LLCs and personal mortgages

38 Replies

Hello BiggerPockets!

I'm exploring the possibility of getting a 10-unit apartment building. With that in mind, I'm wondering if I should get an LLC.

Benefits of LLC:

1. If I live in the property, I, Jared, can rent from my LLC, and that provides come interesting tax advantages. Though I got lost in the weeds here, I couldn't quite figure out how advantageous that would be.

Could someone please provide more insight on this?

2. Liability protection. Well, sort of. Everywhere I read says just go for good insurance, at least for newer investors. Maybe when the portfolio gets larger, or if I were branch into other areas of real estate, it would make sense (wholesaling, agent, flip, etc.).
3. If I want to go buy more real estate, the commercial loan and LLC don't show up on my personal credit.

That's pretty nice if I want to go buy future 1-4 unit properties. However, I've read that the commercial loan / LLC is still something I need to disclose as I try to get funding for my next property. So, does the LLC actually benefit me at all, when it comes to seeking future loans? If the lending institution knows about the commercial loan / LLC after all, it seems like I would probably qualify for the same mortgage amount that they would lend to me without an LLC, but just perhaps I would get a better rate with having the commercial loan in the LLC because I would have better credit.

The reason I ask is because I have not yet utilized the oh-so-beautiful FHA loan, so after I use my full borrowing capacity on the commercial property, I'd probably try to buy up the most expensive 4 unit or smaller that the bank will let me purchase, and knowing how LLCs impact my personal borrowing ability will help me gauge how much I should be able to borrow for the FHA loan. And if I should get the LLC at all.

Cons of LLC:

- It costs time and money to set up and maintain, and it costs different in each state. So...to know if I should get one, I should just make sure the benefits outweigh the cons.

Are there any other pros/cons I'm missing here?

Thanks in advance!
Jared Ryan

@Jared Ryan

You might want to read this first:   https://www.biggerpockets.com/...

Some more info is here:   https://www.biggerpockets.com/...

Next, in general consult a professional...  Also, consult a professional about #1.  That should be a self rental situation.  In that case, your rent is considered active income, subject to all taxes at your ordinary rate including self employment tax I believe.  Meanwhile, your expenses are passive.  That is a really bad situation.

The LLC doesn't provide any tax benefits, only liability protection. But, that being said, there is much talked about how lawyers are able to pierce the corporate veil. I think its because most people don't operate their LLC correctly. Many brag about all the deductions they are doing and that their cpa/accountant is doing for them and its right. However, the corporate veil is a legal issue, not an accounting issue. So, "pure" accountants don't know or care about the corporate veil issue.

Protecting the corporate veil basically brings in lots of additional costs/overheads. The big one is needing to use commercial financing since a legal entity, such as a LLC, is not eligible for conforming residential loans.

Realize that 1-4 family homes are considered residential.  5 or more family homes/properties are considered commercial properties.  So, if you are doing larger properties you are going to be handling it as a commercial transaction anyway.

FHA loans require owner-occupation.

I'm not so sure you understand what you are trying to convey with the following: "...so after I use my full borrowing capacity on the commercial property..."  I don't.

Be wary of those that want you to have the loan in your personal name and the Title in the LLC. I elaborate more in this discussion:

https://www.biggerpockets.com/...

Also, I don't think you fully understanding how real estate lending works...

For your reference, here is a post on the insurance idea side:  https://www.biggerpockets.com/... .  The general idea is when you are starting, you really don't have that much liability that the insurance can't handle is the short of it.

I'd  be happy to chat if you'd like.  Its save me from having to type out a "one-way lecture."  Good luck.

A proper LLC can offer you a lot of privacy as well, which is a big value to a lot of investors. A commercial loan may or may not be recourse, you'd be well suited to talk with lenders about your specific situation. Commercial lenders do take care to evaluate their borrowers and make sure they are well qualified.

I would talk with a CPA about that first one. I'm not sure that's true, as LLCs are subject to pass through taxation. 

@David M. Thank you for the links, I dive in when I get the chance. I'll try to keep my responses on the forum instead of your inbox in case other people have similar questions.

Thanks for clarifying the part about renting to yourself. It seemed kind of odd. I should just check in with experts if I go with the LLC route, and they can help me get the most out of it tax-wise (if anything, since that isn't really its purpose) and liability-wise. As you said, it only semi-protects you since you can pierce the corporate veil, and I think that's why everyone says to just get an umbrella policy for your insurance, instead.

To follow up, my idea is to
1. Sell my current home
2. Buy a 10 unit apartment building with commercial real estate loan.
3. Buy a 1-4 unit home with FHA residential loan.

The idea is to buy the 10 unit building first, with the reasoning that without any mortgages on my record, I'll be more likely to quality for a better loan than I would if I had an FHA loan on record. So that's why the buying order is 10 unit apartment building, then personal residence with FHA loan. And yes, I would live in the FHA home for 1 year, no fraud for me. Anyways, that's what I meant by "use my full borrowing capacity on the commercial property".

So, that's the plan. With the LLC in mind, I'm wondering if I should change it to:

1. Sell my current home
1.5. Set up an LLC.

2. Buy a 10 unit apartment building with commercial real estate loan with an LLC.
3. Buy a 1-4 unit home with FHA residential loan in my name.

If having the commercial loan in the LLC's name instead of mine gives me a better credit score (since I heard the LLC does not impact your personal credit score), I'm wondering if that means I can qualify for more on my FHA residential loan in my name than I would if the commercial loan was in my name. However, I hear you still have to disclose your LLC's commercial loan, so I'm guessing that putting my property in the LLC means I wouldn't really quality for a different loan amount on my FHA residential since the bank is still aware of it...but perhaps I would get a better rate on my FHA loan since my credit score would be better with having the commercial loan in the LLC's name instead of mine.

Having mortgages in your LLC instead of personal name has nothing to do with your credit score, you still can have a top score even with a few mortgages on your credit report. You score actually might be higher with at least 1 mortgage than no mortgage at all.

I just refinanced a couple of conforming mortgages under my name and it was very very hard to qualify, they insisted that I paid off a $137 credit card balance but they did not care at all (did not ask) that my LLC has 1+ million in mortgages. They saw my LLC tax returns showing large mortgage payments (lots of claimed interest) but they counted zero of them towards my DTI. The millions in LLC debt did not matter at all, but a $15 personal credit card payment almost killed the deal…


Buy the 10 units under the LLC so it will not count towards your DTI when you apply for a conventional personal mortgage down the road.

@Jared Ryan

As mentioned above, your credit score (which is really a reflection of your credit history) is really only a portion of qualifying for a loan. This is part of my comment about I don't think you understand what it takes to qualify for a loan. Your DTI is very important and having an investment property can help or hurt it.

I'm not sure how a residential lender will address the LLC. While it is a separate entity, it should be considered part of your income. Unless you get really complciated, you will be some sort of, if not sole, owner of the business. I am guessing the other gentleman's issue was this dti was so tight the easiest way to address was to make that small pay-off.

Again, you need to consult with some qualified professionals upfront about this.  Good luck.

@Jim Spatzenfeld I remember getting the mortgage on my current house, and your story about the credit card is all too relatable. You really concerned about the $25 I have on my credit card when I've made my payments on time for the entirely of my credit history? I'm not suddenly going to go rogue here...

Thanks for sharing your experience about the underwriting process for your conforming mortgages, and your advice.

Just make sure your lender doesn't report the LLC mortgage on your personal report as I heard a few of the lenders do. I have a few mortgages and a few credit cards as well a truck loan under my LLC and none of it shows on my personal credit report.

@David M. You're right, the DTI is the most important part. The focus on credit card was just quoting from another thread about LLCs, and how they don't impact your personal finances. But if that also applies to DTI, then this is a bigger deal than I thought.

The real question is: if I put things in an LLC, how will that impact my personal application for a conventional loan? It appears from Jim's experience that if you put it in the LLC, they don't impact your personal application at all. And, for me personally, putting my 10 unit investment propertiy in an LLC would be much better for my personal DTI. So, I'm leaning that direction.

So, as you mentioned, David, now that I got some information, I can take the question to a few loan officers and know just enough that I can understand what they have to say about it. I was hoping one would show up here and could clarify, but I need to get some quotes on both types of loans for this anyways, so I can kill two birds with one stone.

I think you guys are mixing up the diference between the credit score vs. qualifying for a mortgage.

Don't forget, you LLC's finances will be reported via your tax returns.

@Jared Ryan

Your post just showed up.

Right. Your LLC is a company that you own. It will be on your taxes, regardless if you have a single member LLC or a multi-member LLC. So, that income/loss will be there. That will affect your DTI. this is no different from owning the property under your personal name. Remember, having a LLC has no tax advantages.

I think you mis-interpret Jim's experience. The DTI is not "from the LLC" or "from you personally." It is YOUR DTI. The easist way for them to get his DTI up was to make that small credit pay off. He was obviously that tight.

Again, time and time again BP posts have said that LLC's provide no tax advantages (unless investing with a non-spousal partner). The bottom line is your tax return will look the same regardless if you have a LLC. Perhaps the only differenece is in a multi-member LLC the k-1 effectively hides the details of what would be on a SchE (or so I'm told since Id never received or seen a k-1).

Anyway, yes get off a public forum and enage with some good lenders.  Find out what you can really do with your financial situation.  Good luck.

@David M.  Okay, I think understand now.

LLC Facts:
- An LLC really should limit my liability to whatever properties is in it, if I run it correctly by not piercing the veil.
- An LLC will not affect my DTI as the sole owner. If I get partners, then it could change my DTI...but it gets complicated, so if I get to the point I have partners, then I'll look more into it. Good to keep in mind as I scale.
- An LLC does not show up on my personal credit score. Good to know, but not super important for getting loans.
- An LLC has no tax benefits.

LLC as applied in real life:

As a solo investor, it makes sense to talk to a professional to figure out if it's right for my current risk profile, since its usefulness could swing either way, especially with good insurance being a good alternative.

And if/when I get into business with other people, then it's more of a necessity, and I should talk to a professional about setting that up correctly.

Does that sum it up pretty well?

@Jared Ryan

Really quick look at your profile.  You havea buy and hold staring Dec 2020.  Did you put it in service Dec 2020?  If so, it shouldbe on your tax return.  It would be on SchE.

If you have a single member LLC, you still report it on SchE. Since its a disregarded entity, your tax return looks exactly the same. If you have a multi-member LLC, the details are reported on the 1065 partnership return to the IRS and a K-1 is sput out to you (like a 1099 or W2). Your profit/loss is still reported on your 1040 series filing. However, the math is still the same... the deductions are the same... the characterization of hte income is the same..

So, either way you will have profit/losses showing up on your tax return. As a result, this will affect your DTI. For rentals, residential loans will recalc your SchE with 75% of your rental income (NOT your profit) and they should back out the depreciation (since its a non-cash deduction). ((all of this is covered in various locations whether in multiple discussions on BP or online).

You do realize that DTI stands for debt-to-income ratio, right? Your LLC will be generating income/loss to YOU. It is your business after all.

Depending on your personal credit history, perhaps you want your investment loans to be reported to help your credit history.  Granted, it doesn't take much to generate a decent credit score.

As mentioend in the posts that I gave you for reference, you pay for hte limited liability protection of the LLC. "Everybody" seems to want to get the protection "for free." Most professional will "sell" you on the need for the legal entity. But, they don't always consdier the additional costs beyond just hreir fees.

I should mention that my LLC is a 2 member partnership (wife+me) and we file a 1065 partnership return, which the banks of course always want to see. If you have a 1 member LLC then I believe everything is just alone on your personal 1040 tax return on schedule E, as far as I know, and your case would be totally different from mine.

Having the mortgages under my LLC made huge difference in qualifying for regular mortgages under my personal name.
 
For example, if your LLC has 5 million in mortgage debt and on your tax return all the rent only pays the mortgage, tax, insurance, etc and on your taxes the LLC makes only let’s say $1,000 profit for the year. 
Then you have all your other personal income, let’s say $100,000.

Now you apply for a mortgage under your name. They count all your income, which is a total of $101,000 and then for your DTI they calculate only all your personal debt, let's say your debt is $40,000 a year = DTI of 40% = you qualify.

Now if you had the $5 million LLC debt under your own name, which is let's say $300,000 interest per year, your DTI would be over 300%

Try to go to the bank, tell them you have $100,000 a year in income and you pay $300,000 a year in debt. Answer: you’re denied!

I was not able to get any personal mortgage until I transferred my mortgages to the LLC, even though I took on a lot more debt by taking tons of cash out through the LLC transfer.

Huge difference if you have debt or your LLC has debt!

@Jim Spatzenfeld

LOL!  nice.  but you provided greater/better detail from the partnership return front.

@Jared Ryan to tie in with what I was writing... if you lookat SchE, all the details of your income/expenses will be on it.  As I have heard/read which Sptzenfeld confirmed, the details are "hidden" on the 1065 partnership return.  The K-1 just gives you the bottom line profit/loss to report.

Honestly, I'm not entirely following his debt examples.  You can have plenty of debt, but if you were investing "wisely," you'd have the income to service the debt.  At one time I had over a million dollars in combined residential debt and I still qualified for another investment conventional loan with just my salary (no, I'm some doctor or lawyer raking it in) and the my 1040 (including my SchE).

Again, lots of the financing issues are specific to your situation, and what situation you may find yourself in the future.  Good luck.

@David M. To answer your question, that property is a househack. I bought it in December and found renters for the other 3 bedrooms in April, so I'm unfamiliar with what a SchE is. Is it this? https://www.irs.gov/pub/irs-pd...That's good to know what to expect for my tax returns next year. I frankly don't understand everything you said with respect to this, but that's fine, that's out of scope for this post, and I can study up on that for next year's returns.

Regarding the LLC, everything you said makes sense. Thank you for your patience in explaining it to me. So...if I understand correctly...

An LLC is a legal entity that can be set up to isolate a business from the owners' personal finances. Setting it up and maintaining it has a set of fees. The benefit is of the LLC is that liability is limited to the LLC: in other words, an LLC doesn't show up on the owners' personal credit score, and the owners' personal assets aren't on the line if the business is sued—as long as the LLC is run correctly (you cannot "pierce the veil") and legally (if you commit crimes in the name of the LLC, it's still "you" who committed them). Only the assets the LLC owns are liable. If the owners want to protect the LLC, just like with anything else, they would take out an insurance policy on it.

All profits/losses just "pass through" the LLC to the owners as agreed upon in the operating agreement. In simple terms, if you're the only owner, then all profits/losses are yours personally; they belong to you, and they show up on your personal tax returns. 50/50 split? Then 50% of the LLC's profits/losses show up on your personal tax return.

@Jim Spatzenfeld Thank you for giving me a practical example of how it can be useful for acquiring properties! I am just very grateful for the BiggerPockets community right now, I feel like I'm learning a lot in short period of time, and it's keeping me out of analysis-paralysis.

So, in your situation, you passed on your debt to the LLC in order to change your personal DTI, and you were able to get personal mortgages. That makes sense to me. And it works inversely, too, right? That means there is a separate DTI for the LLC. Which, in your example, wouldn't look as good since you just transferred all the loans to it. So, if you wanted to borrow from the LLC in the future, you'd need to improve that DTI, and one way to work around that is to be the personal guarantor on the loans, so the lender can take your good personal DTI into account when underwriting the LLC's loan. Does that sound right?

@Jim Spatzenfeld With that in mind, it sounds like solid strategy to acquire residential properties, then, would be to acquire the funds, purchase them as yourself, then pass on the property and debt to your LLC. And repeat. This keeps your personal DTI as clean as possible, so you can keep borrowing as much as possible.

Just make sure to not go too crazy and over-leverage.

And I suppose this only makes more sense when you have more money to burn and are growing fast...since you'd need to refinance your loans over to the LLC. Or possibly take out commercial loans in the first place against yourself instead of a residential loan, and that would be directly transferrable to the LLC, if the lender doesn't complain.

This might also count as "piercing the veil". I'd have to look more into that and the threads David posted earlier, they talk more about that.

Found this on the first thread David posted: https://www.biggerpockets.com/...
 
Fannie Mae published new guidelines for lenders on November 8, 2017 that allow transfers to LLCs! Here is the exact language:

"Unless the previous borrower requests a release of liability, the servicer must process the following exempt transactions without reviewing or approving the terms of the transfer.

A transfer of the property to a limited liability company (LLC), provided that a) the mortgage loan was purchased or securitized by Fannie Mae on or after June 1, 2016, and b) the LLC is controlled by the original borrower or the original borrower owns a majority interest in the LLC, and if the transfer results in a permitted change of occupancy type to an investment property, such change does not violate the security instrument (for example, the 12 month occupancy requirement for a principal residence)."

So yeah...you could buy properties with nice, conventional, personal loans in your name, and transfer to the LLC. Just, if it's like an FHA loan, for example, then that's not okay. You'd have to refinance it to get a loan that is compatible with an investment property. And if you wanted to refinance that property into a new Fannie Mae loan, you'd have to transfer it back to a person. And transfer taxes may apply depending on your location.

But @David M. pointed out on that thread that this is bad as far as "piercing the veil" goes. I think I'm inclined to agree. So...this would provide some nice financial benefits to be get loansmore quickly, but if you were brought before a judge when getting sued, it seems like it would be hard to make the argument that your LLC is separate from your personal finances. So you'd lose the liability-isolation benefit of the LLC.

@Jared Ryan I would suggest that you find and talk to a few commercial bankers near you to discuss how commercial loans work.

A 10 unit building is a commercial property and whether you put it in an LLC or not you should operate it as a separate business entity. For lending purposes a bank will look at this property as a stand alone business and it will need to cash flow even after the debt is serviced for them to lend on it. They generally won't care what your personal DTI is for a commercial loan, but they will check your credit score. If the loan is less than $1MM (which I'm guessing it is for a 10 unit), the lender will almost certainly make you sign personally as a guarantor of the loan, even if you borrow as an LLC. It still should not show up on your personal credit report (none of mine ever have). What does show up however is a credit inquiry because the bank will still do a hard pull on you. That can temporarily impact your score.

If it was me, I would do the FHA first unless you were certain the ten unit would positively impact your DTI. Then buy the ten unit in an LLC.

Another consideration though, if you just bought a property in December, you will want to make sure that there aren’t any clauses in that mortgage about needing to live there for a year. Also, you mentioned in one of your posts about looking into the race filing requirements for next year - but if the house was in service in 2020 then it should be on your 2020 tax returns. This will also help you prove experience to the bank when trying to borrow for the 10 unit.

@David M.

Hey David, great responses and feedback!

Just wanted to chime in on the K-1. As an accountant and investor, I have single member LLCs and partnerships. You're correct that the K-1 hides the details, but generally the bank will ask for the form 1065 - Partnership return thus providing the details.

As far as DTI, with recourse commercial loans the banks use something called Global Debt. This is where they factor your personal debts & income along with the debt and income of your LLC adding back depreciation & interest as it relates to rental properties.

The banks have their own measure of risk tolerance, so you'll need to ask detailed questions to know what they are looking for. It's similar to debt service coverage ratio for a property which I've seen banks require as low as 1 up to 1.5 for single family.

@Jared Ryan

I just went through this process and was baffled at the underwriting process for our primary home. I've been pushing rentals properties for a few years now and hadn't been through the primary residential process in able 6 years. Now that I'm self employed & COVID, it was ridiculous.

It took 3 different lenders to finally get this done. The first 2 lenders I could tell the underwriting was done incorrectly because they didn't understand the tax return. I have Scheduled Cs, K-1s, & a S-Corp. It wasn't until I found the 3rd lender who understands self-employment income that my income was calculated correctly and matched what I was able to calculate based on Fannie & Freddie guidelines. 

@David Campbell Thanks for clarifying.  Yes, I thought the banks ask for the company's return, the 1065.  So, its really not all "hidden."  In fact, it gets more complicated, right, since the lender/underwriting has to pour over the company's books.

@Jared Ryan No, there is no real "transfering of debt" to the LLC. It seems to effectively come back to you... Plus, it sounds likeyou are falling into the trap I write about in the third link I posted.

Good researching the relateivel new rules on the Due on Sale clause. I think its in my other posts... I don't see that as an issue. It has little to do with the corporate veil... you should have refi'ed anyway into a commercial loan so that the lien and mortgage is under the LLC's name for the limited liability protection desired (or else, what was the point??)... and finally, if the Note holder does execute the clause, just refinance. If you are not in teh position to refinance (or will not in the future), maybe one should rethink this line of investment. Its called "investing" for a reason, vs. say a "job."