLCs are usually considered better, if you have flip properties often Sub S. Corps are best as you can claim some short term capital tax to regular earned income. You want pass through taxing. Liability is one consideration in forming an LLC but it does matter tax wise. If you are using a managing company that helps out a lot in liability. You need very good insurance anyway. There are several posts about different forms of ownership you may need to look up and read. Ask your tax accountant before you choose anything. best of Luck.

@Jerry W.  

You are thinking what I am thinking! Yes California FTB taxes all LLC's and @Talha K.  you have to make sure it is worth the money. If for some reason you do go down that route, I want to add that you can always put your property into a land trust with the LLC as the beneficiary, as transferring a property into a trust is the one exception for "due on sale" clause, and the LLC will take all the liability of the property. But really, the point of the LLC in my opinion is to shelter some of your assets from the others. If you don't have other big assets, what is there to shelter? And putting a property at this price range into an LLC really limits your options to refinance. What if you want to pull some equity out a couple of years down the line to buy more? If under your personal name, you have a bizillion options with great rates from Fannie and Freddie. If under a LLC, you have about two options with your local credit union at 1-2% higher interest rate. Things to consider. Best luck with the purchase. 

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