So over the past 3 years I’ve been an avid reader of this forum, I’ve read many a real estate book and a couple of real estate courses. I decided awhile back that rental properties seemed like the avenue that I wanted to take, but I got into a partnership with someone who wanted to fix and flip instead and we had a few contracts fall through. So now, after 3 years the partnership has dissolved and I’m on my own in this endeavor, I’ve saved up some money and I’ve also come into some money through an inheritance. At least enough to buy 3 or 4 rent houses with cash if I wanted to go that route, but I will be getting financing with a minimum down-payment so as to make use of leverage and I’ll be doing it one at a time, initially taking the role as the property manager, to play it safe. My wife and I will both be keeping our jobs for the time being because together we make a decent low 6 figure income, but neither of us enjoy our corporate jobs and would like to be doing something else.
Anyway, on to a question I’m still confused about. I’ve read many posts and books that basically say that starting an LLC is the holy grail of the rental business, basically stating that without it you’re screwed if there is ever a problem and that the tenant can take you to court and basically take your money, your wife’s money, all your assets, cars, houses, etc. and leave you a homeless destitute wretch and then you die, so make sure get an LLC.
Then I’ve read a lot of posts on this forum that LLC’s are not worth it in the beginning and sometimes never worth it because as long as the problem that the tenant has can be blamed upon the LLC owner, which could be anything at all if the owner plays an active part in the property management, then an LLC is essentially worthless. As long as you have a million dollars of insurance on every rental, you should be covered in 99.9% of situations.
So I have to ask, which view is right, because they are totally opposite ideas. Let me create a scenario with small odds of happening (but that’s what insurance and LLC’s are for, right): If I had a rental with insurance but no LLC and there happened to be a water leak behind the refrigerator one day and the tenant slipped in it and fell and hit their head on the counter and paralyzed themselves and after doctor’s bills and being taken to court with a judge ruling that their loss of income over the course of their life would amount to something that was more than the insurance would pay, as I understand it, in an instance like that I would most likely have my assets liquidated and a certain amount deducted from my wife’s and my paychecks each week, bascially putting us in the poor house. Would the limited liability of an LLC help in a situation like that or am I looking at this wrong?
The reason(s) you would put the property into an LLC is not for protection, per se (unless you had a ton of equity; more than $100K), but for a better tax treatment. Your attorney/CPA should tell you which entity is best for your tax purposes (holding vs. flipping).
If someone slips and falls, you have insurance to cover you. Before a tenant could get to you, they would first have to exhaust your insurance. And in the scenario you imagined, or anything remotely like it, the tenant would have to prove you CAUSED the damage by fraudulence or gross negligence.
If you buried a pipe bomb in the yard and the tenant’s kids got blown to heaven (or worse), then maybe you’d have a problem. Short of that… ??
You’ve got insurance. Just go with it.
Our family has owned dozens of rentals and the worst that ever happened to us was the new, upper, kitchen cabinets came away from the wall on an old rental (we installed the cabinets poorly with nails, instead of screws) and it dumped the plates and cups on the floor. We had to replace the dinnerware and fasten the cabinets again.
It was a minor cost that was less than our deductible. In 40 years, that was our worst nightmare.
All that said, we treat our tenants with respect and professionalism, and don’t get caught up in amateurish, personality conflicts like small operators often do. We also keep our promises. This is good business, and keeps most small issues from escalating into some sort of drama and trauma episode.
Hahah, yeah you’re probably right. I am somewhat of a worry wort. But I do like to cross my t’s and dot my i’s. :smile That said, I do have appointments with my attorney and an accountant next week to go over rental paperwork with my attorney and normal tax business with my accountant, but I will have a couple of questions for her as well.
What you’re saying does make sense though. Initially, most all the books I read that advocated making use of LLC’s were stating that the main purpose was the tax benefits with a secondary purpose of the limited liability to protect you in rare instances where it would be needed. But it seems that a lot of times when brought up on this forum, LLC’s are being touted first and foremost as basically being an extra insurance policy to double your protection and make it harder for a tenant to file suit against you, some even advocating that you should make use of land trusts inside an LLC for each property and then have an S corp as the umbrella corp. where all your money is funneled. Whereas a couple of people will swoop down on a thread like that and say, LLC’s are not needed in the majority of cases and especially if you’re managing your own properties, because almost anything can be deemed as gross negligence which would void the usefulness of the LLC.
Initially, when reading about, it seemed like an easy enough idea to wrap my head around, but the more I read about it on here, it started to seem a bit confusing.
In a rental property activity, your rental expenses are deducted from your rental income before taxes whether the rental property is held in your own name or in an LLC.
As a general rule for a rental activity, the LLC is tax neutral. That is your rental activity LLC gets the same deductions and passes through the same tax liability as you would have without the LLC.
Your comment is not necessarily wrong, just not correct in the context of this discussion.
That saying just highlights the difference in when business income is taxed and when an employee’s personal income is taxed. As a general rule, a business is taxed on its net income after expenses; the employee pays his expenses with after tax income. For example, if the business rents office space, the rental expense is deducted from income before taxes; whereas, the employee pays taxes on his income then pays his rent with after tax money.
A rental property activity is a business and rental expenses are deducted from income before taxes. This is true whether the rental activity is a sole proprietorship or owned by a formal business entity.
So I talked to my attorney, who was in the rental business for around 15 years and told me that he went into it with no money down on his first deal and walked away after selling everything in 2007 with a $2 million profit after he sold his 24 rentals he’d acquired over the years. He told me that he strongly recommended an LLC for rental properties. He told me that when I get an accepted offer on a property to come to him before closing and he’ll set me up with an LLC for between $400 to $500 and after I close then I can just deed the property to the LLC.
Now my mortgage officer at the bank, who currently owns 3 single family rentals and 1 duplex told me she advises against doing that because if the house is deeded into an LLC then the bank can call the note. She said that rental insurance has served her fine over the years. Then I asked if I should start an LLC and get the loan through the LLC and she said I could do that but I would only have the adjustable rate mortgage option in that case, not the fixed rate. So I’m still confused, what would be best, LLC, or no LLC?
You’ve confused “deeding in” and “deeding to” an LLC. In the first instance, you’re deeding INTO an LLC at the outset, before closing.
In the second instance, you’re inferring “deeding to” and LLC after closing. Technically, the mortgage broker would be correct when saying the bank “can” call the note in that event. However, the bank won’t do that. The mortgage broker evidently doesn’t understand the point of the due on sale clause. It’s about discouraging seller financing when bank rates and terms are significantly more expensive than seller financing terms. Or simply when the existing loan rates that are significantly lower than current rates. It’s not about discouraging deed transfers. Lenders don’t care who owns the property, as long as the loan is current. This has been pointed out ad nauseum on this forum.
I’m not sure about the rate terms being limited only to LLC’s.
You don’t need LLC’s until you’re net worth is over $100k. Short of that, and it’s too much hassle. Keep in mind, you’re talking to an attorney… he makes money doing LLCs (necessary or not).
The banker is saying that long term fixed-rate loans (i.e. conventional loans) are only available to individual borrowers, not LLCs or other entities, per Fannie and Freddie guidelines for secondary market loans. Banks will, however, loan from their own portfolio to LLCs. These are virtually always ARMS, as banks do not want to take interest rate risk in their own portfolio.
Conventional thinking is that deeding from your name into an LLC will not cause a bank or loan servicer to call your conventional loan, even though it’s a clear triggering of the due-on-sale clause, as long as your loan is in good standing. I’m not at all sure that they wouldn’t call it in an environment where current rates are much higher than your loan rate.
There would be a fortune to be made by banks and bond investors if they call your loan, forcing you to pay it off at 100 cents on the dollar when it’s only worth 50 cents on the dollar due to the higher rates. In fact, I may start a business identifying these deals for banks. (Just kidding, I’d never sell out my fellow investors!). It does cause some concern, however, especially if I’m using a single-member LLC, which many regard as somewhat thin asset protection anyway.
Having plenty of umbrella liability coverage is always smart, and surprisingly cheap.