I cringe when I hear the following question from newer investors:
“Should I invest in real estate through an LLC?”
Often, this question is quickly greeted by intimidating big shot investors and lawyers saying things like, “Yes, you MUST use an LLC. There’s no debate about it.”
In my limited experience, I’ve found that there are most often three types of people in the real estate world using ultimatums:
- The very thoughtless
- The very wrong
- The guy who’s selling me something
I’d suggest that you never listen to people who use this type of language. (See what I did there?)
I don’t know whether or not you should use an LLC. The answer differs from person to person. I can tell you that I personally do NOT use an LLC or other business entity to protect myself. As a young, first-time investor, I believe that I have an intelligent rationale for investing this way. I hope that as I explain my rationale for investing under my name, other young, first-time investors will benefit from my reasoning and make an intelligent decision for themselves. At the very least, I hope to be a thoughtful counter to those who dogmatically proclaim that an LLC is a must.
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To give you a little background, I used virtually the entirety of my savings to purchase and repair my first little duplex back in November of 2014. Having put in work to make it livable, I now rent out one unit to some wonderful tenants and live in the other half with a roommate. I purchased the property with 5% down using FHA financing, own the property under my own name, and manage the tenants myself.
And I think I’d be a fool to operate it under an LLC.
I had (and continue to benefit from) several immense advantages in owning this property under my name. These advantages would have been forfeited should I have moved the property into an LLC or other business entity. It’s my belief that these advantages vastly outweigh the benefits of operating the property out of an LLC. Further, in my case, I believe that the protections of an LLC are minimal, easily lost, and expensive at best for investors in similar situations to my own.
5 Advantages to Investing in Real Estate Under My Own Name
1) Access to Financing
In my case, I used an FHA loan insured by the Federal Government to finance my property. This type of loan allows first time home buyers to put down as little as 3.5% on their properties. This type of loan is available to people purchasing primary residences only, not companies. Under their rules, the property that I bought was a exactly that — a primary residence. It just happened to also be a duplex with a very rentable second unit. The same bank that allowed me to purchase this property for just 5% down would have required 20% at least for “The TrenchPire, LLC” to buy the property.
My duplex cost $240,000. Putting down 5%, or $12,000, is a very different proposition than putting down 20%, or $48,000. My entry into real estate investing would have been delayed by years if I had elected to invest through an LLC and purchase the property with $48,000 in savings.
2) Lower Interest Rates
My 30-year interest rate for my home mortgage is 3.475%. Try getting that through an LLC.
3) Special Tax Breaks
Interest on a mortgage for a primary residence is tax deductible on your personal income. Furthermore, I pay mortgage insurance on my FHA loan, which is also tax deductible.
I might not be able to claim either of these tax breaks on my personal tax return were I to move the property into an LLC. These tax breaks are especially important to highly leveraged owner-occupiers like me who pay lots of interest and mortgage insurance each month in the first few years of ownership. Even in pass-through entities like single-member LLCs, these tax breaks are minimized because investors can’t leverage as much. Putting down 5% or less through an LLC is a rare feat I have yet to hear of done through an LLC upfront.
4) Tax-Free Capital Gains
Assuming that I live in the property for at least two years and assuming that the property appreciates over that timeframe, I have the option to sell my investment for a tax-free capital gain. This gain caps at $250,000 for a single person and is limited to primary residences only. Unlike a 1031 exchange, the money is truly tax-free and can be spent on my next vacation, manicure, or other non-real estate assets.
Assuming that my property appreciates 10% over the next two years, I’m looking at a cool $20,000, instead of perhaps $13,000 after taxes. That’s a meaningful difference to me.
5) Flexibility in Mixing Business With Personal
I try to run my property as professionally as I can, using separate email addresses, bank accounts and credit cards for property-related expenses. But because this is my house, at the end of the day, I have the option to cheat when necessary by mixing personal and business assets. I have no corporate veil to defend, and thus have more flexibility in moving assets around, managing tenants, doing work on the property, etc.
2 Disadvantages to Owning the Property Under My Name (& Why They’re Minimally Relevant to Me)
Disadvantage #1: Potentially Unlimited Liability
Let me start this off by saying that millions of investors, some of whom have high net worth, invest in real estate without using LLCs. They protect themselves from liability through umbrella insurance policies, which have worked for decades, and that I trust to work for me. That said, there are two reasons why this advantage to the LLC was not something that I felt was of paramount importance to me.
First, I have an umbrella insurance policy that covers me for up to $1M. In the event that someone successfully sues me for more than that, then yes, my personal assets are at risk. In that event, I lose everything I own. So what? As a 24-year-old kid, and I have virtually nothing to my name besides a few small retirement accounts (relatively hard to lose in a judgement), the property, and some savings I hope to invest in the next property.
Oh well. I’ll just start over and be right back here in a year or two. Not a big difference between waiting two more years to save up enough to put down 20% in an LLC.
Oh, and, by the way, something would have to go very wrong for that to happen. I like to think that I am a respectful and attentive landlord and that I do my best to make sure to respond to any questions or concerns from my tenants. Bad things happen, but I believe that a $1M+ mistake on this little rental would be an extraordinarily unlikely event.
Secondly, LLCs and other businesses only protect their owners from unlimited liabilities if they are run correctly, preventing the opposition from piercing the corporate veil. I see running my business this professionally as something that would be very difficult to do correctly, given that I live in the property and could be considered a customer.
I believe that I am unlikely never to conduct personal business in the property that I live in in a manner that a savvy lawyer could not use against me. I also believe that I am perhaps not legally savvy enough to be perfect in my accounting for which improvements to the duplex are luxuries for my personal happiness, as opposed to improvements for the business. I’m 24 and am running my first ever business out of my home. That corporate veil might have been as easily swept away as the blinds in my living room. (Are they my blinds? Or the LLC’s?)
Disadvantage #2: I Cannot Remain Anonymous Behind the LLC
Many real estate investors prefer to distance themselves from their properties to make it difficult to sue them and to put a barrier between themselves and their tenants. An LLC can be a great way to do that. In my case, and for many first-time investors who are owner-occupiers or owner-managers, this advantage is likely forfeited from day one. I live right next door to the tenants. They see me mowing the lawn, painting, installing shutters, making repairs, and painting walls.
It’s kind of obvious.
Should I use an LLC? You tell me. At the very least, I think that a reasonable person can make the case that I have strong reasons for investing in real estate under my own name.
I’m investing in real estate, and I’m willing to take action. It would have been a lame excuse to hide and continue building wealth at a painfully slow rate merely to kid myself that an LLC would offer me meaningful protection. Assuming I had allowed the weak protections of an LLC to delay my decision to start investing in real estate, I’d still be a renter and wouldn’t have anything to protect in the first place!
As an afterthought, I’ll mention that aside from the massive expenses and disadvantages to operating property under an LLC that I outlined earlier, there are sometimes expensive costs directly related to operating LLCs. These costs, like setup fees, accounting time/expense, and legal expenses in drafting operating agreements, vary from state to state and can be either immaterial or cost thousands and thousands of dollars.
I plan on using LLCs and protecting my assets when and if I build net worth into the hundreds of thousands or millions of dollars. But for now, the risk/reward ratio for owning the property under my own name is so far slanted in my favor that I think I’d be silly to use an LLC. I’m a healthy 24-year-old with no family, and I have almost no wealth. If I were 50 with three kids to put through college and a few million in assets to lose, then that would be a different story, and I’d probably use an LLC. I wouldn’t want legal liability from my rentals to touch me or my family with a ten-foot pole.
But for now, an LLC sounds about as useful as a colonoscopy.
And probably a lot more unpleasant.
Do you invest in real estate using an LLC? Why or why not?
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I am not a lawyer, and the opinions in this article are my own. Please make sure that you consult with an attorney before making any decisions regarding legal structure or business decisions that might have legal repercussions.
Weigh in, and let’s have a discussion!