Legal Entity for Vacation Rental?

Question

Hi everyone,

I'm considering buying my first investment property - a condo in Utah in order to use as a short term vacation rental (and also a place where my family and I can go on vacations when not occupied).  I think I'm going to get a $100K HELOC or Home Equity Loan to get cash for a down payment, updating, furnishing; and then finance the remaining.

Should I, or must I, establish an LLC to buy the rental property?  My Debt to Income ratio personally (after including the HELOC or Home Equity Loan) is about 31%.  My Debt to Income ratio if I combine the rental property and my personal property together is about 46%.  Would I have any chance of finding a lender if I established an LLC for the rental?

Any advice or guidance is very appreciated.  Thank you!

John

John Huber · Answer

Thanks for the insight @Michael Plaks

Michael Plaks · Answer

Not a lending specialist, so no help on your lending question.

You want to insulate it due to the IRS "interest tracing rules": in order to deduct interest on this loan as a business expense, you have to follow these rules. They basically demand a solid paper trail showing that the HELOC (or any other) funds were used for this business and for nothing else.

Your mention of $100k makes me slightly suspicious that you've been looking at the now obsolete option of deducting a $100k HELOC as a personal itemized deduction. That is gone. But the business deduction route is still here, provided you follow the interest tracing rules. In fact, it's a better of the two options anyway.

John Huber · Answer

@Michael Plaks

Michael, could you help me understand why I would want to insulate the HELOC from Personal expenses?  I could make guesses but I’d really like to make sure I’m clear there.

Any thoughts from you on the lender qualification question I have - LLC vs no LLC and the impact of qualifying for the loan?

Michael Plaks · Answer

@John Huber

An LLC won't change anything for taxes (in most cases). It might be recommended by attorneys for asset protections.

If you're planning to use a HELOC for this property - make sure to keep these funds insulated from any personal expenses. Use it strictly for this property and don't mix with other money.

John Huber · Answer

@Steve Hall

Thanks for the response and good question.  I want to have the protection of an LLC but I’m concerned that a lender would not be willing to give the LLC a loan for the property if the debt to income is higher by itself (versus including my personal income).  Is that a valid concern?

First priority would be to rent out the vacation rental to generate revenue but there will inevitably be nights when it is vacant and so it would be an opportunity to take the family there.

Steve Hall · Answer

@John Huber

Yes to the LLC. This is a business, treat it like one.

Why would you vacation in your own STR?