LLC or not?

Question

So me and two of my friends are going into REI together.  We plan on purchasing multi-fam units and renting them out to people.  By the end of this year, we plan on having two properties; one we live in with an FHA loan and one investment property.  Long term we want to expand to have at least 5 houses within the next 4 years. Would it be smarter to have all 3 of us on each title and worry about an LLC later, when we have more properties; or make an LLC and have the title under the LLCs name?  Thanks

Jon Holdman · Answer

Tax-wise, this has no effect at all.  A multi-member LLC is treated as a partnership.  But you've already created a a partnership.  The partnership needs to file a return and send the partners K1's to use for preparing their own taxes.  You CPA (you have one, right?  If not, get one) can help you do this.

An LLC will help formalize things.  But more important than the LLC itself is the operating agreement.  That would document all your agreements regarding the properties.  You need to do some serious thinking about all possible issues.  Like what if someone needs money and want out or partially out?  What if a property needs money and someone doesn't have their share?  What if someone gets married?  What if one of you dies?  ETC.  You need to do this NOW (LLC or not) so you have something to fall back on when disagreements arise later.  And, rest assured, they will.

I have done this.  I think this is a bad idea.  Forming an LLC will help set things up more cleanly, but the real key is to have a thorough understanding of how the partnership works.  Disagreements will arise.  If you don't set yourself up right now to handle those, you're going to have a tough time later.

Account Closed · Answer

Thanks a bunch for the info Steven Hamilton II!  We all plan on being on the title together and probably after two to three properties we will put them into a LLC.  Very good to know about the taxes, I had no idea where to even begin with that.  Thanks for your help.

Account Closed · Answer

Thanks Derek Melander.  I'll certainly look into that book!

Account Closed · Answer

Good point Jon Holdman.  I guess we'll continue to take baby steps as we go along and have all 3 of us on the title and have less risk. Thanks again

Account Closed · Answer

Another thought:  Since you can typically only have 4 mortgaged properties under your name, does this follow the same suit as an LLC?

Account Closed · Answer

Jon Holdman- Thanks for the great advice.  We will certainly talk everything over in regards to contingency plans and what not.

Chris Masons- Thankfully we've been best friends since 5th grade and actually share the same short & long term goals!

Kerry M. · Answer

We used www.northwestregisteredagent.com to form an LLC.  A Maryland lawyer recommended it (I think it's good for all states, however.)

Steven Hamilton II · Answer

Mike Stanphill,

Jon Holdman is correct in that you will automatically be considered a partnership the moment you have decided to be partners wether you have a physical agreement or not.

In my opinion if you can have the LLC in which all three of you are members on title, that would be ideal.  An LLC upfront is not necessary; however, I recommend it for the pruposes of formality in your situation just as I insist on a proper operating agreement.  This operating agreement should discuss everything about the business including how decisions are made, what will be done in the event someone wants out, or passes away, etc.

You will file a partnership return unless you elect to be taxed as a corporation. The partnership will file Form 1065 US Return of Partnership Income.

Derek Melander · Answer

Hey Mike,
I am just getting started as well and just read Garrett Sutton's Own Your Own Corporation.  Good overview material and a quick read as there is much more to think about than just taxes.  You also have to consider asset protection which he goes over in the book.  Anyways, I found it real helpful in my decision making process. 
Derek

Jon Holdman · Answer

If you're mortgaging a property in an LLC you will have to get a commercial loan.  All the four property limits go out the window.  As do 30 year fixed rate loans.  As do 95% (or more) of possible lenders. There are lenders out there that will do this.  The tend to be smaller banks or credit unions.

If you and your partners are all on a property in your personal names and all on the loan, then that one property counts against the limit for all of you.  Further, you will usually have to qualify individually.

OTOH, if one person holds the note, he's taking much more risk than the others.

LLC or not?

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