"Minimize Business Risk by Using a Limited Liability Company (LLC)"
When managing your rental property business, the 4 most important things you can do to minimize litigation risk are:
ADVANTAGES OF HOLDING PROPERTY IN A REAL ESTATE LLCThe first step to manage your investments like a true rental property business is to create a single-person limited liability company (disclaimer: if you're in a state that does not allow this, please consult with a property attorney in your area). The main advantage of a rental property business LLC is that it provides corporation-like liability protection. Thus, your personal assets would be protected if you are successfully sued – the only assets you would have at risk would be those within the LLC. As an added bonus, a single-person LLC also allows you to file your business rental tax deductions on your personal return. So it's very easy to manage.
LLC FORMATION TIPSYou'll want to form your rental property business LLC when you acquire your first property. Any attorney, or online service such as LegalZoom, can help you with this and it'll cost anywhere from $200-$350. And, you can form your LLC in any state you wish. If you plan to acquire only a handful of rental properties (let’s say, 3 or 4), and hold them for only 10-15 years, then it probably makes sense to put all 3-4 properties under the same LLC because it's cheaper to have 1 LLC than several (initial creation costs, plus annual fees). The downside is that a single litigating tenant could theoretically go after all of your properties. Alternatively, you could put each property into its own LLC to limit your exposure to 1 property at a time. However, as your real estate investing business grows, this can get expensive and cumbersome to manage.
BEST OF BOTH WORLDS: DELAWARE SERIES LLCThe best of both worlds is a Delaware Series LLC, which is what I utilize. With this structure, you have an umbrella limited liability company, with each property held in its own "series" under this umbrella as follows.
Since each series is independent of the others, theoretically your exposure is always limited to a single series even though all of them are under the same umbrella LLC. The advantage is that your cost is essentially the same as if you had 1 LLC, yet each property is singularly protected. The downside is that this is a relatively new legal structure for a rental property business and so there is not a whole lot of evidence that the limited exposure per series would hold up in court. In any case, these are just some things to think about. Definitely consult with an attorney to determine the best structure for your real estate investing business.
HOW TO HOLD TITLE IN THE NAME OF YOUR LLCOk, let me say that this is not as easy as it would appear, because mortgage companies will typically not make a property mortgage in the name of your rental property business LLC (even if you personally guarantee the loan). So your personal name will be on the loan, which means that your personal name must also be on the property's deed / title at the time of acquisition. This is a major problem because the title must be in the name of your real estate LLC in order for your activity to be deemed as business activity. Otherwise, you could legally be considered an individual instead of an LLC, thereby putting your personal assets at risk. When an attorney tries to discredit your corporate status, it is known as "piercing the corporate veil." So what you will need to do is transfer the title of the property from your name to the name of your LLC after the mortgage closing via the filing of a "quitclaim deed" (may be called something different depending on your state). Your attorney can do this for you and it will cost a couple hundred dollars. You should wait a few months after you close to do this to give enough time for the original deed to be recorded with the municipality. So for a few months immediately after acquisition you will technically not be running the activity as a business. Luckily, you will have good insurance coverage to close your risk gap in the meantime (make sure you let your insurance company know about the LLC transfer so they can update your policy accordingly).
WORD OF CAUTION WHEN TRANSFERRING TITLE TO YOUR LLCNow, if you set up your mortgage so that the investment property taxes are paid out of an escrow account, there is a tiny risk that your lender will exercise the standard "due on transfer" clause when the title or deed is transferred to the name of your limited liability company. This means that after they get wind of the transfer they could require the entire loan to be paid off in, say, 30 days. How would they know, you ask? Because after the transfer is made, the property tax bill that your lender receives will now have the name of your LLC on it instead of your personal name. This could throw up a red flag in which your lender may erroneously assume that the transfer was made to an LLC not affiliated with you. One way to get around this is to pay the property tax on your own, although some lenders may not allow this. That said, I think the risk of your lender balking is very, very small. And even if they do balk, chances are that you could explain the situation and they would be ok with it. Worst-case, you could simply refinance investment property with another lender that understands what you are trying to do. However, I have filed quitclaim deeds for all of my properties, even those with lender-managed escrow accounts, and I have never run into a problem.
"BEST PRACTICES" FOR DAY-TO-DAY PROPERTY MANAGEMENTSo now that you have a rental property business LLC and your property's title has been transferred to it (and your insurance policy updated accordingly), you can focus on the day-to-day aspect of managing your real estate investing business. The key is to separate all your real estate activity from your personal activity as best you can. That means all documents (except your mortgage docs) should reflect the name of your real estate LLC and not your personal name. Also, you should not use personal accounts for your real estate activity...this is called co-mingling of assets, and it's a key focus for any litigating attorney attempting to pierce the corporate veil. So, get separate accounts.
Tips for Managing Your Real Estate Investing Business
Beyond that, there are other things you can do throughout the course of running your rental property business that can act as preventive maintenance to avoid getting sued in the first place, for example:
Return from Rental Property Business to Homepage 29 Responses to Minimize Business Risk with a Limited Liability CompanyLeave a ReplyYour email address will not be published. Required fields are marked *
|
regarding separating personal assets from llc assets,
1) how do you transfer assets into and out of the llc? is it as simple as transferring funds from the llc account to your personal account and vice versa, or do you have to do something like pay yourself a “salary” from the llc?
2) can you make mortgage/heloc payments directly from llc accounts, or should you transfer funds to your personal accounts first (since the mortgage/heloc is under your name, not the llc)?
3) can you use a single account for all llcs, owned by the umbrella llc, or does each series need its own account?
thanks a lot for your useful site.
Hello,
Thanks for visiting my site. If you are asking about the income you receive, if it is in a LLC then it will all pass through your personal annual tax returns. If you are looking to draw a salary from the LLC, I advise you to contact an attorney to discuss the best approach for your needs.
If you are looking to put the property itself in the name of the LLC, you will need an attorney to do this. In my state the filing is known as a “quit claim deed” but it might be called something else in your state.
I’m not sure about your last 2 questions but again, although I know enough to be dangerous, I would advise you to contact a professional accountant and attorney because all states have different rules and regulations to abide by.
Good luck!
Alan
thanks for the response. i was more asking about separating funds in regards to liability and “piercing the corporate veil”.
for instance, at the beginning stages, if the income from rent isn’t enough to cover all expenses and i need to contribute personal funds, could i just transfer funds from my personal account to the llc account, or would i have to write a personal check specifying “equity contribution” to the llc?
likewise, if significant funds have built up in the llc account and i want to withdraw some funds for personal use, can i just transfer the funds, or would i have to write an llc check specifying “profit distribution”?
i’m just curious how you yourself do this in your own real estate business. likewise with my last 2 questions: how do you handle it in your own business?
further on down the road, i will definitely consult an attorney and an accountant, but i just want to know how things work before i get that far.
thanks again!
legal note: i understand that anything you write does not constitute legal advice and i absolve you of any liability regarding my own financial decisions.
I don’t do what you are describing so again just ask your accountant (which you must have if you invest in property…if you don’t have one, get one before you acquire your first property).
I’m paying cash to buy a property (for getting a good deal). After closing the escrow, I want to cash out some money. My question:
Should I form a LLC before purchasing?
If I do this, later can I use my personal credit to get a loan for this “LLC owned” property? What else should I pay attention to? Thank you very much!
Scenario: You own a rental property that is underwater (you owe more than it is worth). It is being rented but at only a fraction of the mortgage payment. Can you transfer this property to a LLC to protect your personal assets in case you have to default on the loan in the future?
Hello – thanks for checking out my site. I don’t think transferring the property into an LLC will achieve the goal because even though the title will be in the name of the LLC, the mortgage will still be in your personal name and it is the mortgage company that would foreclose. I really don’t think lenders can dip into your assets though, they will simply take possession of the property via the foreclosure process and then sell it to recoup as much of their money as possible. I think your worst case scenario would be losing the house, but that’s where it would stop. Just keep in mind that I am no lawyer, this is simply my opinion of how it could play out. If you’re really worried about it, I’d talk to a legitimate attorney. Good luck!!
I reside in MD, and have rental properties in VA and PA that I had been managing that I own. Would I be protected if anyone got hurt at any of the properties, if I formed LLC Property management company in MD for those out of state properties, without transferring the real estates to LLC? In another words, if someone got hurt, if I claim my property mgt company is worth 10K, then would that be the max that they can sue, and not come after those out of state rental house where they were injured?
Hi Sandy,
Thanks for checking out my site. First, I must advise you that I have no legal training whatsoever so I would DEFINITELY check with an attorney. That said, my gut feeling is that what you are proposing will not protect you. If someone is injured on a property, the owner of that property is the entity that would be liable. The property management company you are proposing would not be the legal owner, and therefore would not be involved. The person or company whose name is on the property’s title is the legal owner – period. And only the legal owner would be liable. I am thinking that the only way your idea would work is if you actually transferred the property titles into the name of the property management company so it would then be the legal owner.
Good luck!
Alan
i have two condos that are free and clear. would it be wise to set up 3 llc one for each unit and the 3rd llc be a property management and should i put the property management name on the title of the other two llc.
Hi Alan,
If a property owner rents a property to a tenant, can the owner indemnify himself / herself against any injuries / etc that may happen on the property in the lease agreement?
Thanks,
I have a rental property in ID; it’s in my own name; can I convert that to an LLC without a huge hassle?
Also–If I buy 2 new properties; say one in UT (where I live) and one in NV; do I need a separate LLC for each state; or can I pick one state and use the same LLC for both states??
Thanks!!
Hello,
Thanks for checking out my blog. Yes you should be able to transfer the title / deed of the property into your LLC. In my state (NJ) this is called a quitclaim deed but might be called something else in ID. Any attorney can do this for you…it’ll cost a couple hundred bucks but will allow your LLC to be the legal owner of title. Also, you can put any property from any state into the LLC, the geography of it does not matter.
Thanks,
Alan
I am considering buying 3 rental properties using only cash. Should I set up an LLC prior to this purchase so that these properties will fall under the LLC? Thanks
Hi – thanks for checking out my site. Yes you should definitely set up the LLC prior to buying the properties. Since you are paying cash, there is no issue with the mortgage company refusing to put the mortgage (and by default) the title in the name of the LLC. You can simply put the LLC on the title from the get-go.
Can you please explain how you handle your mortgage payment each month? Since the property is now titled to the LLC but the mortgage is still in your name, how do you rectify paying the mortgage with personal funds and account for it on the business/LLC side?
Also, how did you handle the initial “seed” money that started your LLC? Do you just transfer money from your personal banking account to the LLC account without any type of declaration of it being a “business” or “equity” contribution?
Hi Robert – thanks for checking out my site. I simply pay the mortgages from my LLC bank account each month. I do not use personal funds to pay the mortgages, even though my personal name is on them. From a liability perspective it doesn’t matter. Although it would be ideal to have the title AND the mortgage in the LLC’s name, my attorney said that the important thing is that the title is in the name of the LLC. As long as the title is in the name of the LLC, irrespective of what name the mortgage is under, from a liability perspective the property is considered owned by the LLC. Now, keep in mind that I am in NJ. I don’t know if this is the same in all 50 states. I would assume it is but I have never researched it.
Regarding the seed money I used to get started, I used a HELOC on my pwesonal residence to fund the down payment, and then refinanced a few months later to remove all ties from the rental property mortgage to the HELOC. Again, the improtant thing to limit yuor liability is the title, NOT the financing.
Hope that helps…
Hello, this is very informative site.
I also want an LLC for asset protection and I apologize if this has been asked before (although I could not find the specific/exact question):
Details – three properties all in MD, I live in PA. I have owned all of them for 20+ years all in my name. One property has a mortgage, the other two do not. I plan on paying off the final mortgage before the LLC transfer. I want one LLC for all properties. How do I perform the transfer to an LLC exactly? What fees should I expect? I have heard that keeping 1% ownership in my name and 99% in the LLC is normal, what does this do? Thank you.
Hi Greg,
Thanks for reading! In my state (NJ) the specific filing to transfer the property from a personal name to the name of a LLC is called a quitclaim deed. There are a few states where it’s called something slightly different but I’m guessing PA is not one of those states. Mt attorney charged roughly $200 to file the quitclaim deed and it took about 6 weeks to get recorded, etc. I’ve never heard the 1% ownership rule so can’t help you on that one.
Good luck!
Alan
Very helpful information. I’m just starting the process of setting up an LLC for rental real estate that I own, so I can’t offer any advice or results of the process.
Alan, thanks for this informative site! I just purchased a rental home for $130k and want to quitclaim it to an LLC. Then I want to sell 49% of the LLC to an investor for $90k. Can you tell me how I should state the initial captial contributions of us both in the operating agreement in this scenario?
Secondly, once I form the LLC to hold the property, do I need to file for a separate business license and tax permit?
Thanks so much in advance!
Hi Harry, thanks for checking out my site! I’m not sure about the first pat of your question as I have never done what you are planning. It sounds fairly complex so I would encourage you to talk to an attorney about it. He she will be able to draw up the necessary documents and will also be able to do your quitclaim transfer. I never had to do any additional filings after doing a quitclaim deed, but I don’t know if it’s the same in every state. Good luck!
Hi…this is a great blog. What tax benefit does forming a LLC offer? I have been using Schedule E for 20 years and have accumulated a lot of losses that I have not been able to deduct because of my earned income level. Will an LLC help with that? Thanks!
Hi Mitch, thanks for checking out my site! Yes an LLC allows you to deduct your property expenses from your total income because it passes through your personal income tax filings, expenses like mortgage interest, property taxes, insurance, mileage, depreciation, and more. I’ve never held property in a different type of entity so I cannot compare any other options. But even if I could, your specific situation involves a lot of variables and numbers that I am not privy to, so it would be impossible and irresponsible to offer specific advice. I strongly suggest you talk to your accountant about your best course of action. And if you don’t have an accountant, get one NOW! Good luck!
Excellent site! I’m just starting in this and finding valuable information.
My situation is somewhat different in that I’m starting unintentionally. I’m being transfered out of state for work, unable to sell my condo, but I have approval from the HOA board to lease.
My question then is, can I not get the same tax benefits from the title being in my name vs. an LLC? My fear is that my HOA board gave me personally permission to lease my unit, not an LLC that I would have to create later.
Hi – thanks for checking out my site. For tax purposes it doesn’t matter whether you hold the property in your own name or in the name of a single-member LLC. For a single-member LLC, the tax variables associated with the property will flow through your personal tax return so there is no difference. Hope that helps!
Hi Great blog.
I’m in the process of buying in NJ and I want to put the property in an LLC. I’m having major problems with the banks giving me a loan. I am very interested to read that you can change the title post closing but I have one question regarding being able to claim the mortgage inertest against rental income.
Can I still make this claim on my tax returns as the mortgage will still be in my personal name but the property is being held/owned by the LLC.
Thanks again for the great info.
Hello – thanks for your kind words! Yes you will still claim your mortgage interest expense as a tax deduction because your single-member LLC taxes flow through your personal tax return. So whether the title is in the name of the LLC or your personal name, the tax treatment is the same. As an example, my mortgages are in my personal name and my titles are in the name of my LLC Panda Realty Group, and I have always been able to claim the deduction. Hope that helps!
Does your website have a contact page? I’m having trouble locating it but, I’d like to send you an email. I’ve got some suggestions for your blog you might be interested in hearing. Either way, great blog and I look forward to seeing it expand over time.