I am a new investor from Houston, Tx. I plan on acquiring my first rental property within a few months if everything goes well.
I have some questions regarding the ownership of a rental property :
- whenever you collect rent, will you have to pay federal income tax on the rents ?
- Is it easier to create a corporation (LLC) if my plan is to acquire multiple properties in the future ? If yes, how does the process work ? are the house at my name or the llc name ? what is the situation regarding taxes ?
For investing purposes, would you recommend getting a real estate licence to have full access to the MLS. How much does it cost to have an active licence in the state of Texas per year ?
Thank you all for your help.
Hi Tristan, welcome.
*** This is not legal advice and I am not your attorney. ***
1. Rent is taxable income and you would pay taxes on the rent; however, you can deduct the cost of paying the mortgage, maintenance. utilities, etc., so you only pay taxes on your profits.
2. I recommend a "series LLC" for my clients who will be acquiring multiple properties. It is basically like having many companies under one roof, but each "series" has its own assets and liabilities and is insulated from the other properties. You would want to acquire the property in the LLC's name, though some lenders do not allow this. Avoid putting properties in your name or being personally liable for the debts of your investments.
3. You can elect "pass through" tax treatment when you form your LLC, so the entity itself is not taxed. You are taxed on the LLC's income, but you pay no corporate tax. You may have Texas franchise taxes to pay, but not right away.
4. To become a licensed real estate agent, you must take a bunch of real estate continuing education courses, pay a fee, and pass the real estate exam. THEN you must find a broker to sponsor you AND you will have to pay an annual fee to your local realtor's association to have access to the MLS. It is a fairly expensive and time-consuming process, so you might be better off finding a flexible, aggressive agent who will help you with listings, comps, etc.
@Drew Shirley I spoke with an attorney last year regarding changing from my current LLC to a series LLC to separate my 7 rental properties. He discouraged using the series's LLC. Do you know of any cons for using this? For tax purposes, our LLC is disregarded (owned by my husband & I). With the series, would we still be able to use the schedule E or would the tax filing need to be different?
@Debra Richard *** This is not legal advice and I am not your lawyer. ***
I think the reluctance regarding series LLCs is based on the fact that they are new and in some ways an unknown quantity. I think they are really the best vehicle for real estate investors who own lots of properties.
That being said, I would not recommend converting an existing LLC into a series. That could be problematic. I would start one from scratch and then convey the properties one at a time into the new series LLC.
In terms of the potential pitfalls...
Some lawyers are concerned that courts will simply disregard the series structure and open the entire entity to exposure -- even though the statute specifically says that the assets and liabilities are segregated.
I really cannot imagine a Texas court "piercing the series" and simply disregarding the statute like that, but I suppose you never know.
There is some concern that states that do not permit series LLCs may not recognize them in those state courts--but again, how likely is that, that a foreign court would simply ignore a business organization?
And there is uncertainty about exactly how each series will be treated for federal income tax (and Texas franchise tax) purposes. Let me be the first to say I am not a tax lawyer, so there may be something definitive out there, but I do not think the IRS has affirmatively said how they intend to characterize series LLCs. I think there is an informal advisory note that says each series can check the box for itself, which seems to be the most logical choice.
I think the massive cost savings and organizational efficiency of the series LLC make it well worth the slight risk that any of these bad things will happen. Compare it to forming a separate LLC for each house, which has always been a nightmare.
@Drew Shirley , thank you for your input. After reading plenty of material, I never came across people discussing taxes and LLC regarding buying and holding properties.
So if I get this right, you would collect your rents for one year and when tax season is on, you would have to prove what maintenance, property taxes, insurance, P&I cost you in order to get it deducted ?
What would you think would be the best strategy for someone starting out. Shall I create an LLC right away or wait untill I acquire more properties ?
In the case of the LLC, I am confused regarding how the money part would be handled. Would the rent be paid directly to the LLC (on a specific bank account attached to the LLC), would it be possible for me to access the money ? Would you mind giving me some more details.
@Tristan S. *** This is not legal advice and I am not your lawyer. ***
I'm also not a tax lawyer, so I'll recommend you read this for a lot of the basics. And by the way, the IRS says you're supposed to pay estimated taxes every quarter, not every year.
In terms of forming an LLC right away, it really depends on if you have any personal assets. Many of my clients are just-starting-out real estate investors, and I will sometimes tell them that if they don't have any money and they're not agreeing to personal liability in their first few deals, there's not really much to worry about. If you don't have any money at all and all your properties are fully leveraged up, you're what we might call "judgment proof." Why would anyone sue you if you have no money?
Certainly the safest, most conservative route is to form the LLC first, then start doing deals. But I personally think it's okay to wait until you have assets that need protecting before you start worrying too much about asset protection.
If you do form an LLC, you would be able to open a bank account in the LLC's name and you would be the signatory for that account. The LLC can act just like a legal person - it can generate income, pay bills, and move money in and out of bank accounts. So yes, the rent would be paid directly to the LLC's account, and then you could either re-invest the money back in something else, or distribute it to the LLC's member -- you. (But beware -- you will have to pay taxes on your profits even if you don't distribute the $$$.)
Cautionary Note ;
Although the series LLC is probably not treated differently than a single llc from a legal point of view, I have several clients that commingle funds among/between their series llcs and I highly recommend you not do this as it is a very likely that this can open the door to"piercing the series". Each LLC should have its own bank account and you need to maintain separate records for each. That includes separate tax filings.
@Account Closed do you mean you recommend a separate bank account for each series?
Yes but if you want to simplify your life a little, you could setup one of your series llc as a management company that receives all rents and makes all payments. That management llc could then make one net distribution to each of the other llc's. The net distribution would still need to be put in a separate account and then distributed to the member(s) but it would simplify the day to day accounting.
Welcome to Bigger Pockets Tristan.
As a new investor, you have a steep learning curve ahead of you. Luckily, you have found a great community of other real estate professionals, reference resources and more learning material than you probably want at this point.
With regards to obtaining a real estate license, the required education to be eligible to sit for the exam can range from $600 - $1k depending on the institution. There is an additional fee to submit your licensing application, sit for the exam, then obtain the required background checks. Brokerage firms will either charge you a flat fee to sponsor for license or a large percentage of any commissions earned. (Some brokerage firms don't let agents list their own properties, so you have to be careful when making a selection.) Board association membership fees and MLS subscription runs approximately $700/year. It can get quite costly if you only plan on using this access for your own deals.
As you are getting started, I would recommend teaming up with an investor friendly agent and work a deal to get the information needed from MLS. If you decide down the road that you need a license, you can always revisit that avenue. Best of luck in your new adventure!
@Drew Shirley , the best way would be to set up a series LLC with a new bank account for each new property ? it sounds tedious but it sounds like it will be easier to keep track of what is happening with each property.
How hard is it to set up a series LLC ? how much does it cost ?
@Nicole Garner , thank you for the input. Indeed, it sounds like a lot of work just for the MLS access. We will see if I feel the need for it in the future.
Keeping a separate bank account for each series is not a legal requirement but may be advisable for accounting and tax purposes, and to avoid any "commingling" of funds.
I charge $990 to set up a series LLC (or $99 per month for 12 months), plus filing fees ($300).
@Drew Shirley , Is it absolutely required to hire an attorney to open an LLC or is it possible to DIY ?
You can form an LLC, or a series LLC, without an attorney. There are certain requirements for the formation documents and the ongoing operations of the entity.
Read more here --> http://www.sos.state.tx.us/corp/formationfaqs.shtml#LLC
@Drew Shirley Thank you for sharing all those information. Another question I had, when a mortgage is taken, will it be at my name or the LLC ?
Finally, are there any good books on the subject ? I found that :
Do you know if it's any good ?