Which LLC to use for a flip

Question

I have done only buy and holds up to this point, and my focus will continue to be buy and hold in the future.

I have two LLCs, #1 is more established with 4 rental properties right now. With all the tax write offs including depreciation it is showing a loss despite healthy positive cash flow.

The other LLC contains no properties yet.

I should also mention my wife and I are in heavily taxed W-2 jobs.

I’ve stumbled across a great flip. Should I (can I) buy it under LLC #1 and can my buy and hold “losses” offset the gains from the flip? Can the LLC shield the gains from showing up on our personal return?

Also I need to get it under contract ASAP and close ASAP so forming a new entity is not viable for this upcoming flip, but possibly in the future if it happens again.

Scott Smith · Answer

Hey @Kyle M.

Congrats on finding a good deal!

I want to just quickly mention points that I believe pertain to what you are discussing. When explaining LLCs from a legal standpoint I want people to understand that an LLC that was created correctly functions like a box. So if you have a bunch of possessions in your personal name and you get sued, then all the assets you currently hold are at risk. However, if you place some of your assets in the LLC, the box, then a personal lawsuit should not impact those assets. It also works the other way around: if someone sues a property inside the LLC, it should only impact those property in the same LLC, the same box, and not your personally. So people will often try to place each property into it's own LLC, so if anything happens to one property, you are only risking that one property rather than a bunch of different assets.

When it comes to liability protection, placing a flip into LLC 1 would have a few drawbacks. (1) You are adding another property to the LLC, which means it would be worth more money for anyone looking to win a lawsuit against you AND (2) you are increasing the likelihood of a lawsuit because there is more liability with 5 properties than with 4. (3) The flip is also a different type of investment and has unique liabilities inherent to these types of investments, so your LLC will also be exposed to additional types of liability. (4) These two types of investments are also listed differently on taxes, so you need to keep this in consideration and discuss it with your CPA.

In a perfect world you would want each property in it's own LLC (or just do a Series LLC,) and then have an operating company that doesn't even own a property to use for all your highest liability actions, such as a rent collection, paying contractors, property management, etc. But if you are just working with the two LLCs I would say the best thing you can do is run one LLC for buy and holds and the other for fix and flips. You really don't want to expose your entire portfolio for a single flip, especially since you are not familiar with fix and flips - there are lots of unforeseen variables that can hit you when you try new things.

If you have other questions just tag me in a reply or DM me.

This is not legal advice, just my opinion as a real estate investor.

Michael Plaks · Answer

They don't for a good reason: it is fundamentally wrong.

Michael Plaks · Answer

@Kyle M.

As a non-attorney, I should not comment on legal issues, but I believe that attorneys will suggest LLC 2, to separate liability. You don't want to expose your existing rentals to legal claims related to the flip. Again, this is my layman's understanding, and I could be completely wrong. Maybe one of our resident attorneys will chime in.

For tax purposes, as @Allan Smith correctly pointed out, your LLCs are probably both disregarded, so it should not make any difference on your bottom line. However, tax deductions work differently when they are attached to rentals vs flips, and for clear separation I would still recommend LLC 2.

Your idea to offset flip gains with rental losses will not work. They are two different buckets and do not mix together. The tax law was specifically designed to prevent this. There is a little bit of room for creativity here, but not much.

Finally, the corporate idea mentioned by Allan is not much help to you when you're both high-earning W2 employees. There is some potential when your flipping numbers are really high, but it's complicated and needs to be discussed with your tax accountant.

One more thing, since this is your first flip. It is far more difficult to make profit on a flip than it seems.

Allan Smith · Answer

Hopefully a CPA will reply. In the meantime.LLC's are pass through entities, meaning their income trickles down to the personal tax returns of the members. So it really doesn't matter which LLC it is in in respect to making sure your rentals offset the income. They will no matter what.I've researched sheltering tax on flip houses a lot, and the consensus is it is just a highly taxable (and profitable) strategy. My CPA puts his clients' flips on schedule D as capital gains if they only do a handful. Most CPAs don't do that, but if you are netting at least $100k or more each year, it will be time for an s-corp or c-corp (i forget which one exactly), which allows you to give yourself a salary and dividends from the business are taxed less.

Which LLC to use for a flip

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