Why the Cost of an LLC is Absolutely Worth It for Real Estate Investors

by | BiggerPockets.com

This article does not constitute legal advice. We recommend you seek the counsel of an attorney familiar with your specific situation and market to ensure you make the best decisions within your real estate business.

If you’ve read any of our previous articles, you know that we are big fans of the LLC structure, and especially of its mightier big brother, the series LLC. The thoughts in this article apply to the series LLC—or any LLC structure, for that matter. LLC entities are one of the most essential tools for anyone with aspirations of long-term real estate investing, as well as anyone with a need for asset protection. Spoiler alert: That’s pretty much everybody, or at least everybody with anything to lose. But as humans, our brains are hardwired to go after instant gratification and avoid pain—and most of us know there are many kinds of pain, but we all know the lengths that people will go to to avoid pain in the pocketbook.

That’s why this becomes the first question many of my personal clients (and many more from the investment corners of the internet) ask:

“Wait, I’m just a dude/dudette with a rental property or two. Is setting up an LLC really worth my time and money?”

Whether the goal is to set up the LLC for asset protection or for other business reasons, nobody wants to take the hit without being sure it’s worth it. And as an attorney, I encourage that: Informed clients who ask the right questions are not only easier to deal with personally, but much more likely to be successful in their ventures.

I’m going to be brutally honest here. The upfront cost of an LLC isn’t bargain-basement cheap. But it isn’t bank-breaking, either. Regardless, I can also promise you that not setting up an LLC is more expensive, especially if you think about your finances in the long run.

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Alright, What Kind of Money Are We Talking Here?

Setting up an LLC might cost you around $1,000 depending on how much you want done with it, whether you also will require a property transfer, and other personal factors. I know $1,000 seems like a lot to pay at first. However, an LLC will pay dividends in the long run. And it is absolutely worth the expense to pay a knowledgeable attorney to help you. Ask anyone with expertise on this subject, and they will tell you that when it comes to setting up your LLC, do it right or don’t do it at all.

Do I Need A Shell Corporation/LLC?

The answer is yes. What a shell corporation does is function as an operating company, which in short means it allows you to have a face to the world. It limits your personal liability from all of the business dealings that you do. While you manage the corporation and profit from it, it is a separate legal entity from you as an individual.

This affects your real dollars in two major ways:

  1. The shell corporation protects you from lawsuits in the first place and from any potential damages, and
  2. Because a lawsuit against you, even one without merit where the plaintiff can’t collect against your assets, goes against your credit score. The shell corporation’s protection preserves your good credit. Lawsuits will also kick in a lovely concept called lis pendens, which means you would be holding the asset in question until the suit is resolved. Learn more about lis pendens and title clouding from my previous piece on the subject.

This second point is critical: Once you have a low credit score, you won’t be able to obtain the financing necessary to operate your business and acquire property. This prevents you from being able to do deals the way that you want to.

Related: The 3 Best U.S. States for Forming LLCs or Series LLCs

Those are real dollars. If you’re talking about less than $1,000 to protect your credit score, you’re talking about pennies on the future dollars that a bad credit score will cost—not to mention the fact that this structure can really save your assets in court. That’s a hard figure to put a dollar amount on, but consider the actual costs—financial and emotional—of ending up on the losing end of a lawsuit and losing everything you’ve worked for.

Is the Cost of an LLC Worth It?

If you plan on being in the real estate business for the long haul—for years or decades—the cost of an LLC is completely worth it. While the cost of an LLC may seem like a lot up front, at least it’s something you can afford.

The Cost of an LLC Structure vs. the Cost of a Lawsuit

On the other hand, no one can afford a lawsuit. It doesn’t even matter if the lawsuit is total B.S., hogwash, or frivolous as can be. The suit could be from a tenant claiming intentional infliction of emotional distress because they claim the color of your house triggers their PTSD or unreasonably upsets their emotional support hedgehog. Never mind that they toured the place with a blindfold on or that the “trigger” seemed to only occur when they decided they weren’t a fan of paying rent. Does this seem ridiculous? Have a quick Google of “frivolous lawsuits” or “landlord-tenant lawsuits,” and you’ll get the idea that this absurd scenario isn’t really all that crazy. Another cost to consider is the fact that you won’t be able to use that asset during the suit, thanks to a little thing called title clouding.

Related: Asset Protection in Real Life: How My Client’s Strategy Avoided a Lawsuit

The reality is simple: One of the perks and downsides of freedom is as Americans, we can sue each other at any time, for any reason. Nobody ever said those reasons have to be good ones. If someone’s money is green and you have stuff they want, some attorney somewhere will take even the most asinine case you can imagine.

The details of a lawsuit are required to be listed in public databases by law, and while most of your business acquaintances aren’t going to bother to read the details of Mr. Hypothetical Crazy Tenant and His Hedgehog, they will see the cash-money damages that Mr. Hypothetical Crazy Tenant is pursuing on behalf of himself and said emotional support hedgehog. All that anyone’s going to really look at, most of the time, is the figure.

So besides severely damaging your credit score and crippling your business, your  business reputation would also be jeopardized.

Think about it: Who is going to want to do business with someone who has  already been sued before? Would YOU do business with a person or company if you knew they were sued? Think about that. In addition to leading a team of asset protection specialists, I am also a real estate investor personally. I know how it feels to be in your shoes.

And from where me and my colleagues are standing, there’s no doubt about the value of a solid LLC for asset protection. It’s a no-brainer. It’s math even third graders can do: the $1,000 you spend today could save everything you own someday.

What do you think: Is $1,000 worth the peace of mind and safety from potential lawsuits?

Weigh in below!

About Author

Scott Smith

Scott Royal Smith is a real estate asset protection attorney based in Austin, TX. His firm, Royal Legal Solutions, designs asset protection strategies exclusively for real estate investors. As an investor himself, Scott is sensitive to the needs of real estate investors; as an attorney, he maintains a working knowledge of the best legal strategies available for preventing lawsuits. Connect with Scott here on BiggerPockets or visit his website, www.royallegalsolutions.com, for more information about asset protection for real estate investors. Check out all of Scott’s previous work for BiggerPockets here.

40 Comments

  1. mike kirby

    I believe it’s worth the money, I have two LLC’s, one a Self Directed IRA LLC with 7 rental properties in it and a 2nd Series LLC with 4 rental properties in it. My issue is that I can’t get Umbrella Insurance on the LLC’s! The insurance companies don’t want to write the policy because the houses are owned by an LLC. Does anyone own multiple rental properties inside an LLC and have an insurance company that will also write an Umbrella property? The LLC stops someone from suing for more than the equity in one house but I have a few hundred thousand dollars of equity in some of my properties and want to protect that equity from any frivolous lawsuits.

    • Scott Smith

      Hey Hogan,
      Here’s a fun fact: some states actually BAN us attorneys from appearing in small claims court. Small Claims issues are state-dependent. But here’s the thing about asset protection: if we’re using our structures correctly, we don’t have to worry about all that.

      So you’re not 100% wrong. If you live in a state where an attorney can represent you, then yes, that attorney would typically need to be paid. As I said above–I prefer to pay a little bit now to know I’m protected later.

    • Scott Smith

      Yes, we get lucky on formation costs here in TX. This is one reason I am able to keep my formation flat fees affordable. I did estimate the cost of involving an attorney as well. Most investors do not have the legal experience to draft the necessary documents and file. Yes ,in theory you could do this. Online services like LegalZoom are cheap because they’re boilerplate documents that may not be the best for your situation. It is always my recommendation that investors seek the help of a qualified attorney when forming an entity, especially if the motive is asset protection. There are just too many details (details I’ve spent my career studying) that can go wrong with “DIY.”

      Also: LLC costs vary from state to state. It’s always hard to give an average so $1k is an estimate . God bless Texas!

      • Ryan Todd

        Paid $300 2.5 years ago when we bought #1. No big deal I thought, we will just do it ourselves.

        Fast forward to 10 doors, oil & gas assets, we are ponying up $2,500+ to get LLC structure, operating agreements, and leases reviewed. Only thing I appeared to do correct is my bank accounts and taxes.

        Could have saved myself $1000 bucks going with our attorney 2.5 years ago. Worth it now, but I echo Scott and say skip the DIY

  2. Shane sigle

    HI Scott, Thanks for the great article. I’ve seen a number of articles suggesting the LLC is a great route to go. I set up individual LLCs for four different properties and then transferred title into the LLCs thinking that would provide some protection. My accountant then informed me that I needed to set up separate accounting for each LLC and avoid “co-mingling” any of those funds. My insurance agent then informed me that they couldn’t do an umbrella policy and recommended I simply keep them all in my name and get a large umbrella policy. Can you comment on this?

    • Scott Smith

      You should most likely speak to an attorney as well as your insurance providers. As an AP professional, I do not recommend keeping things in your own name. It’s like wearing a big neon sign that says “Sue me!”

      Your CPA is correct. SInce you formed separate LLCs, you would need separate accounts. Are you aware of the Series LLC option? If you plan to scale up your business, this may be a more cost-effective and easier approach from a management standpoint. With an SLLC, it can be structured so you’re using ONE bank account for multiple properties–as many as you like. I would strongly suggest reading my other articles addressing Series LLCs, especially the Series LLC vs. Traditional LLC. If you click my name, it will take you to a page with all of my posts.

    • Matt NA

      I’ve refinanced properties under a corp a few times. The banks simply ask you to transfer them into your name prior to closing. After closing transfer them back into the corp, or LLC. A minor hassle but easier to get the best loan.

  3. Scott Smith

    Hey Sean! I’m about to save you a lot of time and stress. Read this to get an understanding of solving the “LLC Lending Problem.”

    https://www.biggerpockets.com/renewsblog/llc-lending-problem

    It’s true that nobody wants to make a loan to a new LLC. If they do, expect to get gouged on interest rates. The article suggests getting financing personally and using a land trust to make the transfer to an LLC without alarming the bank. I hope that helps!

  4. Simon Stahl

    Just remember if you life in California, every California LLC or LLC that does business in California (even a phone call) is subject to the California Franchise tax of $800 per year. And since there are no series LLCs in California, EVERY LLC that you have has to pay that, holding/shell or not. That blows up the cost of LLC protection quickly.

  5. Ricardo Franco

    Dear Scott, you probably have other international investors like me (non resident alien) reading your posts. Does it change anything about this article? I always have questions about LLC x Corp in my case since I dont have intention to distribute the profit to my personal account, avoiding the 30% withholding tax.

  6. John Wanberg

    I have a few properties at this point – but they all have “due on sale” clauses in the mortgages. I have heard that this means you can’t transfer the property into an LLC without your loan potentially getting called by the lender, but have probably allowed this fear to irrationally limit my investigation. Any comments?

  7. Jacob Abraham

    Would creating a property management entity as an LLC be useful in avoiding lawsuits? Landlords like myself would rent the house to this LLC and the LLC sublets to the tenant. That way a business is officially dealing with the tenant, the house can stay in my name, and I can get a loan and insurance for the house. Plus I won’t have to create LLC for each of my houses and the LLC I create won’t even have one house in its name.

    Is this a good idea? Any drawbacks?

    • Jon Lanclos

      Im not an attorney, this is not legal advice. Yes, create an LLC operating company that you will conduct business with the general public. DO NOT hold assets (properties) in this company. There will be nothing to get if this company gets sued. Have the PM company manage your assets, which wil lbe in other LLC’s. Look into a Series LLC for your properties = one tax return instead of many. DO NOT name your LLC with your property address (ie: 1234 Elm St LLC) – Yes you can get a loan thru an LLC, I am doing it with my lender. Yes, you can get insurance for your property in an LLC. Have your leases be in the operating PM company name with your tenants. LLC’s DO NOT avoid lawsuits. They will protect you personally if you get sued IF you are able to prove you ran the LLC as a company (i.e: minutes, board meetings, etc) – THE MOST IMPORTANT TIP – Do NOT just pay $300 to the state and setup an LLC with no minutes, no operating agreement, no way of documenting resolutions – you will fail the test of “acting” like a business and therefore a good attorney can pierce the corporate veil – I have a very good company that will setup LLC and get you on the path of ACTING like a company – this behavior will protect you when/if a lawsuit arises – Private message me

      • Scott Smith

        Hi Jacob,

        I left a lengthier reply on your forum post but have seen investors create their own property management companies many times. I do believe using a shell corporation has value as well. We do want to keep our assets and operations separate as investors–and having the company that does business with the public be one that doesn’t own anything is an effective way of doing so.

  8. Jerry W.

    This seems to be a convincing sales point. The cost of filing your own LLC in Wyoming is $100. There is an online form at the Secretary of States website you can fill out and be done in minutes. You do need a registered agent in Wyoming to accept process however. The reality is that LLCs, shell corporations, and even blind trusts do NOT stop lawsuits. It can slightly change the likelihood of a lawsuit for a frivolous one. If you are personally operating your rental business anonymity is a joke, it does not exist. First and foremost you need good insurance and practice responsible management as a landlord. An LLC is an important liability factor, but keep in mind that you will pay more in interest rates and get much shorter terms of loans and most likely have 3 or 5 year arms. Commercial loans are rarely the same rates as personal loans. In my experience you will pay an additional 1% or more for a commercial loan and usually will only get a 20 year loan with a max of a 5 year adjustable rate mortgage. That means your rate is adjusted every 5 years. A normal personal loan is a fixed 30 year loan. That can have a huge impact on your cash flow. You also have the additional costs with an LLC for book keeping, annual reports, fees for a registered agent if you don’t live in the state, and even more if you have a different office than your home. Not every first time landlord can afford the extra cost. While forming the LLC is cheap if you do it on your own you had also better know the rules on how to operate it. An LLC is useless unless you follow the rules of not commingling money or assets. The rules for LLCs are much more relaxed than for corporations in many states, especially for closed or limited ones. If you have the time and money to start an LLC when you begin investing it is nice to begin with one. However an LLC in the beginning on a tight budget will lower your cash flow and may even make some rentals not profitable. The more assets you have now the more important they become. If you have a total net worth of $20K it is different than if you are worth $200K. Read up on how LLCs work. Determine if your current net worth and financial situation justify the cost and time in the beginning. Threat of bankruptcy is a HUGE deterrent to lawsuits. On a final note a Lis Pendens does limit your ability to use or rent your property, they just limit your ability to sell or get a mortgage. They are usually asset specific and there are often penalties to the filer if not removed promptly after the lawsuit is over. Please note that even a dozen LLCs and trusts do not limit your liability if you personally do something that breaches your duty of acting properly and someone is injured as a result of that. If you sign that disclosure statement and fail to mention the bad foundation you know about you can be help personally liable. if you work on the furnace and mes sup the exhaust and some dies of monoxide poisoning you will be personally liable.

  9. John Marshall

    Good article. Would also be nice to list some of the work involved in maintaining an LLC. There must be some cons with those pros and a balanced look at whether there’s much hassle involved beyond the initial setup would be informative.

    • Scott Smith

      John,

      It would depend on how you’re using your LLC. Routine “maintenance” in Texas means filing “no taxes due” once annually. Shell corps will be used differently than holding companies. This is just going to depend on the investor and how they are using the corporate structure–and definitely is worth getting some professional advice on if the goal is asset protection.

  10. kumail zar

    Scott…if one has a rental policy not under an LLC,is having a large umbrella policy covering that property form any major liability as effective? In your opinion is the LLC offer a much greater advantage than a large umbrella policy?

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