Here are a few not-to-terribly compelling arguments (except for one) to operate under an entity:
Asset Protection
As others have noted, depending upon the risks you take and the amount of insurance you have, it might not matter. Note that this won’t prevent you from being sued. It might limit the recovery of a judgment though.
Privacy
An entity puts slight impediments in front of you if you ever get sued and the plaintiff’s attorney does an asset search on you. This is not perfect and will generally only delay the inevitable.
More important, if you have to send out 1099's, an entity will enable you to use its FEIN instead of your social security number. Of course, you could operate as a sole proprietor (which is what you're effectively doing now) under a DBA and get an FEIN to use on a 1099 instead.
Tax considerations
Probably the best benefit is to be able to avoid payroll taxes on a percent of your income by paying dividends under an S-Corporation. I understand the S-Corp election in an LLC provides the same benefit. This is a real and valuable and worth considering on its own.
Borrowing
Many hard and private money lenders won’t loan to you as an individual if you need money for one of your flips. Entities only, to reinforce a business purpose.
State fees and tax returns are also an issue. In California at least, the minimum franchise tax for an entity is $800. Regardless of what it is in your state, you’ll also have to prepare separate state and federal tax returns which are generally costly if you use a preparer, which you should.
Forcing you to stay organized by maintaining careful tax records could also be a benefit if that’s an issue with you.
Jeff
What liability? Are you cutting corners in rehabs, not meeting code requirements or lying to the buyer? If not, what issues bother you?
If you have title insurance you should sleep very well.
I'm sure more properties are sold by individuals than by LLCs.
Liability only comes from negligence or intentional acts, if you're doing your best and honest that's probably good enough. You should look into getting a liability insurance policy, trip and falls are a bigger risk during ownership than any buyer exposure if you are dealing in good faith, IMO.
Read up here, there is a recent thread about operating individually vs an LLC, get insurance and sleep well, IMO.
There are many arguments for and against using an entity, many of which are covered in various forum posts on BP. I use an LLC because I have a business partner, and because we are trying to build a business, not just make extra money and we felt creating an entity would be the best way to do that.
There is definitely nothing wrong with flipping in your personal name, just make sure you are well insured as Bill Gulley said.
Maybe. I was reading an article a couple months ago about a guy who was breaking into a liquor store after hours, and he got in through the attic. He fell through the ceiling and injured himself pretty bad. He sued the liquor store for his injuries!
Now, I don't know if he did/will actually win the lawsuit (I hope not), but the fact that stuff like this gets litigated at all in our society tells me that having a layer or two of liability protection is a good thing.
In fact, we've all heard stories of people walking in front of houses during a snowstorm, slipping and falling and suing the homeowner. I would argue the homeowner wasn't necessary negligent nor intentionally trying to hurt anyone by not having their sidewalk cleaned immediately...yet there is still potential liability.
I have a couple of links here that might get removed by moderators (due to "competing" website being the host). But you can google search for "John Hyre" and his "You Dealing" article.
http://www.reiclub.com/articles/you-dealing
http://www.*****************/forum/showthread.php?15733-IRS-Dealer-Status
In that last link, read John Hyre's post.
EDIT: Wow, BP's server hides the website of that second link, so you might have to search; or you can "quote" the post and it might show the website address.
Yes is matters. It should protect you from your personal assets and/or other companies assets. They are too easy to setup to not have one. There is nothing wrong with doing business in your own name, but I don't see the benefit of doing it. Too much exposure. Just because you act honorably does not mean every one does. You will eventually piss someone off, it is inevitable.
While my real estate business experience is limited, I have owned and currently manage a business. For the effort it takes to establish an LLC, it's a no brainer for me. In our current society (unfortuntely), there are to many people looking for ways to score or get ahead without the hard work. For that reason alone, more protection would be better than less every time. If your not protected, one small issue can quickly bring down what you have worked so hard to build up.
I did my first dozen deals in my own name. Never meant to do that many without an LLC but just kept putting it off. I eventually used LegalZoom.com to form my LLC. Would use them again.
There is definitely more exposure to your personal assets such as your home, I would always suggest doing flips in an LLC. The only hassle is that your have to present a Certificate in Good Standing for your LLC every time you send out offers. It costs about $30 on your states website to download a current copy. I end up buying one about every 2 months or the REO banks freak out.
You just never know what might happen after you sell the house. It could be dry and sunny for the 3 months you own the property and a month after you sell it to a new homeowner it could flood the basement due to heavy rains. You never know what comes back to you.
As a side note, I always offer a home warranty when selling. I think its a good selling feature, plus it potentially takes future issues off of my back as the new homeowner will just contact the home warranty company instead of potentially contacting me. all for about $425.
This is not the case in my state. I have never had to submit anything with an offer other than proof of funds in certain situations. In KY it is very easy to do a quick search to find out if a company is in good standing, which I assume is why a certificate is not required. Entity requirements/laws are a little different for every state though, so it is important to understand them.
EDIT: Wow, BP's server hides the website of that second link, so you might have to search; or you can "quote" the post and it might show the website address.
Unless the website is malicious in some way, I think it's a bad idea for BP to sensor/block it. Linking to other valuable websites does not diminish the usefulness or revenue potential of this one - it improves it.
I've got to agree with Bill Gulley on all this. I've posted generally on LLCs vs sole proprietorships before but again I'll say it really all depends on how involved in the process you are. If you are directly supervising the rehab (or, even worse swinging, a hammer) or are the face of the LLC, and something goes south, you are going to get sued.
As others mentioned, there's really no benefit to doing business as a sole proprietor, so it probably doesn't hurt to do the LLC (other than the transaction costs associated with owning and operating one), but I generally believe that the protections afforded by these entities are way overblown, at least in the RE business, where individuals (myself included) are actively involved in the management of our rehabs/rentals.
Here are a few not-to-terribly compelling arguments (except for one) to operate under an entity:
Asset Protection
As others have noted, depending upon the risks you take and the amount of insurance you have, it might not matter. Note that this won’t prevent you from being sued. It might limit the recovery of a judgment though.
Privacy
An entity puts slight impediments in front of you if you ever get sued and the plaintiff’s attorney does an asset search on you. This is not perfect and will generally only delay the inevitable.
More important, if you have to send out 1099's, an entity will enable you to use its FEIN instead of your social security number. Of course, you could operate as a sole proprietor (which is what you're effectively doing now) under a DBA and get an FEIN to use on a 1099 instead.
Tax considerations
Probably the best benefit is to be able to avoid payroll taxes on a percent of your income by paying dividends under an S-Corporation. I understand the S-Corp election in an LLC provides the same benefit. This is a real and valuable and worth considering on its own.
Borrowing
Many hard and private money lenders won’t loan to you as an individual if you need money for one of your flips. Entities only, to reinforce a business purpose.
State fees and tax returns are also an issue. In California at least, the minimum franchise tax for an entity is $800. Regardless of what it is in your state, you’ll also have to prepare separate state and federal tax returns which are generally costly if you use a preparer, which you should.
Forcing you to stay organized by maintaining careful tax records could also be a benefit if that’s an issue with you.
Jeff
EDIT: Wow, BP's server hides the website of that second link, so you might have to search; or you can "quote" the post and it might show the website address.
Unless the website is malicious in some way, I think it's a bad idea for BP to sensor/block it. Linking to other valuable websites does not diminish the usefulness or revenue potential of this one - it improves it.
Michael D. - according to info I was given, if you were to put a link to a BP article on that other site, that other site removes the link entirely; they have no links to other sites allowed, so no reciprocity. I put the link there anyway, because like I stated, if you use the "Quote" link near my post, you see that actual website. Although the world would be more wonderful if this sort of thing didn't happen, it's just life I suppose.
Steve,
Wow, it works. Learn something new everyday. :)
As others mentioned, there's really no benefit to doing business as a sole proprietor, so it probably doesn't hurt to do the LLC (other than the transaction costs associated with owning and operating one), but I generally believe that the protections afforded by these entities are way overblown, at least in the RE business, where individuals (myself included) are actively involved in the management of our rehabs/rentals.
John,
Well said. I agree with you & Bill. Rather than forming an LLC and pay the state $800/year, I use that money to buy a $2M umbrella insurance. I flip occasionally, and I always do it under my name. LLC is overblown sometimes.
I'm certainly not opposed to LLCs, I have had several. It's easy to lose your preceived liability protection when you fail to maintain it properly and give it its corporate due. I would guess that most people who have LLCs don't make sufficient entries to the minutes, manage funds very well, stick to well defined business purposes and properly execute all documents, as in doing all of these things. When you get to several properties it will have advantages.
BTW, I'd say lenders are just as happy doing loans with an individual as a business entity, you can't get secondary market money as an LLC, and most all will always be giving a personal guarantee anyway.
This topic has been discussed so many times here on BP and all the info keeps getting regurgitated over and over with the occasional inaccurate post from time to time.
To sum it up, there are many advantages to using the entity, and no advantages what so ever to operating under your personal name, excluding the lame argument of the cost of formation and annual costs. Running a business has costs and the entity costs are just a small part of them. Did Henry Ford run his business under his personal name or did you form a corp and run it as Ford Motor Corp? Perhaps a poor and exaggerated example, but meant to drive home my point.
Flipping homes is a business as is landlording and should be run like one. I disagree with anyone that says that flipping in a personal name is good or OK. While it is certainly legal, you open up many doors to get hurt. Why open those doors, shut them with a simple layer of protection, in addition to your other layers, one of which being insurance.
I agree with Bill. Although I have and would continue to use corporations and LLC's, I only have done it because of the scope of my investments. The larger you get the less control you have of what's going on in your business. If you're buying, rehabbing, managing and marketing your properties and you own several, you probably have employees that may cut corners that you wouldn't have. It opens you up to liabilities for actions that you may have been unaware of.
But if you are flipping 3-4 properties per year, I don't see a problem with not using the LLC. I think many investors falsely believe that just forming the LLC will protect you but if you do something fraudulent or malicious a good attorney is going to piece your corporate veil and go after you personally. Do everything by the book and keep a good insurance policy and you should be ok. If your plans for the future are big, then definitely take the extra steps and form your LLC and hire a good attorney.
It's funny because I see all these people talk about protecting their great personal fortunes and then they go and form their LLC without the help of an attorney that does it for a living. A simple mistake in your LLC and your protection is out the window.
By the way if somebody wants to sue you they are going to do it regardless of how you hold title and you will have to pay to defend yourself either way.
By the way if somebody wants to sue you they are going to do it regardless of how you hold title and you will have to pay to defend yourself either way.
Will Barnard I think most people on BP hear you.
Luis Castillo When I drive, I drive with a seat belt on. I've never been in a serious accident, but the best practice is drive the limit and to buckle up. So I do. If I were a flipper (I don't currently), I sure would not do it in my name.
I thought so Chris but we keep seeing responses to the contrary.
I like your analogy, it is perfect. There is no valid reason to not wear the seat belt, so wear it.
Are you sure you guys aren't attorneys? In 32 years and over 1000 deals I have never seen anyone lose their personal residence, their cars or even less all of their assets from a lawsuit on a single deal. I have seen major contractors and builders put at risk that's why I said if you're doing 3-4 deals you are pretty safe. If you plan on going bigger than that it would be better to secure your business with a corp or an LLC.
Will really, how many people do you know that have lost everything from a real estate deal. On the other hand I personally know many people that have passed away in car accidents. With and without seat belts, terrible analogy Chris.
1
LLC offers liability protection if done right. Every single aspect of the business must be done and documented under XYZ LLC. – the judge will look if XYZ LLC is your alter ego or a legitimate, separate business. Google "Piercing corp veil"
2
If you have 10 rentals under your name or other LLCs and you do 1 flip a year …yes it is better to have the flip done under XYZ LLC because one lawsuit can wipe out all your 10 rentals. Flips is a very risky business ..that's why ROI is so high (if done right). Risk goes hand in hand with reward…
3
When you set up an LLC and lets say it is a single member LLC …and something goes wrong ..the LLC will be sued ..AND YOU WILL be named in the lawsuit as well (no question about that) …it is up to how well you kept your records to drop yourself from that law suit
4
If you have 10 rentals in 10 different LLCs ..and you have another LLC to do the flip …and something went wrong ..and the judgment is way beyond your liability insurance and umbrella etc ..AND you did not prove to the judge that flip LLC was a separate entity (e.g. funds commingling) then you and all the assets you have interest in (rental LLCs, google stock) are exposed.
LLC is only as good as the documentation you maintain. Think separate contracts, bank accounts, water bills, etc LLC is not a document that lives in your desk drawer ..it must be an active legal form
Bottom line:
What you don't own ..can't be taken away from you. many ways to accomplish that : land trust, irrevocable trust, combination of trust and LLC, definitelly not a DIY.
Not an attorney
Just because you have an LLC, you are not 100% protected from lawsuits and yes you personally will get sued also. Get a good insurance policy.
Joe Gore