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Corporate structures can help you lower taxes and limit your liability when investing in real estate. I use Limited Liability Companies (LLCs) and S corporations in my businesses. I have a separate LLC for each of my 20 rental properties, but an LLC is not the right choice for everyone. The main reason I put my rentals in an LLC is to protect myself from liability. LLC’s also help with your tax burden thanks to the new tax law. However, there are many things to consider when deciding to use an LLC for your rental properties. LLCs can affect financing, increase costs, and have many negative consequences as well. S corps can also help reduce liability and reduce taxes if used properly. I completed 26 flips last year and used one S corp to buy and sell those properties. I also have an S corp for my real estate brokerage. I will go over some of the pros and cons of corporate structures in this article, but I am not a lawyer or providing legal advice, and if you have legal questions please consult an attorney or accountant.
Why do I put my properties in an LLC?
I have always put my rental properties in a separate LLC for each property. The reason I do this is because of the liability risk that comes with owning rental properties. If you own a rental property in your own name, someone can sue you personally and attack your assets. That lawsuit can not only affect your rental property but your personal assets as well. If you have your rental property in an LLC with a separate checking account there is a better chance only that rental property will be affected by a lawsuit. There is no guarantee you are protected but LLC’s do help.
How hard is it to set up an LLC?
In Colorado, it is not very difficult to create an LLC. I have my assistant create the paperwork and submit the documents to the Secretary of State. Each state has different requirements and rules to create an LLC. Some states have a very easy process like Colorado and others are much more difficult. Check out your state’s requirements before you take this on yourself. I learned how to submit the paperwork and how to create the paperwork by looking at the documents for other LLCs that were created by a lawyer.
What does it cost to create an LLC?
In Colorado, it costs $50 to set up an LLC if you create the documents and file yourself. Every year there is a $10 filing fee to keep the LLC active. Other states may charge more or less in fees for an LLC. Here is a list of the fees that each state charges to set up and keep up an LLC.
If you want to hire a lawyer to create an LLC it can cost hundreds and possibly thousands of dollars. When I asked a lawyer to create an LLC for me, he wanted to charge $850. One thing you have to consider when deciding whether to use LLCs is the cost. If it costs you $1,000 to create each LLC and $500 a year to maintain the LLC, it may not be worth it. On the other hand, you may want to use one LLC for all your properties. The less LLCs you use the less protection you will have.
One thing you can do is use a lawyer to create one LLC for you. From that point forward you may be able to copy how he created the LLC, to create more LLCs. However, always check with state laws and attorneys to ensure this is legal.
LawDepot also has some cheaper resources for creating legal documents.
Why do you need an LLC for each rental property?
There is the option of putting all of your rental properties in one LLC. According to my lawyers if one rental property is affected by a lawsuit, then all the properties can be affected if they are in the same LLC. Likewise, if you have separate LLCs, but have one bank account for all the properties, it can be argued that the rental properties are not separate entities and could all be affected by the lawsuit.
You could also use one LLC for two rental properties or three to reduce your costs, but again all the properties in that LLC could be affected by a lawsuit.
Is it harder to get a loan if you have an LLC
LLCs can help protect your rental properties from liability, but LLCs can also create problems. Many banks will not lend to an LLC, they will only lend to an individual person. It is possible to buy a property in your own name, get a loan and then transfer the property to an LLC. The problem with this strategy is the bank may have a due on sale clause. Due on sale means, if the property is ever sold to anyone, the bank can call the loan due immediately. Transferring a property from an individual person to an LLC is considered a sale, even if the same person selling the home owns that LLC.
Most people will tell you the chances of a bank calling a loan due because you sold the property to your LLC are very small. However, it can happen and if they call the loan due, you will have to pay it off by selling the house or refinancing in a very short period of time.
There is the option of putting your rental property in a land trust, which in theory does not allow the lender to call your loan due when you transfer the property to an LLC. That is beyond my scope of knowledge!
I use a portfolio lender who will lend to an LLC, and that is why I have no problem putting all of my properties into LLCs. My portfolio lender will refinance the properties that are in LLCs and let me buy new homes with an LLC or transfer my houses into an LLC. If your bank does not lend to an LLC, you may not be able to refinance any properties or buy any new properties with an LLC.
Most lenders are hesitant to lend to an LLC, but there are some that will.
What if you don’t want to use an LLC?
If you decide not to use an LLC or want more ways to protect yourself here are some tips.
- Don’t be a lazy landlord! Make sure your houses have working smoke detectors, carbon monoxide detectors and are safe. Most lawsuits come from a tenant getting hurt or worse because the property was not safe.
- Get liability insurance. Landlords can also get an umbrella policy that will cover all their properties and protect against lawsuits. Take to your insurance agent about your options.
- Talk to an attorney to see if there are other options to help protect you. In some cases, you may not need an LLC or the cost may not be worth it.
An LLC offers a lot of protection in case of a lawsuit against a rental property. However, you will have to decide if that extra protection is worth the cost and the possibility of not being able to refinance homes or get your loans called due. If you plan to use LLCs, always talk to your bank first to make sure they are okay with it. Always consult your attorney about using an LLC and making sure it is set up correctly to protect you.
Entities for House flipping
This information was provided by Clint Coons with Anderson, Legal, Business and Tax Advisors, who specializes in setting up entities for real estate investors who are flipping houses or buying rental properties.
A good real estate planning firm might recommend you treat your active real estate business as a C-Corporation and receive your profits as W-2 income. The advantage to this approach is your lender does not know you own a business, because your ownership is not disclosed on your 1040 (less risk), and you fit into their preferred lending profile – W-2 wage earner. The downside to using the C-Corporation approach is your tax liability will be the same as the single-member LLC. You have to decide if you need the extra income in order to qualify for more loans, which may be an acceptable trade-off.
I employed the aforementioned strategy to assist one of my real estate clients in accessing the equity in his home. My client earned $150,000 on average from his real estate flipping, but lenders refused to give him more access to the equity in his personal residence, because of his source of income. To solve this problem, we created a C-Corporation for his real estate business and treated all of his income as W-2 earnings. Within the year, the lender was willing to give home the loan and he had access to his equity.
Real estate investing requires studying your objectives from many angles, and then deciding on a plan that meets your overall objectives. In some instances, you may only be concerned with taxes, while in others it could be the ability to fund a retirement plan or in the case of my client, borrow more money. Whatever your investing objectives, work with professionals who understand investing and not just the tax or legal aspects of real estate.
What about an S corp
I use an S corp for my flips because that is what my accountant told me to do! While I can give some opinions on why or why not you should use an S corp or C corp they will probably be wrong. I highly suggest talking to your lawyer or accountant to see what structure is best for your situation!
With the new tax laws, there are additional savings for corporations. I am not an expert but experts have told me that using LLCs or S and C corps can save you money over taking taxes in your own name when investing in real estate. The new 20% deduction is the main reason corporations can save you money. Again, talk tot he experts to see exactly what savings you will see and how to get things set up right.
I love making money, but I hate taxes. I don’t just hate paying taxes but doing my taxes. I rely heavily on experts to help me set things up right, which saves me time and headaches. This article may not go into the details than an accountant or lawyer can, but I hope it gives some insights into the entities that can be used with real estate.