Author Topic: LLC?  (Read 14696 times)

KingCoin

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LLC?
« on: April 29, 2013, 05:31:35 PM »
Has anyone gone through the process of creating an LLC to hold their real estate assets? I'd like to shield myself from any liability incurred by those assets, beyond my homeowners insurance policy.

What's the best state in which to incorporate? What are the ongoing and upfront costs?  What are the  incremental time requirements? Any advice or pointers to good resources would be appreciated.

Johnny Aloha

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Re: LLC?
« Reply #1 on: April 29, 2013, 05:57:13 PM »
I've also been looking into this and have some more research to do.  As with everything else, there are pros and cons.

From what I can tell, the benefits are reduced liability & asset protection.

The cons (probably state dependant) include:
- higher insurance premiums
- difficult process to evict tenants (must hire a lawyer since it's a business trying to evict someone)
- more complex tax return (schedule E and schedule C)
- difficult process to set up a HELOC or refinance

There are long discussions on BiggerPockets and other forums dedicated to the issue.  In some states, many owners just carry an umbrella policy.

If you decide to go the LLC route, there's another quandry: how many properties per LLC?  One?  Ten?

I plan on talking to a real estate attorney in the state I will invest just to make sure I'm square. 

Hamster

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Re: LLC?
« Reply #2 on: April 29, 2013, 06:41:21 PM »
My biggest personal issue with an LLC is what to do about the mortgage.

You can take out a mortgage in your own name, then transfer the property to an LLC via a quit claim deed. that is commonly done, but it is actually a violation of the terms of the mortgage. So what? In this situation, the bank can call the remaining balance due or force you to refinance. This is extremely rare. It generally doesn't happen because the bank has no reason to force a reliable borrower into a sticky situation. The mortgage officer I spoke to could think of one instance in 5 years at his bank. But, that could change inf interest rates go up. Right now you can take out a 30 year investment loan for well under 4%. What if interest rates go up to 8% in 5 or 10 years? There is nothing stopping a bank from scouring the rolls of all of their properties and demanding that you refinance so that they earn more, or pay in full so they can lend it to others on more favorable terms. I have heard this has been done in the past when interest rates increased significantly, but I don't know of any real life examples.

The other option is to obtain the mortgage under the LLC. For a small investor, this isn't ideal either, since you'll generally need to work with a commercial lender. Since they don't have the same protections as residential lenders, they will have stricter terms, shorter terms, and higher interest rates.

Also, the liability protection from an LLC may be pierced if you aren't very careful to keep the LLC's finances 100% separate from your own. In those cases, the court may determine that the LLC is just a sham (and there is in fact no corporation as the LLC is just "you" by another name), and you can be fully liable.

tooqk4u22

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Re: LLC?
« Reply #3 on: April 30, 2013, 01:53:51 PM »
An umbrella policy may better address your needs.

Hamster

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Re: LLC?
« Reply #4 on: April 30, 2013, 03:41:15 PM »
Also, you may need to pay excise tax on the value of the property if you transfer it to an LLC.

WhereIsHeath

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Re: LLC?
« Reply #5 on: May 01, 2013, 07:42:37 AM »
I'm also grappling with this question right now.  I have a real estate attorney acquaintance who is encouraging me to put my two multifamily houses in one LLC by quit claiming the deeds over to it.  In addition my insurance agent said it's cheaper to get an umbrella policy for one LLC (with two houses) than one policy for two separate houses.  One of my houses is owned outright, so quit claiming it wouldn't be an issue.  The other house has a mortgage, but from everyone I've talked to (attorneys and mortgage co), it's really not an issue to quit claim over to an LLC as long as your loan is in good standing.  Just can't decide if it's all worth it . . .

arebelspy

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Re: LLC?
« Reply #6 on: May 01, 2013, 07:55:18 AM »
It probably won't happen, but be aware that a quit claim (or other method to transfer ownership) will trigger the acceleration clause (commonly referred to as the due on sale clause) in your mortgage and, if they wanted, the bank could call the whole note due.

It's probably not something to worry about, but definitely something to be aware of, know the risks of, and potential exit strategies if such a thing does occur.
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WhereIsHeath

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Re: LLC?
« Reply #7 on: May 01, 2013, 08:03:29 AM »
Yes, definitely agree.  From everyone I've talked to, it's extremely unlikely and no one has encountered a bank doing it before (including the loan officer at my bank :)  Just trying to decide if an LLC is worth it at all, or if I should just spend the extra money on an umbrella policy instead.

arebelspy

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Re: LLC?
« Reply #8 on: May 01, 2013, 08:18:35 AM »
Yes, definitely agree.  From everyone I've talked to, it's extremely unlikely and no one has encountered a bank doing it before (including the loan officer at my bank :)  Just trying to decide if an LLC is worth it at all, or if I should just spend the extra money on an umbrella policy instead.

Well you do need to talk to some other people then, as I've talked to people it's happened to (not only in the past decade, but talk to people who remember the 80s and the last time it became quite common).

Make sure you understand the risks more that "I talked with a few people and they said it almost never happens so good enough for me."

YMMV.
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WhereIsHeath

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Re: LLC?
« Reply #9 on: May 01, 2013, 08:25:15 AM »
I know it's happened, but the likelihood right now is extremely slim; banks don't want to take on more properties in that manner, especially if the note's in good standing.  I should also clarify that I'm not very worried about the bank calling the loan because, worst case scenario, I would just pay it off.  I'm more concerned with determining whether or not an LLC is worth it, vs just an umbrella policy.

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Re: LLC?
« Reply #10 on: May 01, 2013, 08:43:22 AM »
It's hard to say what servicers will do when the rules are made by the GSE's.  For private investor paper, I suspect when rates and values go up, a lot of folks will find their notes called, especially the "creative financing" crowd.  I'm thinking of paying off an inherited rental in another state where the lender/servicer refused to allow me to assume the loan and would not refinance because of loan limits.  The loan is owned by Fannie, so I'm on the fence about it.  I have a similar problem with a property in California, but I can likely solve that by moving into it if the lender even figures out it is not owner-occupied by the decedent's child.

arebelspy

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Re: LLC?
« Reply #11 on: May 01, 2013, 09:07:57 AM »
For private investor paper, I suspect when rates and values go up, a lot of folks will find their notes called, especially the "creative financing" crowd.

Indeed.  If rates stay low, ala Japan, it may not be an issue.  If and when rates rise, it very well could be.

I'm more concerned with determining whether or not an LLC is worth it, vs just an umbrella policy.

You say it like the acceleration clause is irrelevant in determining if "an LLC is worth it," but the fact of the matter is you have to get the property into the LLC - potentially triggering that due on sale if the bank chooses.  It seems like you don't fully grasp that when you say "I just want to compare LLCs vs. Umbrella," because it is part of the comparison.

/shrug

Whatever.  :)

Here's lots of reading for you:
https://www.google.com/search?q=llc+vs+umbrella+site:biggerpockets.com
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KingCoin

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Re: LLC?
« Reply #12 on: May 01, 2013, 05:23:30 PM »
In my case things are pretty simple. Single property, no debt, contracted with a property manager. It seems like the process of setting up an entity, making sure I keep that entity separate from my own finances, filing separate tax returns, as well as other tasks like keeping "minutes" is more of a hassle than it's worth. A lot of the argued benefits, like the "professionalism" that comes with an LLC are largely irrelevant to me.

I guess the operative question is, if I have $1mm liability on the house, plus a $2mm umbrella, what are the chances I lose a judgement in excess of $3mm? The way umbrellas policies are priced, it must be less than 1/10,000. Probably closer to 1/1,000,000? I read a few of the biggerpockets threads but didn't see this addressed.

arebelspy

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Re: LLC?
« Reply #13 on: May 01, 2013, 05:31:33 PM »
With your setup, an umbrella policy will be cheaper, easier (no legal paperwork to file and keep up yearly) and provide more protection.  IMO.

Of course, don't listen to randoms on the Internet, but consult your lawyer.

(Most of whom will argue for an LLC, because that's what they do, rather than insurance, but hear their strongest argument for it and decide if you need one.)
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WhereIsHeath

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Re: LLC?
« Reply #14 on: May 01, 2013, 07:01:29 PM »
In my case things are pretty simple. Single property, no debt, contracted with a property manager. It seems like the process of setting up an entity, making sure I keep that entity separate from my own finances, filing separate tax returns, as well as other tasks like keeping "minutes" is more of a hassle than it's worth. A lot of the argued benefits, like the "professionalism" that comes with an LLC are largely irrelevant to me.

I guess the operative question is, if I have $1mm liability on the house, plus a $2mm umbrella, what are the chances I lose a judgement in excess of $3mm? The way umbrellas policies are priced, it must be less than 1/10,000. Probably closer to 1/1,000,000? I read a few of the biggerpockets threads but didn't see this addressed.

Yes; this is essentially my dilemma as well.  One of my properties has a low mortgage balance and the other is paid off entirely, so I'm not seeing much point in the LLC when I compare the yearly cost of it to the cost of an umbrella policy.  Think I'm leaning towards the policy and not the LLC. 

Peony

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Re: LLC?
« Reply #15 on: July 21, 2013, 07:41:30 AM »
I own two rental properties and am also puzzling out whether there would be benefits to an LLC (or some other corporate structure) for me. My CPA says no, and in fact he even questions whether an LLC is truly an effective means of protecting assets.

I am somewhat reassured by what I am seeing on this thread to the effect that umbrella policies may be sufficient. Of course I have to put my ass in gear and actually get those policies instead of just talking about it.

Katnina

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Re: LLC?
« Reply #16 on: July 21, 2013, 09:20:12 AM »
My 5 rental properties are held in LLC's, but I paid cash for them so no mortgage acceleration issues; my husband's rental property used to be his primary residence & has a mortgage on it ( which we are trying to pay off ASAP...) so I is still in his name.  Once we get the mortgage paid off, we'll quitclaim it into an LLC.
It would be ideal to have one LLC per property, for tax-free exchange purposes, but I plan on never selling the 5 I own already (cash on cash return is amazeballs), so I try to keep total value of under $250k in each LLC.  3 properties are in one, 2 properties are in another & I'm trying to buy a 6th which will go into its own joint member LLC (my other 2llc's  are sole member LLC's since I bought the properties before we married).
We also have a large umbrella policy.  We are over-insured but I'm happy to pay to protect our assets.

willn

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Re: LLC?
« Reply #17 on: July 22, 2013, 01:31:59 PM »
filing separate tax returns

In this case it will almost certainly be a schedule C on your return, not a separate return.  So the LLC net profit flows to your income (sometimes referred to "pass-through" or disregarded entity).  That's the default classification for a one member LLC.  Two members (you and your wife?) mean the default will be a partnership, which also is Schedule C and flows to your income.

http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Limited-Liability-Company-%28LLC%29

Schedule C is easy, especially if you use Quickbooks + Turbotax, the expense and income entries can be mapped and imported in the software when you do your return.

Undecided

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Re: LLC?
« Reply #18 on: July 22, 2013, 03:06:16 PM »
It would be ideal to have one LLC per property, for tax-free exchange purposes, but I plan on never selling the 5 I own already (cash on cash return is amazeballs), so I try to keep total value of under $250k in each LLC. 

We also have a large umbrella policy.  We are over-insured but I'm happy to pay to protect our assets.

Can I ask, if you're overinsured, what purpose are you trying to achieve by holding the properties in LLCs?

Or do you mean that the LLCs have large umbrella policies? (Which would make sense, because if the LLC is effective at shielding you from liability, your own personal umbrella policy is irrelevant.)

Generally, but depending to some degree on where you form the LLC, putting a property in an LLC that doesn't have assets (or insurance) to reasonably satisfy its liabilities could jeopardize the presumptive liability protection of having the property in an LLC in the first place. So you'd likely still need insurance in the LLC, meaning you're still paying for that on top of the cost of having the LLC.

Peony

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Re: LLC?
« Reply #19 on: July 22, 2013, 04:57:43 PM »
So, Undecided, are you saying that it's the umbrella insurance that protects from liability rather than the LLC, so that there's no real advantage (only expense) to the LLC? Or am I misunderstanding?

Undecided

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Re: LLC?
« Reply #20 on: July 22, 2013, 06:23:40 PM »
So, Undecided, are you saying that it's the umbrella insurance that protects from liability rather than the LLC, so that there's no real advantage (only expense) to the LLC? Or am I misunderstanding?

I don't know exactly what her structure is, but if the investor has no personal liability regarding the property held by the LLC (i.e., any liability arising from, e.g., an accident at the rental, is not attributed to the investor, only to the LLC), then the investor's purchase of a (personal) liability policy wouldn't be relevant to that liability (and wouldn't be available to the LLC to satisfy its obligation in respect of that liability). If the investor doesn't believe the LLC will actually isolate the investor from personal liability (i.e., if the rentals are the primary reason for a personal umbrella policy), then why pay for the LLC in the first place? But I don't know if the liability isolation is her only reason for the LLCs---that's what I was trying to find out (because I don't see other benefits to it in the context she described).

Maybe she has other reasons for having the umbrella having nothing to do with the properties held by the LLCs, such that the potential protection if the LLCs are pierced is just a bonus, too. I'm just trying to understand if there's a potential advantage of the LLC (when one already has sufficient personal liability insurance to survive any plausible liability) that I don't see.

Katnina

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Re: LLC?
« Reply #21 on: July 22, 2013, 08:42:05 PM »
^^^
The umbrella policy protects all of our assets, and those assets include my LLC's.  the LLC's are in place so if something happens at a rental, someone could only sue for the assets held in the LLC (I have landlord insurance policies in place too, which have liability coverage as well), and hopefully the LLC would not be pierced.  If the LLC is pierced, the umbrella policy covers all of our other assets, including my other LLC's + primary residence, official retirement accounts, non-retirement stock investments (I like to swing trade. i traded stocks for a hedge fund for 5 yrs, it's in my blood) & mutual funds, dh's rental house, etc etc.
If something happens not at a rental house but at our primary residence, (or dh's rental, or car or our dog bites someone or whatever) and someone tries to sue us for above our liability coverage on our primary residence or his rental or car insurance, the umbrella policy would cover all of our assets, so no one can take my beloved LLC's away from me.  Or any of our other hard-earned assets :).

Yep we're over insured but my dad's a lawyer and he's seen some major nightmare lawsuits so he recommended the umbrella + LLC route.  I sleep better knowing I'm over insured.


Ymmv!!!


willn

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Re: LLC?
« Reply #22 on: July 23, 2013, 06:40:26 AM »
I own two rental properties and am also puzzling out whether there would be benefits to an LLC (or some other corporate structure) for me. My CPA says no, and in fact he even questions whether an LLC is truly an effective means of protecting assets.

I am somewhat reassured by what I am seeing on this thread to the effect that umbrella policies may be sufficient. Of course I have to put my ass in gear and actually get those policies instead of just talking about it.

This is the general advice I've heard too. Until you have more than say 3 to 5 million in assets at which point my lawyer starts recommending LCs.  LLC's are also defined by state law--it isn't a federal tax classification or legal structure. State laws may vary in their protection.

neoptolemus412

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Re: LLC?
« Reply #23 on: July 23, 2013, 09:59:56 AM »
An LLC is unnecessary unless you plan on being a true real estate investor and want to attempt to limit the liability on a pool of homes by combining them under 1 LLC.  If you own 2-5 homes, an LLC isn't really a necessary vehicle.  A good umbrella policy is fine to cover your assets, along with other insurance as a landlord, property owner, ect.

The downsides of an LLC are you no longer are afforded the same terms as a traditional borrower under a mortgage.  If you plan on using debt/mortgages to purchase properties an LLC is not the best legal entity to do so.  Banks don't like lending to them and the terms on loans are much worse (usually higher interest & bank can call the loan).   It also increases how complex your taxes will be.  Can you do LLC taxes yourself, yes if you want to invest the time to read the code, understand it, & make decisions.  However, most of us don't have the time/patience for such work (or we'd all be CPAs).  So understand a schedule C is not as easy as doing one's 1040EZ.

The upside of an LLC.  You can pool multiple properties under 1 LLC, thus reducing personal liability to that LLC.  Someone can still sue you (this is America), but they would have to go after the LLC & it's assets before your personal assets (home, retirement, ect.).  Another upside is from a business perspective.  Everything is run through the LLC & you're taxed on the net income (rental revenue - expenses).  As such, you can pool expenses easier and lower your tax liability.  You also have a layer of anonymity. 

The main point is don't quitclaim deed a property without the advice of a lawyer & a CPA.  Trust me, I've seen people lose everything b/c they didn't setup a proper LLC/Partnership to save a few hundred $.  When it comes to taxes or legal issues, always consult professionals as it will save you in the long run.


Katnina

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Re: LLC?
« Reply #24 on: July 23, 2013, 10:19:27 AM »
^
Anonymity is another reason our properties are in an LLC.  We use a PO box for the business, and llc filings are anonymous so it is harder for people to figure out who we are and where we live.  Since we have a property manager, we have zero contact with our tenants and we want to keep it that way!

scamutz

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Re: LLC?
« Reply #25 on: July 26, 2013, 07:25:07 PM »
I'm in the process of setting up an LLC - I haven't found the perfect property yet, but expect to in the next couple of months.  In my case it was recommended by my accountant primarily for the ability to write off expenses and have a chance at staying in my current tax bracket.

Undecided

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Re: LLC?
« Reply #26 on: July 26, 2013, 07:32:44 PM »
I'm in the process of setting up an LLC - I haven't found the perfect property yet, but expect to in the next couple of months.  In my case it was recommended by my accountant primarily for the ability to write off expenses and have a chance at staying in my current tax bracket.

How does having the LLC change your ability to "write off" expenses?

arebelspy

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Re: LLC?
« Reply #27 on: July 26, 2013, 07:55:17 PM »
I'm in the process of setting up an LLC - I haven't found the perfect property yet, but expect to in the next couple of months.  In my case it was recommended by my accountant primarily for the ability to write off expenses and have a chance at staying in my current tax bracket.

How does having the LLC change your ability to "write off" expenses?

It doesn't.  An S-Corp or an LLC taxes as an S-Corp might, if it is on flips done in less than a year.  Any rental income and related expenses it won't help (and should be done in an LLC that is a partnership, possibly shielded by a trust, depending on how much asset protection you need).  A CPA shouldn't be telling you that an LLC is for writing off expenses...

Check with your own accountant, of course, but this is my understanding.
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scamutz

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Re: LLC?
« Reply #28 on: July 26, 2013, 08:48:10 PM »
My understanding is that with a business (and recommends that for my situation the best one is an S-Corp or an LLC with 2 people) combined with a designation as a Real Estate Professional.  I'm just learning - but from what I can tell, travel to prospect for properties becomes a write off - dinners with prospective business associates - more vehicle expenses, more office space and equipment expenses, depreciation, etc.  I don't know - I pay the guy to do my taxes because I'm an artist not an accountant....well, I'm a salesman, but it's still more artist than it is accountant.

arebelspy

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Re: LLC?
« Reply #29 on: July 26, 2013, 08:56:15 PM »
To qualify as a real estate professional you must spend at least 750 hours (that's 14 hours per week), and it must be your primary activity (i.e. you must spend more time at it than another job).  If you have a full time, 40 hours job, that's a high bar, because then you have to also be spending over 40 hours/week at real estate.

Are you a full time real estate investor?  If not, you are not a "Real Estate Professional" according to the IRS.

Hopefully your accountant knows this (and you are using a CPA who owns real estate, not just a random CPA).

Even without the LLC you can deduct related activities and expenses, however.  It's all pass through income straight to your personal return.

(Again, consult your accountant, and don't listen to me, a random on the internet, I'm just sharing what I believe I have learned from studying it, and what I have been told by paid professionals.)
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scamutz

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Re: LLC?
« Reply #30 on: July 26, 2013, 09:02:24 PM »
I'm a bonafide real estate professional....I have a full time gig in new home sales, and I'm looking to get into some investing in hopes that I can turn it into a part time retirement job in a few years.  Thanks for your input - I'm a complete noob when it comes to not blowing every extra cent I have while living the American dream and I'm now soaking up every tidbit of knowledge I can find in an attempt to atone.

arebelspy

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Re: LLC?
« Reply #31 on: July 27, 2013, 12:01:12 AM »
I'm a bonafide real estate professional....I have a full time gig in new home sales, and I'm looking to get into some investing in hopes that I can turn it into a part time retirement job in a few years.  Thanks for your input - I'm a complete noob when it comes to not blowing every extra cent I have while living the American dream and I'm now soaking up every tidbit of knowledge I can find in an attempt to atone.

Having a job in real estate is not being a "real estate professional" necessarily(from what we are talking - the actual term is active versus passive - so you may be a real estate professional but that doesn't mean you qualify as active instead of passive).  For example a Realtor* does not typically qualify, from what I understand...  A job earning an income is different than being an investor.

*Of course, they can deduct expenses related to their job, but that doesn't mean they qualify as active instead of passive with regards to rentals they own.
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Hamster

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Re: LLC?
« Reply #32 on: July 27, 2013, 01:10:27 AM »
I'm a bonafide real estate professional....I have a full time gig in new home sales, and I'm looking to get into some investing in hopes that I can turn it into a part time retirement job in a few years.  Thanks for your input - I'm a complete noob when it comes to not blowing every extra cent I have while living the American dream and I'm now soaking up every tidbit of knowledge I can find in an attempt to atone.

Having a job in real estate is not being a "real estate professional" necessarily(from what we are talking - the actual term is active versus passive - so you may be a real estate professional but that doesn't mean you qualify as active instead of passive).  For example a Realtor* does not typically qualify, from what I understand...  A job earning an income is different than being an investor.

*Of course, they can deduct expenses related to their job, but that doesn't mean they qualify as active instead of passive with regards to rentals they own.

There are two issues
1) Real Estate professional: Most agents, builders, developers, etc meet this requirement if that is their primary line of work.
Quote from:  IRS Pub 527
You qualify as a real estate professional for the tax year if you meet both of the following requirements.
*More than half of the personal services you perform in all trades or businesses during the tax year are performed in real property trades or businesses in which you materially participate.
*You perform more than 750 hours of services during the tax year in real property trades or businesses in which you materially participate.

2) Material Participation: This is what you are talking about, and in the case of investments, a real estate professional may not qualify for material participation in those activities (even if they are materially participating in the buying and selling of houses).
Quote from:  IRS pub 527
Generally, you materially participated in an activity for the tax year if you were involved in its operations on a regular, continuous, and substantial basis during the year. For details, see Publication 925 or the Instructions for Schedule C.
If you go to pub 925, you'll see there are many ways to qualify for material participation, and you can qualify if you meet any of them. The easiest to meet are either of:
Quote from:  IRS Pub 925
2. Your participation was substantially all the participation in the activity of all individuals for the tax year, including the participation of individuals who did not own any interest in the activity.
3. You participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any
other individual (including individuals who did not own any interest in the activity) for the year.

In general, if you qualify as a real estate professional - as defined above - and you manage your own properties, and spend an average of 2 hours a week on those investments (you can elect to combine all your properties for this purpose), then you qualify.

The whole point of this, though, is to qualify to claim passive losses above the amount allowed by non-real-estate-professionals, which in many cases doesn't matter. If your income exceeds your losses (including "paper losses" from depreciation), then [to my knowledge] there is no advantage in qualifying for the above.
« Last Edit: July 27, 2013, 01:41:23 AM by Hamster »

arebelspy

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Re: LLC?
« Reply #33 on: July 27, 2013, 01:16:27 AM »
Thanks for the clarification Hamster.  Appreciate it.  :)
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Hamster

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Re: LLC?
« Reply #34 on: July 27, 2013, 01:37:43 AM »
My understanding is that with a business (and recommends that for my situation the best one is an S-Corp or an LLC with 2 people) combined with a designation as a Real Estate Professional.  I'm just learning - but from what I can tell, travel to prospect for properties becomes a write off - dinners with prospective business associates - more vehicle expenses, more office space and equipment expenses, depreciation, etc.  I don't know - I pay the guy to do my taxes because I'm an artist not an accountant....well, I'm a salesman, but it's still more artist than it is accountant.

I strongly recommend you read IRS Pub 463, as well as the publications I mentioned in the previous comment. It would also be worth getting a book specifically about taxes for real estate investors/landlords. Even if you hire an accountant, it is up to you to know the rules and keep adequate records in case you are audited. Your CPA will just ask you to fill in a line for how much you spent on business meals. They don't go through your receipts and records and know the context around each of those receipts.

You don't need an LLC to claim any of those deductions above. I'd also urge you to read the rules about what can be considered a business expense in terms of travel, meals, entertainment, etc. That is all in Pub 463.

It is my understanding that people incorrectly claim a number of the following based on a lot of misconceptions:

If you take a 7 day trip to Hawaii and spend a day looking at investment properties (even if you buy one), you cannot claim your airfare to Hawaii as business travel.

If you have a party for prospective clients, but don't have a substantial business discussion, then that cannot be deducted as a business meal or entertainment. The "prospective business associates" thing is very abused by real estate agents - "everyone's a prospective client". If you aren't discussing business immediately before or after the meal, then sorry, it doesn't count.
Quote from:  Pub 463
A business discussion will not be considered substantial unless you can show that you actively engaged in the discussion, meeting, negotiation, or other business transaction to get income or some other specific business benefit.
Did you know that only 50% of the value of a meal is deductible? That means at the 25% marginal tax bracket, you are getting a 12.5% discount on the cost of your business meals (it's something, but not much).

If you drive to the other side of town, spend 8 hours working on your rental house, and take a break to eat lunch out, that is not a business meal.

IF we are just talking about a handful of rental properties, I'm not convinced that the LLC or S-corp will actually save you any money (then again I'm not an accountant). Not to be a dick or impugn anyone's motives, but I do know that the increase in accounting complexity will mean your CPA will charge you more.

Hamster

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Re: LLC?
« Reply #35 on: July 27, 2013, 01:49:00 AM »
Thanks for the clarification Hamster.  Appreciate it.  :)
Thank you (and everyone else contributing) for keeping these discussions going. They are very informative and they make me go back and review all my sources, correct my misconceptions, and fill in my gaps in knowledge. I'm always learning. 

That said, I hope everyone takes everything said by any of us (me included) with a grain of salt. It's a little scary how much all of us can rely on these discussion boards when there is good authoritative information out there in books, and from the IRS in this case. I run into the same thing in the practice of medicine. People tend to trust a "familiar" opinion on the internet or an anecdote over reams of well-conducted research (I don't consider a google search to be "research").

I guess that doesn't stop me from sharing my opinions, though... ;-)

Daleth

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Re: LLC?
« Reply #36 on: July 27, 2013, 04:17:48 PM »
An LLC is unnecessary unless you plan on being a true real estate investor and want to attempt to limit the liability on a pool of homes by combining them under 1 LLC.... The upside of an LLC.  You can pool multiple properties under 1 LLC, thus reducing personal liability to that LLC.   

Talk to your lawyer, but I don't see that as an upside at all. If you put, say, 10 properties under one LLC and someone sues the LLC over a slip-and-fall (or whatever) that happened at property #1, that litigant has access to ALL TEN of your properties because ALL those properties are assets of the LLC that they're suing. What if your ten properties are worth $2 million, they sue you and win $2 million, and it's something your insurance doesn't cover? You just lost all ten properties! You've got a $2 million judgment to pay, the plaintiff's lawyer will record that judgment against all your properties, and you will be FOREVER unable to sell or refi without paying off that plaintiff!

The only alternative that I can see is to put each property under its own LLC--or maybe, say, 2-3 properties per LLC. But that's an enormous headache and jacks up your expenses (each LLC needs its own bank account and needs to file its own informational tax return with full depreciation schedules for the properties--tax preparers who can do that are not cheap, and you have to really like paperwork or else just getting things in order to send to your tax preparer is a nightmare).

But honestly, after forming an LLC to buy our first big property and handling it that way for several years, I just stopped seeing the point of an LLC. Because the thing is, we are all making decisions here--we personally decide to shovel the walk in front of X property or not; to go do it ourselves if our usual contractor can't make it soon enough, or not; to perform certain repairs and maintenance, or not... Long story short, WE PERSONALLY are making those decisions and so if those decisions end up causing someone harm, WE PERSONALLY are potentially on the hook for it legally even if we do hold the property as an LLC. A litigant can just sue the LLC and us at the same time.

So we've stopped holding property as an LLC. If you're legally married, one thing that helps, I think, a lot more if you live in a state that has "tenancy by the entireties" as a way to own property is to have one spouse actually run the property business, make all decisions, etc., but own the properties together as "tenants by the entireties" (TBE). Only married couples can hold property that way, and what it does is prevents creditors of spouse A from taking any property held as TBE by spouses A and B together. The concept is this: spouses A and B are both considered to own 100% of the property, and they own it together--they can't split off their percentages of ownership. So someone who sues spouse A and wins cannot record that judgment against the property because the judgment is only against spouse A, not A and B.

Anyway I'm simplifying but you can easily google this. The key point is that this works BECAUSE only spouse A is responsible for whatever went wrong at the property and triggered a lawsuit. If spouses A and B run the property company together and each have decision-making power, it's much trickier because the plaintiff could potentially sue both of you.

One last note--if you do hold property as an LLC, make sure that your property and liability insurance names you PERSONALLY (and your spouse if any) as an "additional insured." In other words the insurance policy covers your LLC and also covers you. The reason for that is huge--if someone sues the LLC and also sues you personally, being named as an additional insured should normally mean that your insurance company has to pay for YOUR legal costs in defending yourself (as well as the LLC's costs in defending itself), and also, of course, has to pay (up to policy limits) for whatever judgment may ultimately come down against you personally.

neoptolemus412

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Re: LLC?
« Reply #37 on: July 27, 2013, 08:48:14 PM »
An LLC is unnecessary unless you plan on being a true real estate investor and want to attempt to limit the liability on a pool of homes by combining them under 1 LLC.... The upside of an LLC.  You can pool multiple properties under 1 LLC, thus reducing personal liability to that LLC.   

Talk to your lawyer, but I don't see that as an upside at all. If you put, say, 10 properties under one LLC and someone sues the LLC over a slip-and-fall (or whatever) that happened at property #1, that litigant has access to ALL TEN of your properties because ALL those properties are assets of the LLC that they're suing. What if your ten properties are worth $2 million, they sue you and win $2 million, and it's something your insurance doesn't cover? You just lost all ten properties! You've got a $2 million judgment to pay, the plaintiff's lawyer will record that judgment against all your properties, and you will be FOREVER unable to sell or refi without paying off that plaintiff!


As I said, a LLC is unnecessary for the majority of 'real estate investors' as they don't have the appropriate level of assets to gain from the positives of an LLC.  To clarify, an LLC is more about how one wants to structure their business life.  You could setup an LLP, LP, buy as a sole prop, LLC, a trust, or multiple other entities.  However, for example, a doctor/lawyer who owns their own practice definitely wants their real estate investments under an LLC/other entity.  It shields their core business from potential liabilities related to an investment that has nothing to do with their practice.  Crazy lawsuits are not the top concern.  It's more about one's risk tolerance and the best fit for the type of business you wish to run. 

Spouse - The spouse point is more of a personal liability piece.  Some spouses place their names on businesses they run as a part of their estate plan.  They can setup an S-Corp, hold the majority of the shares, transfer it easily to family members, ect.  It's up to that couple.   If you want to shield a spouse, consult a lawyer.  It's very complex and not as simple as the advice given.  Again, this is America, if someone wants to sue you, they will.  So do not setup any legal entity without consulting an attorney.  The money spent is worthwhile to CYA.

Deductions - Business deductions can be taken as long as it's a legitimate business.  The problem is doing business as a sole prop. brings greater risk of audit by the IRS (mainly b/c so many people abuse the system).  50% of meals/ent, business travel as long as over 50% of the days are related to business, automobile depreciation, and countless other deductions can be taken with proper record keeping and justification.  Also, any CPA can tell you the deductions.  They're simple & easy to find in IRS publication/tax preparer software.  It's the actual documentation, justification, and record keeping of activities that people have trouble with.  Consult a CPA to do your taxes and keep detailed records throughout the year.

Blogger advice = BS - As far as this thread, I suspect the majority of investors here are small time (< $3 million in assets, mainly residential properties).  A large scale investor/developer (10m+ assets, commercial properties or multi-home developer) is setting up a business entity as this is their livelihood.  A small time investor doesn't have to because they do this as part of their investment strategy rather than their sole income.  One can setup an LLC to invest in stocks & bonds.  However, few people do this b/c it's an extra expense that doesn't add much value to them.  Same with real estate.   Don't setup an LLC if it adds little upside & you've insured the properties in case of a macro event.  As mentioned, it's imperative you speak to your CPA/lawyer to gain an understanding as well as read the authoritative literature yourself.  Anyone who takes a blog at face value is off of their rocker. 


Daleth

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Re: LLC?
« Reply #38 on: July 28, 2013, 02:13:30 PM »
However, for example, a doctor/lawyer who owns their own practice definitely wants their real estate investments under an LLC/other entity.  It shields their core business from potential liabilities related to an investment that has nothing to do with their practice.

See, that's the thing--I'm not sure it DOES shield their core business. If you are the guy who made the decision not to go shovel the walk in front of your rental the morning after a blizzard, and someone slips and hurts themselves, they'll sue the LLC--but they'll also probably be able to sue you, since YOU are the guy who made the decision that ended up hurting them. The fact you own the rental through your LLC does not shield you from the consequences of the decisions you personally make. In a situation like that the only way you would be shielded, at least as far as I can see, is if you hired a property manager and the property manager is who decided not to go shovel the walk.

That was my point and the reason I said to talk to a lawyer rather than just assuming that operating as an LLC or S Corp will shield you.

DoubleDown

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Re: LLC?
« Reply #39 on: July 29, 2013, 01:49:09 PM »

See, that's the thing--I'm not sure it DOES shield their core business. If you are the guy who made the decision not to go shovel the walk in front of your rental the morning after a blizzard, and someone slips and hurts themselves, they'll sue the LLC--but they'll also probably be able to sue you, since YOU are the guy who made the decision that ended up hurting them. The fact you own the rental through your LLC does not shield you from the consequences of the decisions you personally make. In a situation like that the only way you would be shielded, at least as far as I can see, is if you hired a property manager and the property manager is who decided not to go shovel the walk.

That was my point and the reason I said to talk to a lawyer rather than just assuming that operating as an LLC or S Corp will shield you.

Daleth you are a lawyer, correct? If so, please help me understand this (this is an honest question for clarification, not a challenge).

Isn't that the whole point of a corporation, shielding you from personal liability? So in your example, the person who sues the LLC should not be able to go after the property manager's personal assets, only those owned/operated by the LLC, correct (unless they successfully pierce the corporate veil)? Otherwise, what's the point? Wouldn't individuals all the time be losing their personal assets in lawsuits when they are acting as an agent of the company? I don't recall seeing people losing their personal assets when acting as agents of a company, assuming they are doing so lawfully and reasonably.

Or in the example of the doctor who owns real estate through an LLC -- if successfully sued, he/she might lose all the LLC's assets and properties, but his/her medical practice and personal assets would be exempt from the lawsuit, no?

arebelspy

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Re: LLC?
« Reply #40 on: July 29, 2013, 04:38:02 PM »

Isn't that the whole point of a corporation, shielding you from personal liability? So in your example, the person who sues the LLC should not be able to go after the property manager's personal assets, only those owned/operated by the LLC, correct (unless they successfully pierce the corporate veil)? Otherwise, what's the point? Wouldn't individuals all the time be losing their personal assets in lawsuits when they are acting as an agent of the company? I don't recall seeing people losing their personal assets when acting as agents of a company, assuming they are doing so lawfully and reasonably.

Or in the example of the doctor who owns real estate through an LLC -- if successfully sued, he/she might lose all the LLC's assets and properties, but his/her medical practice and personal assets would be exempt from the lawsuit, no?

If they are named as a personal defendant, and not just the company, yes, their personal assets are at risk.

The LLC + using a property manager (who has their own insurance) is one solution.  Umbrella insurance is another.  A trust could potentially be another, as could be holding no assets.

But the LLC doesn't provide as much protection as one thinks, especially if that person is involved in day to day decisions that lead or are related to an accident.
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Hamster

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Re: LLC?
« Reply #41 on: July 30, 2013, 01:19:01 AM »
I'm not a lawyer. But, from what I read on the interwebs, you must have good recordkeeping, and a good firewall between yourself and the corporation to maintain liability protection. If you are just using the corporation as an extension of yourself for your personal business, then if someone sues the corporation, they can try to lift or pierce the corporate veil that isolates you from the corporation. I'd love to hear what an attorney with experience in this area thinks.

Quote from: some website nolo.com. Or just google corporate veil
Factors Courts Consider in Piercing the Corporate Veil
The most common factors that courts consider in determining whether to pierce the corporate veil are:
*whether the corporation or LLC engaged in fraudulent behavior
*whether the corporation or LLC failed to follow corporate formalities
*whether the corporation or LLC was inadequately capitalized (if the corporation never had enough funds to operate, it was not really a separate entity that could stand on its own), and
*whether one person or a small group of closely related people were in complete control of the corporation or LLC.

Some corporations and LLCs are especially vulnerable when these factors are considered, simply because of their size and business practices. Closely held companies are more susceptible to losing limited liability status than large, publicly traded corporations.

Daleth

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Re: LLC?
« Reply #42 on: July 30, 2013, 10:56:36 AM »
Daleth you are a lawyer, correct? If so, please help me understand this (this is an honest question for clarification, not a challenge).

Isn't that the whole point of a corporation, shielding you from personal liability? So in your example, the person who sues the LLC should not be able to go after the property manager's personal assets, only those owned/operated by the LLC, correct (unless they successfully pierce the corporate veil)? Otherwise, what's the point? Wouldn't individuals all the time be losing their personal assets in lawsuits when they are acting as an agent of the company? I don't recall seeing people losing their personal assets when acting as agents of a company, assuming they are doing so lawfully and reasonably.

No, it's not the whole point. To explain why, I have to explain the difference between debts that come from contracts and debts that come from torts. Basically (this is oversimplified) there are two reasons someone could sue you:
(1) Contracts: because you had a contract with them and you breached it--for instance, if you had a contract to buy business equipment, they gave you the equipment, and then you didn't pay. Or
(2) Torts: because you intentionally, recklessly or negligently did something that caused them to get hurt--for instance, if you don't shovel your walk and they fall, or if you're a doctor and you commit medical malpractice.

So, corporations were not invented to shield business owners from lawsuits for torts; they were invented to shield investors and business owners from being liable for the company's contractually incurred debts (i.e., contracts where the company agreed to pay someone money, or where the company agreed to provide some product or service but then failed to provide it and that failure cost the other person money). In other words, before there were corporations, if you started a business or a bunch of investors got together and put up money to start a business, and then entered into all the usual contracts for business equipment, rental space, employment contracts and so on, and then the business failed, all the creditors could come after the business owners and investors personally to get their money back. And that's still what happens today if you're not a corp or an LLC; if you're a sole proprietor or a partnership, you're personally on the hook for your company's business debts.

Corporations were invented basically because if investors/owners are on the hook for all of a company's contractually incurred business debts, then it's really risky to start a new business. To make it less risky, we the people decided there could be such a thing as a corporation (or more recently an LLC), so that the investors would know up front that the only money they could lose was the money they actually put into the company. If the company failed, it wouldn't take them down with it, at least not beyond the actual money they'd already put into it. I'm slightly simplifying here, because there were corporations before there was limited liability--that is, the law permitted corporations to exist before it permitted owners of them to avoid personal liability for the company's debts. Also, there are debts that are neither contractual nor tort-based (for instance, business taxes--and yes, for those you may be personally liable, corporation or not). But that's the basic gist.

So that's the background. As for piercing the veil, that's where the owner or owners gets held liable for the company's debts, and it's generally done on one of the following grounds:
  • The company is basically a sham; there's no real difference between the company and its owner(s). For instance, the owners might mingle business and personal money, writing checks back and forth from personal and business accounts or using the business's money to buy personal stuff (or vice versa).
  • The company's actions were wrongful or fraudulent. For instance, the owners might have recklessly borrowed or lost money, made deals knowing the company couldn't pay for them, or otherwise acted dishonestly (thus leaving the company on the brink of bankruptcy and unable to pay its bills).

It's academic quibbling whether it counts as "piercing the corporate veil" to hold a corporation's agent personally liable for the torts they commit. I think of that term as applying to contract issues, not torts, but whatever. Whether you call it piercing the veil or not, the gist is the same: if you personally commit a tort while doing your job or fulfilling your function as a corporate/LLC owner or manager, you may be personally liable for that tort. The company may also be liable, but the main issue is that YOU did something wrong that hurt someone, and so YOU are liable.

The most obvious example is this: if you go to the hospital and a doctor there commits medical malpractice that hurts you, that doctor is personally liable even though he committed the malpractice while performing his job for the corporation (nonprofit or for profit, hospitals are pretty much always corporations). If the malpractice insurance isn't enough to cover your injury, you can go after the doctor's personal assets.

Whether you're going to be personally liable for torts you commit relating to your rental business is a matter of your state's law so I can't give any specific advice there, other than to talk to an attorney in your state (and I would recommend a defense-side personal injury lawyer for that conversation, NOT a real estate lawyer). And also, I agree that INSURANCE is critical and if you do have an LLC or corp, make sure that YOU PERSONALLY--as well as any co-owners or family members who work in your business--are named as an additional insured on its insurance policies. But here are a few links just so you know I'm not smoking crack:

http://www.michbar.org/journal/article.cfm?articleID=973&volumeID=11

http://www.patentlyo.com/patent/2013/01/piercing-the-corporate-veil-corporate-officers-are-liable-for-their-own-torts.html

« Last Edit: July 30, 2013, 11:13:33 AM by Daleth »

Undecided

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Re: LLC?
« Reply #43 on: July 30, 2013, 11:05:57 AM »
Re Daleth's post, just to point it out, as regards small investment properties, in many states, the primary debt associated with the property (the mortgage) is going to be non-recourse anyway (and secured by the property), so the property itself is essentially the limit of the exposure to that debt even for a personally-held property. But this (and especially the details) varies widely by state, so in some states an LLC may be irrelevant on this point, while on others it may be useful. (Not that the readers here would buy investment properties that weren't "sure" to much more than cover their costs, including debt service.)

DoubleDown

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Re: LLC?
« Reply #44 on: July 30, 2013, 11:27:29 AM »
@Daleth -- thanks very much for your thoughtful reply, that definitely clarifies things!

DoubleDown

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Re: LLC?
« Reply #45 on: July 30, 2013, 11:41:02 AM »

If they are named as a personal defendant, and not just the company, yes, their personal assets are at risk.

The LLC + using a property manager (who has their own insurance) is one solution.  Umbrella insurance is another.  A trust could potentially be another, as could be holding no assets.

But the LLC doesn't provide as much protection as one thinks, especially if that person is involved in day to day decisions that lead or are related to an accident.

Yeah until Daleth's response I didn't recognize the difference between contract/debt lawsuits and torts, and the protection a corporation gives (or doesn't give) in those instances. I always thought a corporation shielded people from torts as well, but apparently that's not the case. And I'll bet I'm not alone in that mistaken belief.

I've only used a now-defunct LLC in the past primarily as a partnership agreement and business operating model with partners, and carried a few layers of personal insurance for protection from lawsuits. But if I had done something stupid as the managing partner and was successfully sued, I would have (wrongly) expected to be shielded from personal liability by the LLC! I'm glad I never had the occasion to find out.

Thanks for your tips on some other ways to provide additional levels of protection, like an LLC + a property manager with their own insurance. I like that suggestion, I'll keep that in mind if I ever join the ranks of mega property lords like Arebelspy!

LinCO

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Re: LLC?
« Reply #46 on: July 30, 2013, 04:06:20 PM »
Lots of good points on this topic, I'll add a couple I didn't see:

1. This is all to protect against potential threats so the actual protection you get may never be needed. Here's hoping!! I write mortgage checks on my rental business account and I'm pretty sure the bank just wants them to clear-they haven't activated that acceleration clause. I do think there's a remote possibility of the LLCs being found to be sham but that's where the umbrella policy comes in. My understanding of costs is that going full-on, borrowing through the LLC etc would really cut into my ROI.

2. My CPA thought it was a *terrible* idea to pay her to do additional business tax returns on my entities, so I took over doing them myself! I have 2 houses per LLC, and 1 on my 1040.

3. I've been really surprised at the outcome of my son's application for financial aid and just finished reading about small business exemptions for expected family contributions. I guess the fact that we have less income from work is what's important, and the value of the businesses are shielded. I think in his first semester of college, the costs of creating these entities and paying the CPA, etc., will all be recouped. So I don't know, "corporations have taken over America," and now I have corporations. I don't see these benefits to incorporating going away any time soon.

Daleth

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Re: LLC?
« Reply #47 on: July 30, 2013, 06:13:42 PM »
2. My CPA thought it was a *terrible* idea to pay her to do additional business tax returns on my entities, so I took over doing them myself! I have 2 houses per LLC, and 1 on my 1040.

Your brain must be different than mine. My brain explodes if I even think about trying to calculate depreciation on a rental property etc. etc. I have no issue with math but the pedantic mind-numbing regulations that dictate how to calculate everything are more than I can endure. I hand that sh!t over to an accountant because life is too short, and my brain lacks the necessary parts.

3. I've been really surprised at the outcome of my son's application for financial aid and just finished reading about small business exemptions for expected family contributions. I guess the fact that we have less income from work is what's important, and the value of the businesses are shielded. I think in his first semester of college, the costs of creating these entities and paying the CPA, etc., will all be recouped.

Wow, that's kind of nuts, but really good to know! I say "nuts" because most people with multiple small businesses have more money than most people with only a salary, and it seems like in this approach, the regular working Joe or Joan gets shafted. But still, good to know.

moostachio

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Re: LLC?
« Reply #48 on: August 01, 2013, 09:43:38 PM »
My circumstance is a little different in that my rental property is not housing but is instead recreational land that is leased to a Club and farm land.  The recreational land is "high risk" due to boating, swimming etc.. Our attorney formed two LLCs, called series LLC.  The LLCs each have their own Liability insurance, the Club (tenant) is required to carry liability insurance per the lease, the lease indemnifies me of liability, and in addition I carry a $2M persoanl umbrella policy.  Each LLC has their own bank account and taxes done.
The main point.. I think it is about having layers of protection, including the LLCs, the LLCs need to have their own business liability insurance too.  Most of the posts talk about umbrella or LLC, I think it is wise to have LLC(s), with it's own insurance, and in addition have a personal umbrella policy too, and leases that indemnify.  I also suggest it is wise to have one law office handle all of these things so they know how all of the assets interact from a liability standpoint. It is not cheap to have an attorney form the LLCs, Operating Agreement etc, but after having done it is worth it (at least I hope to never have to test it).