Form an LLC to manage property for first rental unit?

Question

We are moving to another home that we have renovated, and will be renting out our primary residence on a long-term lease. The rents are good in this area, and it should cash flow well. I will be managing the property myself. We have rented houses before, but always used a management company. We are excited to try out property management for the first time on this home, but not sure if we should set up a business first. I am using the RentRedi software, and it suggested that we receive rents using a business checking account and not a personal bank account. So is forming an LLC and getting an EIN to set up a business checking account to receive the security deposit and collect rent payments a good idea? I have searched through the forums looking for an answer, and I have read that some people say getting an umbrella insurance policy is better. If so, what is the best type of insurance company to contact regarding that policy? And I also wasn’t sure if it was a good idea to transfer the house into the LLC also once it was formed. I have read that in some instances, the mortgage company will use its due on sale clause, so that makes me a little hesitant. I have read other people’s posts suggesting putting it in a trust? Any advice or suggestions for someone just starting out with property management would be greatly appreciated! Thank you!

Drew Sygit · Answer

@Ryan Fox

How does an LLC Logically Protect a Landlord?

A lot of landlords are advised to put their properties in the name of an LLC for asset protection.

While this is basically true, the reality isn’t what most landlords think.

If a legal issue occurs with your property resulting in a lawsuit, there’s a decent chance the plaintiff’s attorney will be successful in “piercing the corporate veil” of your LLC if you were sloppy and being able to sue you directly.

Why? Because most landlords don’t follow all the legal requirements to maintain their LLC as a separate entity.

So, what else can a landlord do to protect their personal assets from a business lawsuit?

Well, what types of lawsuits is a landlord most likely to face?

Lawsuit from tenants for personal injury!

How many tenants have the funds to pay a retainer fee to an attorney to handle the lawsuit?

Not many! Most will find a personal injury attorney that will take their case on contingency – meaning the attorney will charge very little, if anything, upfront, but take a third or more of whatever they collect.

And here is the secret of using an LLC to protect your personal assets – by “hiding” them!

You see, there’s nothing worse for an attorney taking on a contingency case, fronting all the legal expenses and investing their time to win a case and obtain a court judgment – then NOT be able to collect on the judgment.

So, astute attorneys will research the available assets and insurance before accepting a case on contingency. If they can’t find either, why would they waste any resources on the case?

If all they can find is the property in the LLC, it may not be worth the additional hassle of trying to force a sale of the property to collect on their judgment.

So, they’ll research who owns the LLC and what assets that individual has.

If you act as the agent for your LLC and use your personal address – guess what? You’ve just made it super easy for them to find you and now they can research your other assets and probably sue you!

So, if you’re going to go through the effort of setting up an LLC, be sure to take the extra steps to find an attorney, CPA or other professional willing to act as the agent for your LLC and allow you to use their address. Most will charge a reasonable annual fee, but think of it as insurance.

Lastly, consider just getting more insurance, typically an umbrella policy to cover your entire portfolio, instead of OR in addition to an LLC.

Of course, discuss all this with an attorney!

John Mason · Answer

One great thing about LLC is though that you can build business credit and get Business Line Of Credit further down the line and scale quicker!!

Nathan Gesner · Answer

An LLC is useful for two things: anonymity and legal protection. In most cases, neither is warranted.

Warning: I am not an attorney, and this can be a complicated topic. Please note the information provided below is a layman's definition designed to provide a basic understanding for the general audience. You should consult an attorney or CPA for your specific situation.

ANONYMITY: When you create the LLC, your name is recorded on the documents and published on the Secretary of State's website for all to see. So you're not completely anonymous. If you want to be completely anonymous, you can use a Registered Agent. The Registered Agent will record the documents on your behalf so only their name and information appear on the documents. I've done this with my properties because I'm well known in my small town and don't want people to know what I own.

LEGAL PROTECTION: By placing your assets in an LLC, you are legally separating them from your personal assets. If someone injures themselves and sues, they will be suing the LLC and not you personally. If your insurance coverage isn't enough, they could seize the LLC assets, but not your personal assets.

Additional thoughts:

1. An LLC is not free. You can spend as little as $100 to form an LLC, or you could use an attorney and spend $1,000 or more. There are also additional costs of operating and maintaining an LLC, like separate bank accounts, annual report filings, tax filings, etc.

2. There are rules to follow! If you fail to follow the rules, you may open your personal assets to a lawsuit. An example of this would be mixing your personal money and LLC money in the same bank account.

3. You do not need a separate LLC for each property or a series LLC! Don't make your life more complicated than it has to be. Most professionals will recommend a separate LLC for every $1 million in assets but I don't think that's necessary. In my case, I have residential rentals in one LLC, commercial properties in another, self storage in a third, and my real estate company operates in a fourth. Some have more than $1 million in equity while others have less.

4. The need for an LLC is grossly exaggerated on BiggerPockets and other websites. Have you ever heard of a Landlord being sued by a Tenant and losing property? I've been on this board since 2010 and haven't found an example yet. You've probably heard of big Landlords losing property, but only because they were flagrantly violating Fair Housing, running a slum, or otherwise violating the law in an egregious manner. You are more likely to be struck by lightning twice. The vast majority of lawsuits against Landlords are for wrongful eviction, security deposit disputes, and Fair Housing Violations. Your primary insurance policy with $300,000 in liability coverage should be sufficient in 99.999% of all lawsuits.

5. The best protection for you and your investments? Know and obey the law. I manage around 400 rentals with 14 years of experience and have never been sued once. Even if I were sued, I document everything and obey the law, so I won't be found guilty. Even if I were found guilty, the cost would be in the thousands, not in the millions. Insurance would cover it, I would pay the deductible, and no assets would be lost.

If you are in an area like San Diego where people are more likely to sue, a judge is more likely to find you guilty, and the payout is expected to be higher, you may consider an umbrella insurance policy. This policy will provide additional coverage above what your existing policy covers. It's easy to obtain, costs very little, and doesn't require extra, on-going effort to maintain.

Chris Seveney · Answer

@Ryan Fox

Realize if you setup a separate LLC to manage then it’s third party managed and you will need to most likely get licensed as well as additional insurance. Not sure it’s really worth the cost as if a tenant sues. It will be for something the property manager did and they most likely will name that owner in the lawsuit (which is you).

Recommend researching this more before committing to it

Tom S. · Answer

@Ryan Fox As you've read, there are lots of pros and cons on BP on this subject. Personally I've kept my properties out of LLC's and just used the separate business account and an umbrella insurance policy.

Most people says there's little chance that transferring the title to the LLC will cause the note to be called, but there's always a chance. And if you have to refinance down the road, you'll probably have to transfer the title back into your personal name for that (most conventional lenders won't allow you to close directly in an LLC). So that creates a pretty easy paper trail for lawyers to find if you are sued.

Again, your decision and I'm just posting my approach. I've always kept my properties to code, addressed any issues brought up in insurance inspections and run it has a good business. I've never had any lawsuit threats over 20 years.

Ty Coutts · Answer

I personally have set my rentals up as LLC's and gotten an EIN number in order to set up bank accounts in which all the rents get deposited and all the expenses get taken out of. This will not only protect your personal assets from any potential renter who is looking to sue, but it also will vastly help the underwriters track income when looking to get approved for future loans. This will also help you be organized when completing taxes and writing off any potential expenses like furniture, utilities, repairs etc. that come with the rental business. Please note that I am not a CPA or an attorney, so please seek professional advice for any legal or tax questions as I know just enough to be dangerous! If you want any good contacts for those realms as well, let me know!

Ty Coutts · Answer

Congratulations on your move @Ryan Fox! An LLC can provide a layer of protection by separating your personal assets from your rental business. There is also an ease of financial management; it's easier to keep business and personal finances separate. Although, there are costs associated with forming and maintaining an LLC, such as state filing fees and annual reports that are to be noted.

It's generally a good idea to keep rental income and expenses separate from your personal finances. An EIN is required to open a business checking account for your LLC.

I would recommend looking into an umbrella insurance policy for your properties.

Good luck!

Ryan Fox · Answer

Thanks @Ty Coutts! So the best thing to do would be to get an LLC with a business checking account to use for that property, plus get an umbrella insurance policy on the rental?

Form an LLC to manage property for first rental unit?

Form an LLC to manage property for first rental unit?

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