How To Pay Yourself From Your Properties
New to Real Estate · Stuart, FL · Member since 2019 · 28 posts · 47 votes
Perhaps this isn't the right place to ask this, but in the most innocent way possible I am curious as to how people who have quit their jobs in order to pursue investing as a full time gig make money. Basically anything I've read states that you have to keep your money separate from the properties or any personal assets can become a liability and at a risk of loss. If you are creating an LLC for your investments, how does one (eventually) use the income made on investments as personal finance without blending the two? If not operating or investing under an LLC, how do you prevent your personal assets from the risk of potential lawsuits?
You get “paid” automatically....the llc is disregarded as far as taxes go, so you’re paying tax on any profits anyway, you simply take the distribution...no need to “pay yourself a salary” as that turns passive income into active income, with ss/med taxes getting added in.
@John Teachout How do you protect yourself from a liability standpoint if something were to go wrong? Don't your personal assets (other properties, personal vehicles, etc.) become at risk during a lawsuit if something were to happen sans entity?
If I could be convinced that holding properties in an entity would completely protect my other assets, I'd be doing it. I've just heard too many instances of those walls being easily knocked down.
I also don't have an umbrella policy because when I looked into it, I would have had to increase liability limits in many other areas of insurance such as auto, etc. I am very much a minimalist when it comes to insurance. ie, I'll buy enough auto insurance to meet state requirements to buy license tags. I have high deductibles on all policies, etc.
I'm not a deep pocket. We own our properties free and clear but all of them added together wouldn't buy one duplex in California.
I don't lie awake at night wondering if/when we'll be sued for something. No matter how much insurance or protection one has, is it ever enough? So we just live our life, keep our properties in good order, maintain good relationships with our tenants and continue looking for good deals on properties...
@Cody Malave R.E.S.P LLC. Respect it but it doesnt solve all your liability issues. The simplest way to solve this problem is two fomd because the liability of giving you advice is so specific to your situation. You need a tax strategist, a cpa, and a lawyer. And you need to find some balance between all of their ideas.
I don't take any money out of my rentals. It all goes back into the company for more rentals. The money I live off of is flips and wholesales. It takes a while to build up enough rental income to live off of.
@Cody Malave
99.99% chance you will never get sued so don't sweat it. Make an llc and don't have too much equity. When lawyers see a lot of equity in property, they're more likely to sue. Also, you can get insurance but tenants and lawyers are more likely to sue if you have insurance so it's a double edged sword.
Unless, someone owns huge multifamily properties, I think getting umbrella insurance is BS. The chance of a tenant suing is 0.1%. The chance of a lawyer taking on a case when the landlord has low equity, an llc and no insurance is zero percent. Then ask lawyers how likely it is for them to actually get the money. Lawyers want big fish, not bob who owns 4 properties in llcs and with no insurance and low equity.
@Nick Barlow I'm in the same boat as you...haven't paid myself anything yet. Proceeds are all going back into the trust.
We tend to be so worried about getting sued. I have an LLC for my 8 rentals and it's a hassle to be honest. Wish I would have just done an umbrella. Has anyone heard of anyone being sued as a landlord? If so, what happened? How much for and did they go after personal assets? I assume they will only sue for the liability amount and settle with that.
I have an expanded question on the original. Once you've bought a property and it is getting income, are there any special details needed to add capital (out of pocket from personal) to it for your next purchase/down payment if needed? I realize you can track any money you put into it from personal, but are there tax issues or anything that need to be accounted for?
@I K.
I would avoid taking out a loan, it just makes things messy for no reason. And you get hit with payroll taxes on wages so i would avoid that too.
It’s best just to take shareholders draws/distributions when you need the money
@Chinmay J. I agree. I do need to purchase a property first, but I'm trying to do my due diligence before just hopping in. I more or less have 1-3 down, and still in search of 4. I'll be starting small but I don't want to learn small so to speak.
@Cody Malave
No need for an LLC if you don't own anything yet. Just buy the first good deal (strong cash flow after accounting for vacancy, repairs, capex, prop mgt, etc) and get your feet wet. Stabilize it, then in 6 months / 1 yr buy another one while incorporating lessons learned from the first one.
There is a lot of info out there saying you must set up an LLC first to create a liability separation but honestly, if you are just starting out, and you're not a multi-millionaire already, you really don't have much for tenants/lawyers to go after in the first place.
Point being, don't let setting up an LLC delay your pursuit of financial freedom and jumping in on a good deal (cash flow after expenses) Property. Spend the time you save on NOT setting up an LLC on analyzing 70 - 100 possible RE purchases. You'll be better off.
Once you pull the trigger and own a few properties, you can set up an LLC and have the equity/assets to warrant one.
Best wishes on your start!
@Cody Malave
If I were to give advice to a younger person who is just starting out I would say stop analyzing and start taking action. A typical newbie starts out investing and using FHA as house hack or conventional with 20% down then Id say KISS...Keep It Simple Silly (PG version). Buy the first 10 under your own name if you have a good W2. You will get best rates and terms on a 30 yr fixed. Invest time in finding a good insurance agent who can give you good policies that will protect your assets and yourself. Add Umbrella policy for the extra layer of protection. Forming an LLC or Living Trust or any other method that gets tossed around is waste of time and money. Most of your rentals will not have much equity so most attorneys will not bother.
In current RE climate it will take time to pay yourself a wage so you can quit your job so dont worry about how to pay yourself if you have yet to generate cashflow. That will take time and by then you will have developed so much more knowledge by doing than reading most books.
I would advise you to stop analyzing and take action. Learn to find deals, negotiate and the other half of the equation will be easy to figure out. Go through the process of buying and locating deals. Let the money pile up in your account then figure out how things work from there.
Best of luck and hope you crush it in 2020.
I appreciate everyone's feedback, and I'm so grateful to be a part of this community now.
@Luciano A. I agree with the action over analyzing aspect of the pursuit, but action without knowledge is worse than delayed action. My initial goal is definitely house hack, and because of the area I'm in, I will probably end up with an SFH and renting out individual rooms rather than getting a multi-family because the whole plex scheme doesn't really exist here. That, or they cost an absurd amount of money and don't make a lot of financial sense. I'm talking a fairly run down triplex for 300-400k with current tenants paying 800-1000 per unit.
I would love to invest out of state where the market is much better but relocating for my type of work isn't an option so I'm stuck investing here if I want to pursue the househacking option. An unfortunate but necessary evil for the time being. I lived in a highly saturated HOA. So I need to do more research on renting out rooms individually as I know most HOA's aren't a fan or don't allow that. Just trying to cover all my bases as I go.
I appreciate the information! I haven't actually acquired any properties yet.. just trying to cover all my bases before I jump in. I plan on househacking in the beginning to have a lower initial capital investment but I wasn't sure how that worked liability wise, particularly if I was doing it in an SFH instead of a multi. I suppose talking to an accountant would be my best bet?
Since you're early in your experience, this would be a great time to get educated.
The question you're asking has to do with structuring your business entities for the best advantage. You can also build asset protection into that, but that's a separate discussion.
You'll want to learn about how cash flows through a business entity structure. While I'm not a financial or legal professional, what I have learned is that you don't want to take cash through an LLC. You'll want cash to come through an LLC into an S-corp where you can set yourself up as an employee. You can then take a minimal salary plus a dividend. The salary is subject to SUTA / FUTA / FICA, etc., however the dividend is regular income (lower tax rate). The usual split is 1/3 salary, 2/3 dividend. That way you have a personal income to support your credit profile. As an employee, you can also set up a 401(k) or a Roth IRA for yourself thru the S-corp.
The education I have includes a 2-day Tax and Legal class (on-line, on-demand) which explains it all in great detail.
@Cody Malave
Wayne nailed it...I’m a full time buy and hold landlord and I pay myself whenever I need money. No set schedule. It’s a “member distribution” not a salary. The nice thing about being a landlord is that most, if not all of the money I pay myself is tax free due to depreciation. So my running joke is that I pay myself with money that the IRS says doesn’t even exist.
Your mindset has a flaw in the depreciation is to allow replacement when the usable life has expired. These cap ex item expenses is a certainty. You may think some of the items have life beyond the depreciation period which is true but many of the cap ex items have lifespans less than the depreciation period So the irs is not indicating that money does not exist but realizing those expenses do exist and is a cost of owning a rental unit They have decided instead of you writing off full value of the expenses when they occur that you can depreciate the expense starting with the full value of the structure at purchase.
To add to my reply. For the life of me I can't figure out the advantage or disadvantage of an LLC if you don't have any employees. There are pros and cons but it seems very complicated and not needed for the most part. I really don't want to have a hundred rentals and a hundred LLC's and then three holding companies. I thought REI was anoint passive income and sitting on the beach drinking margaritas and Coronas for crying out loud.
@Fred Cannon I'm certain that we both know it's not truly passive. It's definitely about enjoying the life it offers vs. the work it requires, but I'd rather get the sweat equity in now and retire by say, 45, then just piddle along so another 30 years making minimal gains. I'm not chasing exorbitant wealth, but I do intend to live above what most consider comfortable. Anything under 100k in annual net profit doesn't feel worth chasing. 100k in 15 years, that's the starting goal. But that's a minimum.
Our RE is approaching 8 digits in value. We strive for 75% LTV but are always lower for various reasons (probably ~50% right now). I suspect this places us as mid size RE investors on this site. So we have substantial equity in our RE.
Our tax person who is also a lawyer has told us that lawyers are offered classes in piercing LLCs. He has taken a one day course on this subject and believes there are a lot of ways to potentially pierce the LLC. In addition, in CA each LLC has a minimum $800/year tax.
All of this was taken into account on our asset protection. We have a single LLC with no illusion that it cannot be pierced by a good attorney. We hope that it may discourage a law suit but it may not do anything other than provide us our name at a cost of $800/year.
We also have an umbrella coverage that should exceed any judgement. This is our primary legit form of asset protection. I am a fan of the umbrella coverage not only because there is no separation of entities to be pierced but it is like having a world champ on your tag team. If we get sued, it is the insurance carrier’s battle at least as much as it is my battle because unless it goes over our coverage limit, the insurance will be paying it.
We have never been sued in RE but we are threatened with suit often (many times a year). Most are so frivolous that they would not bother me without the umbrella coverage. However, a few have had enough merit that it may have caused stress if it were not for the umbrella coverage (for example evicting a tenant with ESAs for lease violation of repeatedly introducing ESAs without following the process in the lease). Since the umbrella coverage, we have only been threatened by one suit that caused any stress, me a little stress, the wife quite a bit of stress. It was an easement dispute. The other party had a lawyer who was feeding us his interpretation of the easement which was BS. I told him I would be seeing him in court and we expecting it to go to court. Nothing has happened in over a year and I now suspect nothing will.
I think it is good to think about your asset protection early. I believe an umbrella coverage is sufficient for quite a while. I suspect $1m coverage would provide someone new plenty of protection. You can scale it up as your net worth increases. The cost does not increase much for significantly higher coverage but I just do not believe someone starting out needs more than $1m of coverage. How many lawsuits against individuals exceed $1m of verdict?
Good luck
@Cody Malave Cody LLC's are only one part of protecting personal assets. They do have a maintenance cost and are sort of a pain in the neck when it comes to loans and such. Another and maybe better way to protect personal assets when you are starting out is with an umbrella policy or by increasing your liability insurance on each house. This is relatively cheap to do. In the overall scheme of things my personal assets (boat,car, toys, and cash on hand,etc) are much smaller than the equity in my rentals. This is done on purpose me thinks. Remember a lawsuit cannot get the portion of the asset owned by the bank. Proper leverage management helps this as well. You have to be very careful with leverage but at the same time fully paid for properties are targets. There is a fine line there. Lots of people worry about getting sued but it seems to me that in realestate the ones that get hit with lawsuits that are bigger than the liability insurance on the property did something to be sued for. RR
Ok so if your goal is 100k a year income you are going to need to invest around 1 million at 10% return over the next 15 years. At today's prices a 10 % return on REI is obtainable but it's getting harder to find. It's a competitive market. Also figure you will have another million or two of debt to cover as well. This game is not get rich quick unless you are rich in the beginning. It's a game of adding assets as you go. Debt does not equate to wealth, just my opinion. That's why the banks have all the money and we have all the debt. Not trying to rain on your parade just saying don't quit you day job just yet. Have a plan and create the path. Good luck, stick to it and you will succeed and be successful make sure your deals have cash flow and appreciation. When using Other People's Money just remember they want it back. Advice from a guy old enough to be your Dad
@Mark Beeson. I just re financed 4 properties and sold one. I put about 150 k in the bank tax free there's no income tax on a loan. The payments on the four re-fis went up about 300 a month overall but went from 25 yr amortizations with balloons to 30 year ams and no balloons. I took some of the proceeds and bought another unit all cash that produces about 400 a month cash flow, and I will use some of it to pay off my storage units for another 600 a month CF. That left me around15k to spend. One of the re-fi's was my primary I bought last year. That payment dropped $200 a month. At the end of the day I picked up another 6-700 a month cash and had 15k left over. The payments for the new loans are all being made by the tenants in those houses and I'm making more than I was before. The house you spoke of with 300k equity that cash flows 173 a month needs managed or sold. It's netting .006% a year or 2000 a year. The 300k is losing buying power ( the time loss of money) at a rate of .02% or about $6000 a year. Unless the house is going up in value faster than that the property is loosing about $4,000 a year. That's how financing can help you out when the market is hot. I don't use HELOC's. I use cash out re-fis and either Portfolio loans or conventional's. I'm 66 and try to keep my global leverage pretty low so as to keep my cash flow a little higher. A younger man probably could go with a little higher loan to value ratio in order to grow his portfolio. RR
@Tracy Munger nope it’s called an owner contribution. Taking money out is called an owner draw. Simple as that. Just do it electronically make a note in the memo box. Your CPA can look at the note online and put it in the proper category. At the end of the year he has most of what he needs to file your taxes RR
@Fred Cannon I appreciate the advice. I have no interest in getting rich quickly, or really at all. I think 100k a year is a modest income while also being an achievable goal. If on average each property cash flows positive at say $300 a month, and I acquire 30 in a 15-year span, that's only two properties a year at $108,000 income. There are countless individuals who make millions in a much shorter or similar time frame, so I feel as though I'm barely grazing the surface of what some consider to be a lofty goal.