Dave - what do you think of LLCs?

devorahAugust 13, 2008

My husband and I are adding a 2nd rental (triplex) to our investments. Our daughter and her husband have formed an LLC for their investment properties and are urging us to do the same. Is there a downside outside the set-up cost?

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Hi Devorah,

First the requisite disclaimer; I am not an attorney, and none of my comments, opinions or advice are intended as legal advice.

Now, regarding holding residential rentals in LLCs;
Is there a downside outside the set-up cost?

Very few... and certainly far fewer downsides than advantages. I *really* like LLCs as business entities because you generally get full liability protection, plus in many states you have the ability to have your business revenue treated EITHER as a 'pass-through' (like sole proprietorships and partnerships) *OR* as a standalone corporate treatment.

Note that recently some courts have deemed single-member LLCs as having less protective and income-seperative effect... but that is very easily remedied by establishing at least 2 or more seperate members... one or more of which can be OTHER entities (like family trusts, other held LLCs, etc.)

NOW... let's remember & realize you're asking a finance guy (and there are several attorneys here who can step in for legal perspectives,) so let's look at financing perspectives.

A) Regardless of how you choose to hold title (yourself, or in an entity,) when you are financing a 1-4 unit residential property you will have no choice but to personally guarantee the loan with full recourse (the only exception being a primary residence purchase loan, and that's in California only.)

B) You *MAY* in some cases (lender dependent, and jurisdiction dependent) be required to have title transfered (generally via quit claim) out of the entity and into your personal name for the moment of executing the loan documents... and then be allowed to transfer it back underneath the corporate veil. This may be required for purchase transaction financing, and even for refinance as well.

C) LLCs generally have far less administrative requirements versus corporations (such as keeping minutes of periodic meetings, certain bookkeeping requirements, etc.) *HOWEVER* as with all fictitious entities there ARE still records housekeeping that must be maintained in order for the courts to uphold your defense if/when you ever need it. Setting up an LLC is a low-maintenance child... but NOT a "one and done" deal.

D) When growing your holdings and considering how many to put in any single LLC (a very common question,) forget about "how many properties" and instead think along the lines of "how much cash-value equity." Your LLC is there to protect your cash value, so you could theoretically have dozens or even hundreds of 100% liened/encumbered properties all held in a single LLC... however, you might want to create additional LLCs and seperate out various properties among them when you begin accumulating equity (cash value) entrapped in the individual properties themselves. HOW MUCH then? That's an individual issue... some believe establishing a seperate LLC in order to protect anything with more than $50,000 of cash-value of equity is cheaper and more effective than paying an additional premium for liability insurance to cover that value to the last $50k... some argue the opposite. Opinions vary, that makes a horse race.

Good luck with your new rental property!!!! That's always exciting!!!!

Dave Donhoff
Leverage Planner

    Bookmark   August 13, 2008 at 5:13PM
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I too am not an attorney, and my advice is based on limited knowledge. One of the risks on owning rental property is getting sued by a tenant. Nobody likes to think about that, but it does happen more often than most people realize. If and when you decide to incorporate, you should make sure that your method of incorporation provides a good measure or protection against lawsuits going after your personal assets. I think you need an attorney to advise you on this.

    Bookmark   August 13, 2008 at 6:26PM
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What I dislike about an LLC is the annual minimum tax.

    Bookmark   August 13, 2008 at 10:40PM
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thank you all so very much. We will pursue this just as soon as we close on the new property.

    Bookmark   August 15, 2008 at 3:29PM
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An LLC can be a C corp, a S corp, a partnership or a sole proprietor depending on how many members you have and how you are organized.

For the tax implications of each, you need to talk to an experienced tax adivsor.

    Bookmark   August 15, 2008 at 10:30PM
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