New Investor - DBA, LLC, or Incorporate???

Question

I am looking to purchase my first investment porperty and I am wondering if I should setup a DBA, an LLC, or incorporate. I am an individual investor, but will also put my wife on the deeds. I plan to make her a 50% partner.

Can anyone advise me which option (DBA/LLC/Corp) would be best? What are the pros and cons?

Thanks for the help.

Can anyone advise me which option (DBA/LLC/Corp) would be best? What are the pros and cons?

Thanks for the help.

Michael Mulrooney · Answer

I know many people that have a few property's in several LLC's for protection, but that would be best decided between you and your attorney.

My dad has always warned me about being sued and has thrown that at me ever since I have been buying property. He has never purchased property or tried to improve his situation because of that type of fear. If you get sued, then deal with it at that time. Don't let that hold you back from making a profitable decision.

Wes Tuinstra · Answer

Hello Froehlis,

And welcome to the forum!

You ask a question that all investors ask sooner or later.
I'll let others chime in, but from what I've seen when a 
person is just starting out, there is not the need to incorporate
right away.

But those that own dozens of properties are probably incorporated.

If you are just a beginning investor, wouldn't it be better to master
the art of the deal and begin to show some profits? Then you will
be in a better position for an attorney to give you advice.

Jeff Takle · Answer

On that point, I fully agree. There are benefits to using an LLC for your property management.  Just remember to generate a legal property management agreement between you (the owner) and you (the LLC), as well as leases between you (the LLC) and your tenants. Set up separate checking accounts for the LLC and have all rents paid into them.

Then, and this is important, if you want the LLC to provide actual protection you need to deduct a fair market management fee before paying the remaining rent back to you (the owner), typically 8-12%.  If you just pass the whole rent back to yourself, then the courts will do what's called "piercing the corporate veil". Basically it means the courts will see this as you setting up a false company to try and protect yourself. To provide real protection, it must operate like a business.

I'd also recommend having the LLC pay all maintenance and deduct that from the rent income before passing it on to you (the owner). As an LLC is a tax pass-through entity, you (the owner) will receive the same tax benefits as you would if you deducted these repair/improvement expenses on your personal taxes--but, if you use the LLC, it helps legitimize the LLC, is more defendable in an audit b/c it reflects a real business process instead of tax evasion, and frankly it makes it easier and faster during tax time.

How might this help in reality? Let's say a tenants asks the LLC to repair a broken deadbolt lock and it takes you 3-4 days to get around to it, and in the mean time someone breaks in and assaults your tenant, you could be charged with negligence towards the safety of your tenant--this is serious stuff. If your LLC is operational and its books are clean, you may be able to house all liability with an LLC that "responded negligently" to a tenant request and did a crappy job of property management. This is MUCH better than you the owner (with no LLC) responding negligently to a property management request. This might help shield your personal assets from scrutiny and just look at the assets of the LLC property management company. If your PM company is like mine, there aren't a lot of assets!  A lot of rent money comes in and a lot goes out, but the company's operating cash is minimal (versus the operational cash sitting in each of your client's accounts, which you manage for clients but can't touch b/c it isn't yours).  This would require a judge to rule that your personal assets should also be at risk in the lawsuit, in addition to already finding the LLC guilty and proposing penalties in excess of the LLC's assets--two rulings against you instead of just one.  [actually this specific case may not be the best example b/c according to case law in Massachusetts, negligence with safety and locks tends to solicit particularly harsh penalties from the judges, but you get the point.]

The difference between this protection and that offered by having the LLC own the property is that this protection may shield you from liability that you can show was "property management-related" if the LLC is clearly a property management company. LLC's outright ownership of the property would, in theory, shield you from pretty much any kind of liability. Does this help clarify?

Jeff Takle · Answer

There are some good points in here. First, let me recommend that you "SEARCH" on this site for "LLC".  This topic has pretty good coverage.  A quick recap of some of the highlights (from my perspective):

LLC will only provide liability protection against a lawsuit if ALL of the following occur:
  1. You are sued
  2. You don't settle or go to arbitration
  3. You lose in court
  4. The claimant is awarded damages in excess of what your insurance covers
  5. The claimant is awarded damages in excess of what your insurance AND all of your other assets (except the house) will cover so that the house is your only remaining option.
  6. You have an LLC and it has been running like a legitimate business, e.g. you keep separate books in Quickbooks, you have a separate checking and savings account for the LLC, your state and federal filings are in order and taxes are up to date, and the LLC is legal owner of the property.

In that instance, the courts might protect the property in the LLC. This is, to say the least, not a likely occurance. And, if you balk at the $1,200 per year you pay for property insurance, you'd pay maybe $1,000 per year in time, state filing fees, accounting, and corporate diligence to have and sustain a legal LLC.  Seems like very expensive insurance for an unlikely event.  Especially if you only have one or two properties, I'd skip it for now. On the other hand, it's always fun to learn how to set up a company!

Also, yes you will find it VERY unlikely that a bank will give a mortgage to a new LLC with no assets, credit history, or money of its own. They may let the LLC "have" it with you personally as a co-signer but that almost certainly negates the legal liability protection outlined above.  You could also buy the property yourself and move it to an LLC at/after closing. But to do so you'll either have to do it behind the bank's back (in which case the LLC doesn't really have clear title to the property and you could still lose it in your lawsuit), or you'll have to refinance with a bank...which of course the bank won't do unless the LLC has credit, cash, or assets.

You can transfer a property directly into an LLC no problem if you own the property outright. Then, it's a piece of cake.

Whatever you do, keep learning and asking questions.   /Jeff

Wes Tuinstra · Answer

Michael!...Thank You.

I hate to say this on a forum which depends for its existence
on the willingness of people to make comments but...

People make comments to "help" you either because they
want to share from their experiences, or they want to 
share from their fears.

If it's the latter, they actually are hoping to have their fears
reinforced by what they read on forums like this.

Many people -- many -- have the belief that once a 
person is "rich" then their wealth is an albatross to them. This
fear keeps them from becoming "too" wealthy and holds
them back.

Don't fall into this trap.

Sean Carty · Answer

I am new to this also and I have gotten this advice about using or having an LLC.  You have your LLC manage the properties, you own but the tenants pay the rent to your LLC.  Tenants are less inclined to play around with a company than a person, provides a slight intimidation factor.

Like I said this is just one idea I have gotten.

N/A N/A · Answer

I agree with most of these people and there ideas.
 Unless you have some really substantial assets you arent going to be a big target for litigation. If you are just starting out then that is probably not the case. My thoughts are, go down and get you a DBA. They are usually very cheap (about 10 bucks here) and give the IRS a better idea that you are actually a working business. What that does is help you look more legitimate in the eyes of the IRS when you start deducting your business expenses. The DBA will offer you absolutly no asset protection but unless you have any type of assets to protect then it is a moot point. Here is the key to getting sued. Lawyers want to know if you have money, if you dont then they dont have a lot of incentive to sue you since it is highly unlikely they will get anything. So, after you have become successful and have grown your business, then you should get a GOOD attorney to help advise you and set up an entity. They can be very complicated and each of them have their own advantages and disadvantages.

Wes Tuinstra · Answer

It is not always a simple matter to move a property to an LLC.

But if, after doing several deals you feel confident and competent,
then sell the original properties for a profit and begin putting all
new properties into the LLC.

From your remark about tenants being hurt I can see that you
may not be psychologically ready to be a landlord. You are
risk averse, and that will hold you back until you can remove
it from your mind.

Better to try rehabbing or flipping or whatever first.

Scott Froehlich · Answer

I agree with the feedback and wonder if a DBA or LLC can help seperate the real estate holdings in the event a tenant is injured, etc. In DannyK's post, someone recommened buying the property and moving it to the LLC later on. That seems to make sense any advice here?

Thanks again.

Jason Shaffner · Answer

The largest benefit to incorporating, whatever the flavor ... inc, LLC etc ... is that it provides some level of separation between you and the business for liability purposes.  The tax benefits, and I am NOT a tax attorney, are going to be minimal as far as I can tell.

I agree with Wesley, you would be better served learning the game first.  If you do a couple of deals you could then go to an attorney and say "How do I structure this so that it works for me?"

Doing some deals would also help the financials as well.

New Investor - DBA, LLC, or Incorporate???

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