3 rental properties - Time to form LLC? OK to use Legal Zoom?

27 Replies

Hi Folks,

My business partner and I now have 3 rental properties in both of our names. We have read on numerous occasions that the best thing to do is form an LLC together and transfer the properties into it to mitigate risk and also take advantages of tax benefits. I am looking for advice as to whether this is the best course of action? and if so, would you recommend using a cheap online legal marketplace such as LegalZoom to do so? I have also heard putting each property into its own LLC is an good option.

Any feedback is very much appreciated!

A little background info:

We are 50/50 partners. We each own a primary residence.

Thanks!

First big warning: transferring property to a business entity will probably trigger the due-on-sale clause on your mortgages (i.e., you might suddenly have to pay the FULL amount of all 3 mortgages on the day you transfer into the company)

Second big warning: the best legal advice is that which comes from a competent practicing lawyer

So... I'm going to strongly encourage you to suck it up and pay for an hour with a competent local lawyer to discuss your goals and the best course of action to achieve them.

Hi Lewis,

Great question.  I am looking into the same thing as we have 2 rentals and I was researching Legal Zoom as well.

Originally posted by @Will Porter:

First big warning: transferring property to a business entity will probably trigger the due-on-sale clause on your mortgages (i.e., you might suddenly have to pay the FULL amount of all 3 mortgages on the day you transfer into the company)

Second big warning: the best legal advice is that which comes from a competent practicing lawyer

So... I'm going to strongly encourage you to suck it up and pay for an hour with a competent local lawyer to discuss your goals and the best course of action to achieve them.

We are using a small bank that has given us an assurance in writing that we are able to transfer title to an LLC. (They require 30% down, so no major risk for them!)

Originally posted by @Lewis Clarke:

We have read on numerous occasions that the best thing to do is form an LLC together and transfer the properties into it to mitigate risk and also take advantages of tax benefits.

In the event you need an LLC to shield you or your other assets from liability, do you really want to rely on a low-cost solution as your legal foundation? Of all the things to cut corners on, I wouldn't do it on paperwork that may one day save your rear end in a courtroom.

Get a good insurance policy and forget all the other hype.

Joe Gore

Originally posted by @Joe Gore:

Get a good insurance policy and forget all the other hype.

Joe Gore

@Lewis C.  

There are no tax benefits to forming an LLC for your rental properties. In fact, you will lose a benefit if you are currently taking advantage of the $25K net passive loss allowance. Unless you have a net worth in the high seven figures, you probably don't need the LLC. But, you do need insurance (even with an LLC). So purchase the highest liability rider coverage you can get for your rental properties.

@Lewis C. I buy all my properties in an LLC ... it;s cleaner, and I like it for accounting, and for the level of protection between my business and personal assets. With that said, nearly always you are signing a personal guarantee on your loan for the LLC.

You can have an umbrella insurance policy off your primary residence that covers your LLC from that standpoint. And run absolutely everything possible expense wise through your LLC as well ... we pay car, cell phone, internet, etc ... all of those things also benefit from having a business to run expenses through first and then pay taxes on the difference.

Always get a good insurance policy for your protection.

Joe Gore

Welcome to BP.

Having a series LLC is a better option than just regular LLC because you place one property in 1 series and second property in series 2, that gives you added protection. And YES, you do get a break on taxes because you bought property under your LLC and that is your business.

It actually helps  a lot in terms of capital gain tax as well. I am not a CPA, however I just saved a lot of money when I filed my 2013 taxes. 

Also, kindly spend some money and get a real estate attorney to set up your series LLC because setting up an LLC is not easy. It requires a lot of legal stuff and you want to make sure that you are protected.

Hope it helps.

@James Syed 

The Series LLC has not been tested in court, nor is it recognized in all states, so we are not sure yet whether the protection you mention will stand up.

I disagree that there are tax benefits the accrue to an LLC for a rental property activity. At best, the LLC pass-through entity is tax-neutral, though I have previously identified a potential loss in tax benefit for an LLC treated as a partnership for tax purposes.

For a residential rental property activity, I am not aware of any tax breaks (benefits) for an LLC that you don't already have if the property is owned in your own name. Likewise, I don't see capital gains treated any differently for the LLC owned rental property versus the personally owned rental property.

If you are seeing true tax benefits for the LLC owned rental property, then would you enlighten us?

Originally posted by @Nathan Brooks:

You can have an umbrella insurance policy off your primary residence that covers your LLC from that standpoint.

Nathan,

Are you sure.  My insurance carrier is telling me that they will not extend liability from my primary residence policy to a commercial activity.  I suspect this is the norm for the insurance industry. 

Perhaps, some insurance agents on the board will clarify the situation for us.

My CPA/lawyers state that my social security number acts like a business entity, I get to write-off my phones, vehicle, sq ft of office space in my home as business expense, depreciation and all my repair expenses on my properties. The same exact things an LLC or any other business setup.

Get a good insurance policy that covers, this will protect your personal assets.

Spend an hour or two with a current practicing lawyer and a CPA and pick their brain on your local laws/practices.

Originally posted by @Dave T:
Originally posted by @Nathan Brooks:

You can have an umbrella insurance policy off your primary residence that covers your LLC from that standpoint.

Nathan,

Are you sure.  My insurance carrier is telling me that they will not extend liability from my primary residence policy to a commercial activity.  I suspect this is the norm for the insurance industry. 

Perhaps, some insurance agents on the board will clarify the situation for us.

I am not an insurance agent, but I did just get an Umbrella policy last month.  My agent told me my $1 million policy would cover up to 4 rental properties. 

@Dave T Thank you for commenting. 

I should have mentioned tax benefits while flipping a property that was bought under your business name (in this case LLC) not buy and hold. And you do NOT have to pay capital gain tax, if the property was flipped and bought under your business name (in this case LLC) because that is your business. If you had bought it under your name (Social Security), you would have to pay capital gain taxes.

As far as series LLC is concerned, I could only speak for Illinois. I had a real estate attorney when I formed it and it was mentioned to me that it gives me added security because each series acts like a separate LLC without having to create a whole separate LLC. Just imagine if you own 50 properties, you would have to have 50 LLC which would very expensive and too complex for book keeping.

Hope it helps. 

Note! I am NOT a cpa or attorney, the best advise would be contact them in your state.

Dave NA You are correct. The personal umbrella covers personal liability, not commercial liability. If you personally own a couple of rental properties - the magic number is usually four - then the umbrella looks at that ownership as personal investment, not commercial activity. If you create a company that owns and operates the assets, that entity is commercial and not covered by a personal umbrella. The LLC would need its own insurance policy and a commercial umbrella.

@Lewis Clark Welcome!

If you do get into any Legal trouble it's unlikely that Zoom will help you. So I always recommend folks load up on the Insurance - Home Owners, Fire Policies and Umbrellas (high deductible and highest Liability, usually $1000./$1M) then have a local Competent (in Real Estate Asset Protection) Attorney review your Plan, Set it up and Update it Annually.

James,  

The original poster's question was asking about an LLC for rental property, not flip property. Once again, I assert that there is no tax benefit for owning rental property in an LLC vs owning in personal name.

For your flip property scenario, flip profit is taxed as ordinary income for both the pass through LLC and for the sole proprietor. There is no difference in the tax treatment. You don't have to have an LLC to take a home office expense deduction, either. All ordinary and necessary business expenses are legal tax deductions for the LLC as well as the sole proprietor who operates without an LLC.

Dave NA 

You don't lose the $25,000 passive loss allowance by forming an LLC. As long as you meet the requirements to take it whether it is held in your individual name or in an LLC is irrelevant.

@James Syed 

I should have mentioned tax benefits while flipping a property that was bought under your business name (in this case LLC) not buy and hold. And you do NOT have to pay capital gain tax, if the property was flipped and bought under your business name (in this case LLC) because that is your business. If you had bought it under your name (Social Security), you would have to pay capital gain taxes.

James, whether it is ordinary income or a capital gain the LLC wouldn't change the treatment at all. If you buy a property under the LLC for 50K, spend 20K improving it, and sell for 100K you've got $30,000 of gain whether it's in your name or the LLC's.

I don't see it that way.  Not all LLCs are treated the same way for tax purposes.  

The original poster asked about tax benefits to be derived from a partnership LLC. In order to take the net passive loss allowance, the taxpayer must be a part owner of the property (I seem to recall at least 10%). As I see it, the partnership that happens to own rental property is the property owner, not the partners themselves. The individual partners fail the ownership test and, consequentially, do not qualify for the net passive loss allowance.

It is a fine distinction, but just how I see it.

There really aren't tax benefits specifically be forming an LLC I agree.

But as long as you're a general (not limited) partner in the LLC, hold 10% interest in the activity and actively participate you can absolutely take the $25,000 loss if you meet the other qualifications. It doesn't matter if we're talking a 50/50 LLC in which the LLC itself owns the property. You own 50% of the interest in the activity. Kind of a muddled way to describe it but that's what the code says.

I've been a CPA for 8 years and been a part of 2 different firms and never have I met a CPA with a different interpretation of this.

@Erik Sell  

The net passive loss allowance is a special exception to the passive loss rules that is given to individuals who own and operate a residential rental activity.  To qualify for the net passive loss allowance, the TAXPAYER must both own at least 10% of the property and actively participate in the rental property operation.

The original poster asked about tax benefits of putting his and his partner's rental property in an LLC. I maintain, that once ownership is transferred to the partnership, it is the partnership and not the individual taxpayers that own the property. The taxpayers would have to answer NO to the question on their personal 1040 that asks if they own at least 10% of the rental property. Consequently, the partnership that owns and operates the rental properties is still a passive activity, but the individual partners lose the net passive loss allowance on their own 1040s.

Just how I see it.

Dave NA 

You're seeing it incorrectly.  I guess you can have that opinion but it's wrong.

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