Income will be kept within the entity to use for acquisitions down the line. Additionally, I plan to sell the property in 5-10 years for a profit and 1031 exchange it into another property. I'd like the legal entity to provide liability protection and mitigate taxes.
What entity should I use? S-Corp, C-Corp, LLC? Or should I just get an umbrella coverage insurance policy and report the property on my 1040 Schedule E?
Brookfield, WI · Member since 2011 · 31 posts · 18 votes
15y
Jeremy,
There are only two choices that make sense:
1) Limited Liability Company (LLC)
2) Personal Ownership
From an asset protection perspective, the attorneys will tell you to use an LLC, because it may protect your personal assets in case something awful happens that results in a large liability lawsuit.
However, an LLC will thrust you into the wonderful world (sarcasm) of commercial lending. LLC's do not qualify for conforming loans. You may not be able to get fixed rate financing, and if you do it will probably involve higher rates and points.
Your choice will come down to a statistically small chance of a large loss vs. a lower return due to higher financing costs plus interest rate risk.
Unless you have an enormous asset base to protect, you might consider titling it in your name and purchasing an umbrella liability policy that includes coverage for the rental property.
Accountant · Member since 2008 · 119 posts · 52 votes
15y
I'd probably just go with a LLC for the simplicity of things. No need for a corporation since the income is passive and you won't need the ability to split income between salary and distributions. All the income will be taxed as passive income. All you are looking to do here is limit your liability. A single member LLC will be no different tax wise than you owning it personally and putting it all on your schedule E. To keep your liability protection intact, keep all finances seperate and have all income and expenses run through a business bank account in the LLC's name. You are likely to show a loss on paper anyhow.
This is not legal or accounting advice, just what I would likely do with your facts you posted.
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
15y
Originally posted by Homer S.:
how much are the taxes on something like that in burbank? more than $1500, i'd imagine.
Taxes in CA are based on the purchase price and are around 1.2% for that area so the taxes would be approx. $5700 annually.
Herein lies the problem: So may investors here in CA do not understand real cash flow and many of them will be sadly surprised down the road. A duplex in this area, depending on the size and location, willlikely bring in around $3k-$4k monthly which is well under 1% of the purchase price which equals negative cash flow.
As to answering the OG question, that is always a great question for your tax advisor as every investor's situation is different. That stated, the most common suggested entity tohold is an LLC and with any entity, you should ALWAYS have additional layers of protection such as insurance.
Accountant · Member since 2008 · 119 posts · 52 votes
15y
Originally posted by Homer S.:
yes, i did. from his blog, i dont think he has the cash laying around to buy a 480 house. (could be wrong though)
how much are the taxes on something like that in burbank? more than $1500, i'd imagine.
I'm just playing the devils advocate here. But yeah it does not sound like a good deal to me outright....of course this could be a property worth $1mm.
Accountant · Atlanta, GA · Member since 2011 · 9 posts · 1 vote
15y
I'm aware of the overall benefits of an LLC
- easy of operation
- basis for depreciation
- no double taxation
However, double taxation only occurs in a c-corp when distributions are paid to share holders. I want to retain the earnings in the entity for future growth and acquisitions.
Since this property will positively cashflow, and my wife and I already make average incomes - using a C-Corp to separate rental earnings would appear to be beneficial.
Additionally, in my experience if you're working with a lending company and they see a K-1 reported on your 1040 tax return, they start asking for financial statements, corporate tax returns, etc. etc. etc. Since an LLC is a pass through entity, I would have to go through the head ache.
The problem I see with a C-Corp is:
- I may not be able to do do a 1030-exchange in it
- Any transfer of assets is will be taxed as capital gains
- There may be no basis for depreciation
- Mandatory shareholder meetings
- I don't think that the current earnings level could substantiate the amount of maintenance needed for this entity
I'm just starting out in real estate investing so any input would be appreciated. In your experience are my assertions about C-Corps correct?
Knowing more about my situation what legal structure would be most beneficial for now and future growth?
Note Investor · Pasadena, CA · Member since 2009 · 849 posts · 544 votes
15y
Jeremy,
Hate to break it to you, maybe Jon Holdman will come in do the numbers, but the #s look pretty bad on this one.
As to best entity, I would say Land Trust with your LLC as the beneficiary. You get the privacy with the Land Trust, and the LLC maximizes your liability protection.
Accountant · Atlanta, GA · Member since 2011 · 9 posts · 1 vote
15y
Property is brand new never been occupied and covered under builders 2/10 warranty
Because of the warranty maintenance will be minimal.
Heating unit is covered under warranty.
No AC unit.
Both tenants sign a 12 month lease and pay for utilities.
BTW - Thanks for the input, but I'm not interested in arguing about cash flow and the specifics on figures. I don't mean that in a harsh way. I'm just interested in opinions on the best legal entity/legal structure for this investment property and future growth.
Accountant · Atlanta, GA · Member since 2011 · 9 posts · 1 vote
15y
Thanks Loc - I've never heard of doing a Land Trust with your LLC as the beneficiary. I'm going to have to look into this. It seems that solution would provide both liability protection and keep profits off my personal return.
Accountant · Atlanta, GA · Member since 2011 · 9 posts · 1 vote
15y
I'm providing my profitability estimate to hopefully answer any other questions about the deal. But again, I'm not interested in whether you think it's a good deal or not - I'm interested in legal entities.
479,000 price
16,765 amount down
Interest rate 4.5% 30 year fixed
Yes, I'm renting to section 8 tenants.
Yes, I understand the risk.
Property is brand new - never been occupied
Historic vacancy rate for similar deals is less than 1% since these tenants are racing to get into a new property like mine.
Property is covered under builder's 2/10 warranty.
Because of the warranty maintenance will be minimal.
Heating unit is covered under warranty. No AC unit.
Brookfield, WI · Member since 2011 · 31 posts · 18 votes
15y
Jeremy,
There are only two choices that make sense:
1) Limited Liability Company (LLC)
2) Personal Ownership
From an asset protection perspective, the attorneys will tell you to use an LLC, because it may protect your personal assets in case something awful happens that results in a large liability lawsuit.
However, an LLC will thrust you into the wonderful world (sarcasm) of commercial lending. LLC's do not qualify for conforming loans. You may not be able to get fixed rate financing, and if you do it will probably involve higher rates and points.
Your choice will come down to a statistically small chance of a large loss vs. a lower return due to higher financing costs plus interest rate risk.
Unless you have an enormous asset base to protect, you might consider titling it in your name and purchasing an umbrella liability policy that includes coverage for the rental property.
Accountant · Member since 2008 · 119 posts · 52 votes
15y
Originally posted by jeremy Salvador:
I'm aware of the overall benefits of an LLC
- easy of operation
- basis for depreciation
- no double taxation
However, double taxation only occurs in a c-corp when distributions are paid to share holders. I want to retain the earnings in the entity for future growth and acquisitions.
Since this property will positively cashflow, and my wife and I already make average incomes - using a C-Corp to separate rental earnings would appear to be beneficial.
Additionally, in my experience if you're working with a lending company and they see a K-1 reported on your 1040 tax return, they start asking for financial statements, corporate tax returns, etc. etc. etc. Since an LLC is a pass through entity, I would have to go through the head ache.
The problem I see with a C-Corp is:
- I may not be able to do do a 1030-exchange in it
- Any transfer of assets is will be taxed as capital gains
- There may be no basis for depreciation
- Mandatory shareholder meetings
- I don't think that the current earnings level could substantiate the amount of maintenance needed for this entity
I'm just starting out in real estate investing so any input would be appreciated. In your experience are my assertions about C-Corps correct?
Knowing more about my situation what legal structure would be most beneficial for now and future growth?
If you were running a business or actively participating in your real estate investment according to the IRS, then your C-Corp analysis would sort of make sense. Although an S-corp elected LLC is still an easier option IMO. You would cut yourself a small salary which would be subject to Self Employment tax and treated as ordinary income and the rest as a distribution subject to capital gains rates.
However, since you are just holding a rental property, the LLC is your best bet, all income will be treated as passive income subject to capital gains no matter what way you slice it. You will not qualify as actively participating with just one rental property.
Accountant · Member since 2008 · 119 posts · 52 votes
15y
Originally posted by Roger Rouse:
Jeremy,
There are only two choices that make sense:
1) Limited Liability Company (LLC)
2) Personal Ownership
From an asset protection perspective, the attorneys will tell you to use an LLC, because it may protect your personal assets in case something awful happens that results in a large liability lawsuit.
However, an LLC will thrust you into the wonderful world (sarcasm) of commercial lending. LLC's do not qualify for conforming loans. You may not be able to get fixed rate financing, and if you do it will probably involve higher rates and points.
Your choice will come down to a statistically small chance of a large loss vs. a lower return due to higher financing costs plus interest rate risk.
Unless you have an enormous asset base to protect, you might consider titling it in your name and purchasing an umbrella liability policy that includes coverage for the rental property.
Commercial Real Estate Lender / Syndicator · Dallas, TX · Member since 2011 · 888 posts · 309 votes
15y
Depending on the size of the operation, I kind of agree with the personal ownership route ... especially given the fact that you can usually increase your liability policy up to $1M per property for less than the cost of one day's lunch.
Accountant · Atlanta, GA · Member since 2011 · 9 posts · 1 vote
15y
Thanks everyone for the constructive input. Sounds like for the amount of income here the personal ownership route is the way to go.
At what point should I consider an LLC?
If I'm considering growth, additional acquisitions, and possible buy/flip deals when should I start to consider a C-Corp? (for corporate credit purposes)
Saint Louis, MO · Member since 2009 · 168 posts · 40 votes
15y
Jeremy, just some positive criticism since this discussion is about protecting yourself with an LLC or Corp. You state your insurance is only $52 a month, that sounds too cheap for adequate coverage... just my opinion, unless you got one hell of a broker.
Real Estate Investor · New Orleans, LA · Member since 2011 · 54 posts · 13 votes
15y
After reading this thread a questions popped in my head.
If you own the property in your name and manage it yourself but you create an LLC for you managing it does this offer asset protection?
-In my case i own 3 houses 1 primary and 2 rentals. All have mortgages. I manage them and have no llc's but I do have high liability on each house and an umbrella policy. The reason I have yet to put them in an LLC is cause of my transfer clause in the mortgage. (diff. topic but have you had a problems with the bank when transferring to your own llc). Would me creating a management LLC protect my assets if sued by the tenants?
If the property is in a llc do you really need to form a LLC management company to protect assets?
SFR Investor · Orange County, CA · Member since 2009 · 1k+ posts · 1k+ votes
15y
Originally posted by Jonathan Sher:
You state your insurance is only $52 a month, that sounds too cheap for adequate coverage... just my opinion, unless you got one hell of a broker.
I pay around $400 a year for $1 million in liability protection for my SFR rentals. $600/year for a duplex may be just about right, but I agree he should double-check how much coverage he is carrying.
SFR Investor · Orange County, CA · Member since 2009 · 1k+ posts · 1k+ votes
15y
Originally posted by Mickey Harrison:
If you own the property in your name and manage it yourself but you create an LLC for you managing it does this offer asset protection?
This is something I need to discuss with my attorneys. I'm not really in the mood to form another $800/year California LLC just for property management, at least not until I'm managing more of my properties myself.
Here is how I see it in regards to your question - if you own property in your own name, but manage them through an LLC, you're only really covering yourself as a manager. Therefore, as the owner of the property, you're wide open, i.e., if anything goes wrong at the rental, there's a 99% chance they're going after you.
I believe it's far better to have the LLC on title as the owner and then manage the property yourself, if you must, but I would still check with an attorney. And make sure your tenants only know you as "Mickie", the property manager. Avoid giving them your last name and have all correspondence mailed to a private mail box or ghost address - the same address your cell phone bill goes to. Also have your LLC manager-managed so your manager can sign all official documents.
I have yet to hear of anybody getting into hot water with their lender for transferring their property into a legal entity. My attorney said for about every 1,000 transfers he's seen, a red flag was raised maybe 4 or 5 times and the lender dropped it after receiving a short letter of explanation from his office.