As I begin seriously investing in real estate, I'm considering starting an LLC to both apply for business credit and hold properties as I build my portfolio. I've had some thoughts on how to get started and am looking for some feedback to help me see my blind spots.
My wife and I currently own a 3/2 SFR that we've been renting out since 2013. We paid it off a couple of years ago and took out a HELOC last year with an 80K line. At the time the house appraised at 126,000. We used some HELOC funds to replace windows and the roof on our primary residence and now owe 30K.
I would like to use the house to help establish the LLC and am looking at two approaches: 1) start the LLC, apply for a BLOC, use BLOC funds to purchase the house for the LLC, or 2) refinance the house and use the funds to pay off the HELOC, establish the LLC, and provide an initial operational reserve. I'm leaning toward option 2, figuring there's a way to move the house under the LLC once nothing is owed against it.
Any thoughts/advice is appreciated!
I have been running several businesses for more than 50 years and I discussed having LLC's with my attorneys and CPA's more than 20 or 30 times. Because of all the hype I was always thinking an LLC would have benefits, but my attorneys and CPA's always told me they had too many drawbacks and they talked me out of forming LLC's. The answer seems to depend on who you are asking. You really have to look into how you pay taxes through them and that seems to be a nightmare. YOu have to look at what the total cost is for the extra bookkeeping and taxes and whether or not the LLC will really protect you. One problem with LLC's is when you don't do everything perfect you lose your protection. The other problems are many banks and vendors do not want to business with LLC's because they feel there is no Personal Liability. Who does the creditor hold liable for payments not made?
Personally, I am 100% for the C-Corporation because at the end of the fiscal year I wipe out my bank corporation bank accounts so I don't have to pay double taxes . My corporations never pay one penny of tax with the exception of my annual corporation fee of $800 and then I only pay my personal taxes.
For those who do not know what double taxes are; when you have a C-Corporation that earns a $50,000 profit at the end of the fiscal year the corporation had to pay tax on that profit. So, the corporation may pay 20% x $50,000 = $10,000. That leaves you with $40,000 you can pay yourself. So, when you pay yourseld the $40,000 you pay another 20% x $40,000 = $8,000. Now, from your $50,000 you have only $32,000 for yourself. If you pay yourself the $50,000 before the end of the fiscal year you would pay $10,000 in tax and have $40,000 for yourself.
You really need to do your research to see how taxes work for LLC's.
Do your research online for the pros and cons of LLC's.
An LLC is primarily as asset protection tool. My personal rule of thumb -
If personal wealth + investment wealth < $1M, then use $2M umbrella policy
If personal wealth + investment wealth > $1M, then use $2M umbrella policy and LLC
@Account Closed thanks for your reply and the additional considerations to take into account. I was aware an LLC could make finding bank financing more difficult, but hadn't thought too much about the tax side. Definitely a lot more to learn.
@Terrell Garren thanks for your reply. I like your rule of thumb, it's simple to understand.
One of the main reasons I've been considering the LLC is to keep the investing and personal finances separate. My wife is very reluctant to take on additional debt in order to invest in real estate and holding the properties in an LLC is one way is one way of making the thought of investing more tolerable for her. I'm sure there are other ways to, I just haven't learned them yet.
LLC don't exist for the IRS. They are state structures.
An LLC can be taxed as a partnership, a C Corp, an S Corp or totally disregarded.
Most LLC structured for buy and hold real estate are usually either taxed as partnership or disregarded entity. They are as such tax neutral for its member and don't pay taxes directly as they pass the tax to the member(s).
They are used for asset protection mainly. The problems created by these LLC are the cost to maintain the entity (state fee, registered agent), maybe a 1065 informational tax return CPA preparation cost for multi member LLC taxed as partnership (but you can also do it yourself), the higher cost of credit (lending rates for LLC is usually higher than for individuals, and lenders are more difficult to find), and the cost of using a lawyer to represent your entity in court when needed.
On the other end, they will insulate your assets in case of lawsuit from either inside liability or outside liability attacks.
Only you can decide if the cost of creating, maintaining and operating such entity is worth its protection benefit for you.
In my personal case I made the decision to use multiple entities to hold each of my real estate asset, using also other tools like land trust, holding LLC and also a management c Corp for some of its tax advantage and benefits.
Thanks @Mike S. , great information.
@Derek Loveland it really does depend on what your cost is to keep your LLC's registered. You are not required to file tax returns for each individual LLC. They should roll into your personal return on your schedule E. That being said, talk to your current CPA to verify what your state specific rules are.
As Mike noted above, LLC's are used for liability protection. Different investors will tell you different ways to set your businesses up; I come from the school of each property needs it's own LLC. It is best to set the LLC up how you purchased the property. If you and your spouse bought the property together then set the LLC up 50%/50% and title the property in the LLC's name (even if there is a loan on the property). Being the property was owned by both of you, you can own the property in a LLC owned together.
Setting up LLC's require banking accounts for each individual LLC. You will want to deposit the rents inside the LLC's letting the account balances build up. You can take some of the money out once you have some reserves built up.
The umbrella is an important tool as well but you want to make sure other insurance; homeowners and auto is set up correctly.
What are your rents on your current rental?
I would cash out refi the home you purchased in 2013 to 75% LTV and use the money to pay off the $30k HELOC. Minus closing costs you should have about $59K to use to buy two or three other properties depending on the purchase price in your area. If you are risk adverse, put $10k in a reserve account just in case it is needed. You would only set the loan up this way if the rents covered the payment plus some additional cash flow.
If you are thinking the refinance makes sense, then you want to complete your refinance before you title the property in the LLC name. This is because there are lending rules if you change title how long the change in title needs to be in place before you can borrow money against the property.
The next question is how many rental properties do you want to own? Do you want to manage the properties or use a property management company?
Sit down and create a strategy of what your ultimate goals are and then talk to a lender to see what is possible.
I would be happy to answer questions if you would like to visit. Direct message me your phone number or email if you would like to connect.
Thanks @Tim Roberts , a better understanding of the lenders perspective would be quite helpful.