SHOULD I CREATE AN LLC OR CORP?

47 Replies

Originally posted by @Storm S. :

No it doesn’t matter if you elect S-Corp status that has nothing to do with legal liability. I’m saying if you form a corporation vs forming a llc the llc has greater liability protection if set up right

 It sounds to me like you're advising on legal issues where you are not qualified.  The taxation has nothing to do with it's legal status. That is a common misnomer. Maybe someone like @Jerry W. can chime in for some actual advice. 

If you want to learn more about what I'm talking about look up CorprateDirect and talk to an attorney there. They have a program called armour 8. I'm not trying to give legal advise, I'm just trying to inform people that they might not be as protected as they think and should go talk to a qualified attorney.

I'm gonna have to agree with John Underwood he gave you the just of it. However make sure you do your homework especially in your own city as some LLC & S-CORP give better slightly different coverage in different cities. Good luck!

Originally posted by @Mike Gel :

Just getting started in investment properties. Is something like Legal Zoom to set up an LLC sufficient for personal asset protection when I plan to purchase about 1 rental property/year or is it worth it to hire a lawyer to do it?

After listening to many podcasts, reading forums, and talking to 3 law firms, my recommendation is to hire a professional. I have not formed a LegalZoom LLC, but from my understanding, their LLC operating agreement is not geared towards real estate investments. You should also research the forums more about LLCs.

Cheers.

So you buy 1 rental, then another, then another....... at what point is it most advantageous to start an LLC? From day one? Do you need one for each property or can an llc hold more than 1 property?

Thank you for the info.

@Natalie Kolodij   @Steven Hamilton II @Jana Cain I was told by the person putting together my paperwork that Corp does not subject me to SE Tax. Also, he said ill have same kind of asset protection under Corp, and the main reason people in Real Estate use llc is for Foreign Money (investors) because only citizens and residents can use S Corp. I am just trying to get a more accurate picture of what i'm doing and the competency of the person handling my paperwork. He def said S Corp is better for tax purposes. Please Advise and also anyone else paying attention to this thread.

Originally posted by @Jim Webster :

So you buy 1 rental, then another, then another....... at what point is it most advantageous to start an LLC? From day one? Do you need one for each property or can an llc hold more than 1 property?

Thank you for the info.

You will get varying responses on this. The primary reason I have an LLC is for asset protection. I have all four of my properties in one LLC. If I were to get sued, the person suing me could go after all the assets in my LLC, i.e. all my properties. But because I'm leveraged and have a large umbrella policy, I'm ok with that risk. The next property I purchase will go into a new LLC, which I already have set up. Depending on the value of the rentals, I'll put no more than 3-4 properties in each LLC. Some investors will set up an LLC for each property they own, which I totally understand. That's just personally more than I want to keep up with.

Natilie Kolodij is right on here. I investigated both of these options at length. While I'm not a tax accountant, I decided to start with an LLC, and move to a corporate structure when things got going well. I figured why complicate things in the beginning? I want to be investing, not holding "shareholder" meetings with myself (with a C Corp anyhow).

First off, I am not a lawyer and I highly recommend you approach one specializing in either Real Estate or Business law. This is probably the one area you do not want to shave dollars, and a consult is typically free anyways. While each situation is different, the books I have read suggest either the use of an S-Corp or an LLC at the most basic application. Corp vs. LLC really begs the question if you ever plan to be a publicly traded company. Entity structure is more of a asset protection play if you read Garrett Sutton's (no relation) "Start your own Corporation" book. He will go through essentially all of the possible entities and combinations of them that will fit asset protection needs in certain situations, and the tax benefits of doing so as well. If you read nothing else, this book will at least orient you before you pursue a discussion with a legal professional.

In my situation, I am investing in Buy & Hold properties (buying cashflowing deals with the intent to sell one day and 1031 up when appreciation looks good enough), so for my investment partner and I an LLC makes sense for now. In the future, we may break the assets into seperate LLC's for asset protection and structure the sub-LLC's into another entity, but that is just a thought for when things get more complicated.

Good luck!

Originally posted by @DeWayne Mann :

I see no mention of a Series LLC. Maybe GA does not recognize the Series LLC entity?

GA doesn't have a Series LLC act. But the conversations in here are making my mind blow.

Please talk to a local attorney before making any decisions off the internet.

Originally posted by @Derrick Gordon :

@Natalie Kolodij  @Steven Hamilton II @Jana Cain I was told by the person putting together my paperwork that Corp does not subject me to SE Tax. Also, he said ill have same kind of asset protection under Corp, and the main reason people in Real Estate use llc is for Foreign Money (investors) because only citizens and residents can use S Corp. I am just trying to get a more accurate picture of what i'm doing and the competency of the person handling my paperwork. He def said S Corp is better for tax purposes. Please Advise and also anyone else paying attention to this thread.

Your CPA is correct. They have the same asset protection- additionally S corps have limitations on foreign investors. I do believe though that a permanent non resident (green card holder) can own an S corp. 

The downside to the C Corp is you're paying tax twice, and even with the new lower C corp tax rate for 2018 for many people it's still MORE tax than it would be with an S corp with the new 20% pass through deduction. 

The most important thing though is to consider what type of real estate you're doing. If you're holding rentals, doing buy and hold. You won't want it in ANY type of Corporation 99% of the time. It creates a whole tax tornado you're now in the center of. 

If you're holding rentals you will just want an LLC or a multi member LLC (partnership) in most cases.

@Natalie Kolodij How exactly would it benefit for landlords to have an LLC, and flippers to elect S Corp? I'm basically doing both but don't have ANY entities yet.

The LLC and asset protection is a very thin veil....... if you are a small time landlord, a decent lawyer will tear apart that veil if there is ANY cross between your personal fiancés and the LLC finances. A couple of expenses paid from your personal account or any income put into a personal account and the protection is toast

From all my research and talking to some lawyers, its a false sense of security that will quickly fall apart if you get sued. You may think you are protected but one tiny issue will bring that crashing down

The advice I have been given is to forgo the initial cost and yearly fees for an llc in many states and just be very heavy in liability coverage....until you start to get big enough that it truly is a company by itself and not just you trying to pretend to be one by having some document that says you are

Originally posted by @Maugno M. :

@Natalie Kolodij How exactly would it benefit for landlords to have an LLC, and flippers to elect S Corp? I'm basically doing both but don't have ANY entities yet.

LLC offers no tax benefits, just legal protection. So after discussing with their attorney many investors choose to place properties in an LLC for protection. Rentals on their own only create passive income, not subject to self employment tax.

Flipping generates active/ordinary income which is subject to self employment tax. An S corp is very popular way to reduce that self employment tax. 

@Ned J. does that not mean you should be more meticulous about keeping personal and business separate. I was told that what you are saying is correct about comingling finances, so if you do that you are in trouble.  However, if you do what you are supposed to and keep it separate, you "should be" just fine.  

@Derrick Gordon the answers seem to be getting away from your original question. Yes there are at least a couple of reasons to choose an LLC.

They are easier to run with less corporate formalities. This is important for a small operator. If you fail to follow appropriate formalities your LLC or other entity can be "Pierced" meaning a court rules it basically doesn't exist. There goes you liability protection. Less formalities to follow, like annual meeting, means less chance you miss something and your corporate Veil is pierced.

C Corporations are a terrible way to hold property from a taxation viewpoint. Some of this may have changed with the new tax law. One example I believe is you can't do a 1031 tax fee exchange in a C Corp.  I will let others  more knowledgeable speak to the specifics. (See Correction from Dave Foster below)

Now I will add some additional points;

Taxation and liability are separate issue and what affect one may not affect the other. Do not go to a CPA for legal advice or an attorney for tax advice. This is a common mistake for people new to business.

Liability

Like @Ned J. said an LLC offers less liability protection than many people believe. One issue is what Ned (the other Ned, he must be a smart guy) speaks to is their owners don't run the company properly. It is not that an LLC is inherently weak regarding asset protection but more a matter of careless operation allows them to be pierced.

Some specifics would be: not being properly capitalized, no or inadequate insurance, owner signing name to documents without specifying that they are signing as an officer of the company, not having a separate bank account, not having proper books, not having a separate address or phone number. Most of these things by them self will not cause an entity to be pierced. Each case will be looked at separately.  Co-mingling funds or not signing documents are an exception. They alone could cause you to lose your liability protection. 

You are always responsible for your own actions. 

  • You run over a little old lady while driving  - you are responsible
  • Your employee runs over a little old lady during work - the employee and the company are responsible
  • You run over a  little old lady while driving for a work purpose. - YOU and your company are responsible

So if you are the only member of an LLC they almost everything the company does will be you doing it. No entity is going to give much if any liability protection in that case.

Despite that above, I don't know any attorneys that own property in their own name. They will always put it in an LLC or other entity.

Taxation

Rents are considered passive income and NOT subject to self employment tax (about 14.5%). Flipping is ordinary or earned income and IS subject to self employment tax. 

There is no tax advantage to and LLC. A single member LLC is taxed as if it doesn't exist and the income flows to your personal tax return. A multi member LLC is taxes as a partnership and again your share of the income ultimately flows to your personal return.

You can elect to have your LLC taxed as a "S" corporation. This has no advantage for rentals. However for flipping or earned income it can save you some Self employment tax. Some of your income would came as wages with SE tax and some as dividends not subject to SE tax.

Important - many new investors or business people think they don't pay tax unless they take money out of the company. If you have an LLC, whether taxed as a disregarded entity (sole member) partnership, or "S". you are taxed on All the money the company makes whether you take it out or not.

A traditional C corp is taxed twice. The company files it's own return and pays tax on it. Then any money you take out is taxed again on your personal return. The advantage to the C corp is that money you leave in the company is taxed at a lower rate than on personal returns. 

Multiple companies.

So if you hold rentals and do flips you may want more than one company. If you are really large you may even want a C corp as management company. my partner and I have multiple companies: parent LLCs, Baby LLCs and an LLC taxed as an S corp. We didn't start that way. It has evolved over time as our business changed.

Don't be impressed that we have a lot of companies and a complex structure. It is a pain in the butt. One consideration not mentioned here is the cost of running and maintaining a company. There is an actual financial cost; annual LLC fees and accounting fees, for us about $1,000 to $1,500 a year. There is also the cost of time. This is more than one might expect.

As you can see the issue can be quite complex, which is why people say to go to an attorney. However i believe it is worth research before you go to an attorney. When you understand the issues, you can better communicate with your attorney what your needs will be and you will better understand his or her recommendations. 

One good resource for legal information is the books and website from NOLO Press. 

Good luck.

PS I am not an accountant or Attorney. The above is my laypersons understanding of the law. It is not intended as specific legal or tax advice.

@Ned Carey , great summary of a wild rodeo of a topic!  One clarification - any tax paying entity can do a 1031 exchange.  the only requirement is that the tax paying entity is the same on the selling and purchasing side.  

@Derrick Gordon , first you have received a lot of well intentioned advice here some of it is great, some of it is misguided.  @Steven Hamilton II and @Ned Carey and @Natalie Kolodij have explained it so well that I have very little to add. First entity creation is about asset protection from liability. If done correctly all will protect you in most situations. The laws that create them are very clear about their benefits. There is actually a little bit of protection from LLcs that is not present in C or S corps. If you are in a state that has charging order protection it can actually protect you somewhat you get sued and go broke, but your LLC does not. There are even closely held LLcs or corps that require fewer formalities in annual meetings and minutes, but require extra knowledge. Not all states give LLC protection the same, but the idea that cities can alter how much they protect you seems pretty unlikely to me. Laws for corporate entities are set at the state level, not the city level. Cities cannot pass rules that undo state statutes without permission from the state legislature. There are huge tax ramifications based on which way you choose to be taxed, so get a good accountant to help with that choice. Passive income versus non passive income has special rules. Good luck in your investing. You are asking good questions and appear to be learning a lot from the answers, just be careful to who you listen to on online advice.

Bottomline....If you are putting all your rental in LLC's to protect them from liability, then you had better actually run them like a true LLC business........ and I would bet that 90% of the "small time" landlords don't.... they think they just do the paperwork and pay the fees to be an LLC and that's all they need to do to "shield" those properties....and they are still vulnerable

In some states the fees etc with an LLC can add up pretty fast..... in many cases that extra $$ is better spent on increasing your liability insurance