newbie LLC and asset protection questions

4 Replies

I plan to buy my first rental property in a few months. I have money saved up. I have met with several bankers. I am learning to analyze deals. I am about to contact a real estate lawyer to set up an LLC and obtain a business license. I will not need the cash flow because I make a good salary. I will plough all of the cash flow back into the real estate company. I understand that losses generated in the real estate company can be used to offset my W2 income and lower my taxable income. Does my LLC have to be a subS so that those losses pass through on my personal tax return or can I accomplish the same thing as a sole proprietorship? My understanding is that I will not be able to buy the house in the LLC because the bank will not loan the LLC any money. I will have to buy the first house in my name, correct because the bank will only loan me money? If I transfer the house into the LLC, there is a risk of foreclosure for violating the do on sale clause, right? How does the house get into the LLC so that the benefits of asset protection can be obtained? Years from now when the LLC has significant equity and cash, then will the banks loan the LLC money so that there is greater protection as the purchase will be out of my name entirely? Thanks for the help.

Q: I understand that losses generated in the real estate company can be used to offset my W2 income and lower my taxable income. 

  • The general is a rule allowing up to $25,000 of active participation(see below) rental real estate losses as a deduction against nonpassive income.
  • You will be deemed to be actively participating if you make management decisions in a significant and bona fide sense. Management decisions that are relevant in determining whether you actively participate include approving new tenants, deciding on rental terms, approving capital or repair expenditures, and other similar decisions.
  • There is a phase out if your MAGI is above $100,000(2016). 

Q: Does my LLC have to be a subS so that those losses pass through on my personal tax return or can I accomplish the same thing as a sole proprietorship?

  • All the LLCs, partnerships, and S-corps are the pass-through entities and they will end up on your personal tax return just like sole. 

Q: How does the house get into the LLC so that the benefits of asset protection can be obtained?

  • Note: You should get Good Insurance no matter if the LLC owns the house. Insurance gives you similar protection.
  • Yes, transferring the ownership of a house with a mortgage can active the due on sale clause. But if you want to have to house in an entity, the LLC has to own the house and uses its name to contract. It needs to maintain its own books. To get the desired asset protection, you need to treat LLC as a separate entity. Don't pierce the corporate Veil:
  1. This can occur if the entity either is poorly capitalized.Inadequate Initial Funding of the entity
  2. or fails to maintain a separate identity from its owners
  3. Conversion of entities Assets for Personal Benefit:
  4. Another factor that poses a risk of piercing the corporate veil is the draining of entities assets (such as payments of large salaries to shareholder-employees) that leaves the entity with inadequate resources to pay its debts. 

Q: Years from now when the LLC has significant equity and cash, then will the banks loan the LLC money so that there is greater protection as the purchase will be out of my name entirely.

Yeah, haveing a house in the LLC gives you greater protection, but you should always get an insurance.

Good Luck@Frank C.  

Thanks for your response, Ashish. I definitely plan to maintain good insurance. I will also keep everything separated and treat the real estate like a separate business that it is. For the first house, say that I fund the LLC with 50K and use this money to make a 20% down payment, pay for repairs, closing costs, etc on the house. Will the bank loan money on the house owned by the LLC? If not, does the LLC have to buy the first house with all cash, then refinance it once it is rented and performing well?

Originally posted by @Frank C. :

Thanks for your response, Ashish. I definitely plan to maintain good insurance. I will also keep everything separated and treat the real estate like a separate business that it is. For the first house, say that I fund the LLC with 50K and use this money to make a 20% down payment, pay for repairs, closing costs, etc on the house. Will the bank loan money on the house owned by the LLC? If not, does the LLC have to buy the first house with all cash, then refinance it once it is rented and performing well?

Frank, even with the 20% down and covering the cost, Banks hesitate and deny the loan to LLC, unless you have a good relationship or your LLC is well established and can show the cash flow from prior operation.

Loan to the LLC is generally "Non-Resource" loan rather than "Recourse loan"- which back can come after you personally if there is a default. Non-recourse loan can be only satisfied via the asset securing the debt. Sometimes, an asset is not enough to satisfy the debt and bank want to come to your personal asset for that. Thus, since LLC protects you from the business creditors and bank can not come after the owners of the LLC, a bank does not want to loan to LLC because they know they cant come after you. (I know some people have bought the property via LLC and personally guaranteed it, in that case, LLC owns the house, the exact thing you want. You have to convince the bank) 

If you have cash and there is no financing involved, yes, LLC can own whatever it wants.

After you have a good portfolio and also a relationship with the bank, it will loan directly to the LLC.

Call your local banks, sometimes they will work with you if you have large enough downpayment via LLC.

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