I am new to real estate investing and would like to buy and hold rentals. I am wondering if it is best to set up and LLC, get a business accounts and business credit cards before actually buying a property? I want to keep my personal finances and rental property finances as separate as possible so I am thinking yes. Any advice or experience with this is awesome! Thanks!
Welcome to b/p, I used LLCs and land trusts. Agree with you on setting up entity's and keeping things separate.
I 100% think setting up an LLC before you invest is putting the cart before the horse. For so many reasons. If you want to keep the finances separate, just create a separate checking account for the rental properties. That's what I have- an account where all the mortgages go out of and all the rental income is deposited into. There's nothing other than rental property money in and out of it. And then an umbrella insurance policy will cover liability issues for the property (which is what everyone thinks they need an LLC for).
The LLC, business credit cards, and businesses accounts are huuuuge overkill when you're just getting started.
It is best to form the LLC first so you can purchase the property in the name of the LLC. However, this limits your financing to commercial loans, because lenders won't give you a typical conventional residential loan under an LLCs name.
Some people prefer buying SFRs and 2-4 units using residential financing, so they get a loan and buy in their own personal name then transferring to their LLC later. However, it's technically a breach of your loan agreement because residential loan agreements have a clause in them that says if you sell or transfer title, the lender can call the entire loan amount due to be paid in full immediately. Google "due on sale clause" to look up the risks. That's why it's preferable to form the LLC and take title in the name of the LLC first. You don't run the due on sale clause risk. But your financing is limited to commercial financing.
Also, if/when you go the LLC route, you MUST keep rental profits and losses separate from your personal accounts. I'm glad you prefer to do it that way anyway, but keep in mind it's not about preference, its important so your LLC remains legitimate in the eyes of the courts and you will retain your liability protection.
Thanks @Ali Boone , @Max Gradowitz @Marcus Auerbach , and @Steve Haight . Sounds like I could go either route and be alright. I am in Oregon so the filing fee for an LLC is only $100 which is not terrible.
I am wondering now if anyone can answer a questions about financing or if I should start another post...
Would it be smart to use a HELOC for my down payment then a second mortgage to finance the rest of an investment property? This would be assuming that I do not have enough saved up for a down payment.
Another scenario would be for a cheaper place... Would it be smarter to use a HELOC to buy an investment property than using a second mortgage if my main attraction is cash flow? I understand it can be a bit dicy with varying interest.
@Eric Struben If you're buying residential and can get a fixed, 30 amortized loan then why would you want to get an commercial loan with an LLC where the term will be between 5-10 years, a high interest rate, and you'll still have to guarantee the loan?
You may also want to clarify about what you mean about a second mortgage. A bank will want to be in first position. HELOCs will naturally be subordinated to junior positions on your primary residence.
@Eric Struben I don't think either way is going to be fine. This is not about the filing fees. You are hung up on the LLC issue and the associated legal risk you seek to mitigate. You have to consider other risks, like the risk of higher financing cost (if you get a 5 year commercial loan) or the risk of the bank calling your note due, because you have moved the title. The LLC does not protect you from legal risks, it just firewalls it within the LLC (and that's not even guranteed, there are ways around). Legal entities make increasingly sense when you are a high net worth individual. You can take out a HELOC from your home for down payment, but make sure that you have a plan in place to pay it off quickly. If you buy property with two loans and combined 100% financing your financial risk is quite high andthe debt service will cut massivley into your cash flow.
@Marcus Auerbach You are correct, I am not worried about filling fees. I would like the protection an LLC has to offer, but you bring up a good point as to whether I could even get a loan through the LLC (especially with no assets currently). I have also head that there are tax incentives to getting your properties under an LLC, is that true? I would obviously like to pay the least amount of taxes as possible.
Not to be an echo but, an LLC is a must. Even with a single property. Owning property + No LLC + some random dude cutting across the lawn and breaking a leg = a crap ton of PERSONAL LIABILITY. It’s worth the money.
And with the loan issue..... just research or ask your attorney about revocable trusts/ land trusts. My company(s) structure philosophy is “own nothing but control everything”. You can have a property with a traditional mortgage transferred into LLC protection structure through a trust without defaulting the banks terms and the bank calling the loan due.
I started with a single member LLC - bought three properties, and am looking at changing title to my personal name. Here's why:
1) You need to find a portfolio lender in order to expand your business into more loans with a LLC. A portfolio lender is going to want you to also have a "personal banking relationship" despite having business accounts. How many personal checking/savings accounts do you want? Portfolio lenders are also regional which means that when I establish a banking relationship with a portfolio lender in Colorado, they won't lend me money in Indiana.
2) Your income is passed through on Schedule E and on Schedule C of your personal income tax return. Talk to a good TAX ACCOUNTANT about this. Your Schedule E losses can go up to $25,000 but if you have expenses that cannot be allocated to the rentals, they show up as a passive loss (that you can't deduct) on Schedule C. Essentially, to make it work, you'll also need to flip some properties so you have income to offset those losses.
3) For a couple of rental properties (less than 10 or so), a simple umbrella policy with your local insurance company will cover your liability on your rentals - talk to your insurance agent about this.
4) If you are investing out of state, there are bi-annual requirements for "foreign LLCs" and there is a fee for those filings...and there is a fee to use a registered agent. In some states, it's about $100 for the filing, in other states it's $1,000 for the filing. Registered agents can run about another $100. So if you see an opportunity in Texas as an example, you have to $900 to register your company and another $100 for a registered agent. That's $1,000 out of pocket and you haven't even done the deal yet...
5) If you plan to continue to work, and you get laid off, having a LLC can jeopardize your unemployment benefits. Rental income does not count against you, but working at "your business" does - whether you pay yourself or not and your rent receipts may give you problems with relation to claiming that unemployment benefit.
Those are just some of the examples....
Use your LLC to give you loan to purchase in cash. File lien for that loan. Then go to a bank an refinance the existing mortgage. So no I don't think having an LLC is overkill to start if this is a strategy plan to implement. @Andrew Postell could fill you in with more details. He is the one who introduced me to this strategy.
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