Forming LLCs for a Duplex House Hack

9 Replies

Dear BP Community,

I am buying both units of a duplex, leasing one unit to someone else and living in the other. I’m taking a hardship withdrawal from my 401(k) to fund the purchase. Any comments regarding my decision to use my 401(k) to finance the purchase should be directed here. The details of the deal can be found here. If the deal goes through, I will inherit a tenant from the previous owner.

I am in the process of forming an LLC (we'll call it LLC #1) to hold the property's title. I will also be forming another LLC (we'll call it LLC #2) to act as the property manager.

Question 1: Is it possible to transfer title from me to LLC #1 a few days after closing, or am I disqualified from doing that because of my situation (see above links)?

Questions 2: What important aspects am I not considering?  (I don't know what I don't know.)

Question 3: What are the advantages and disadvantages of forming two LLCs to accomplish the objectives I’ve stated above?

Let me know if this post is unclear or if you need more information. I will read every reply and will try my best to respond to them all. Thanks in advance.  

Originally posted by @Joe Bertolino :
Sounds very complicated for a duplex. Why not just buy an umbrella policy and save the elaborate risk management structure for when you need it?

I don't really have the time to delve into why sole proprietorships are poor legal entities, but this audiobook explains it.  Listen to the first few minutes and see if it helps.

https://www.youtube.com/watch?v=6AxPVCiMxvA

Forget Both LLC's, and get decent insurance. With an LLC you'll lose your section 121 Exemption form cap gains on your owner occupied side, plus it just adds a bunch of other issues/problems.....due on sale clause issues, non homestead taxation, tougher insurance issues, etc.

Originally posted by @Wayne Brooks :

Forget Both LLC's, and get decent insurance. With an LLC you'll lose your section 121 Exemption form cap gains on your owner occupied side, plus it just adds a bunch of other issues/problems.....due on sale clause issues, non homestead taxation, tougher insurance issues, etc.

 Thank you very much for the insight!  I haven't researched all of the issues you brought up,  but I will.  I have researched the "due-on-sale clause" issue.  I want to use the Living Trust tactic I learned from the book How to Use Limited Liability Companies and Limited Partnerships, Second Edition by Garrett Sutton.  I'd like to know everyone's thoughts.

"Many mortgages are written so that any transfer will technically trigger a due-on-sale clause requiring the borrower to pay off the full amount of the loan. By law, however, mortgage companies have to allow a transfer from a borrower to a Living Trust so that the borrower can achieve his or her estate planning goals. I have had clients explain in advance to the mortgage company that they are first going to transfer the property into a Living Trust and from there transfer it into an LLC/LP so that they can further accomplish their estate planning and gifting goals. When the mortgage company agrees they then explain that because there are often transfer taxes and other costs associated with it all they are just going to do one transfer, from their individual name to the LLC/LP. In most cases, this works. I have had other clients consciously risk that the mortgage company's computer will never notice a transfer as long as the mortgage is paid and transfer away without notice to anyone. A key factor in the due-on-sale question is whether interest rates are in balance or not. If older rates are at seven percent and newer rates are at 12 percent you can be sure that mortgage companies will be out looking for ways to trigger due-on-sale clauses so they can lend money at higher rates." Thanks. -Edward

@Edward Stephens

I'm curious to know how your distribution qualified for a hardship as it does not to seem to fall under the immediate financial need category but rather for investments purposes. 

Here is what the code says. "For a distribution from a 401(k) plan to be on account of hardship, it must be made on account of an immediate and heavy financial need of the employee and the amount must be necessary to satisfy the financial need."

"Whether a need is immediate and heavy depends on the facts and circumstances. Certain expenses are deemed to be immediate and heavy, including: (1) certain medical expenses; (2) costs relating to the purchase of a principal residence; (3) tuition and related educational fees and expenses; (4) payments necessary to prevent eviction from, or foreclosure on, a principal residence; (5) burial or funeral expenses; and (6) certain expenses for the repair of damage to the employee's principal residence. Expenses for the purchase of a boat or television would generally not qualify for a hardship distribution. A financial need may be immediate and heavy even if it was reasonably foreseeable or voluntarily incurred by the employee."
(Reg. §1.401(k)-1(d)(3)(iii))

Originally posted by @Edward Stephens :
Originally posted by @Joe B.:
Sounds very complicated for a duplex. Why not just buy an umbrella policy and save the elaborate risk management structure for when you need it?

I don't really have the time to delve into why sole proprietorships are poor legal entities, but this audiobook explains it.  Listen to the first few minutes and see if it helps.

https://www.youtube.com/watch?v=6AxPVCiMxvA

I am more than familiar with the various legal entities and risk management techniques for owners... and unfortunately I am also familiar with how litigation can play out. But I also understand the mindset of applicants attorneys (hate to admit I worked for one for way too long prior to entering insurance and real estate). I try not to make any snap judgments but If you have to borrow from your 401K for a down payment on your primary home that you are going to house hack... I don't think your net worth would get many applicants attorneys excited. They will take the insurance limits and move on... if your insurance limits are high enough. They have been in the game long enough to know that chasing somebody without money is a wasted effort. Forming two separate LLC's to manage a duplex with one tenant is like putting on a condom while you are getting dressed to go to the club. It may be needed at some point but you are likely jumping the gun. It is expensive ($800 per year per entity in my state) plus separate tax returns and it makes financing a challenge when you go to refi or buy a new property. It makes sense for a lot of people to act like a small guy when you are a small guy and then convert to a LLC when the need arises. At that point you should have credibility with banks and be moving into portfolio loans where they will not have issues with the LLC's.

Just my 02 cents, no legal advice offered. Talk to an attorney that isn't trying to sell you a LLC package.

If it's your primary residence, transferring to an LLC will disqualify you from the exemption from capital gains on personal residences provided you meet the qualifying conditions. Does your area offer homestead prop tax exemptions? You'd likely lose that as well. For liability related to one side of a duplex, I'd just purchase adequate liability insurance and be a good landlord to reduce the risks.