Many “average” Americans are dipping their toe into the world of investment real estate. Not satisfied with owning REITs, many non-real estate professionals are turning to buying vacation homes, single family rental properties, small multi-family dwellings and even small commercial buildings.
If you are in this group (or thinking of joining this group), I want to give you three letters to remember as you begin your journey – LLC.
LLCs is an acronym for limited liability company. It is a form of entity recognized by states as providing liability protection for its members. At the same time, it receives different tax treatment than traditional corporations. It also is much more flexible than corporations when structuring relationships between members. The following is a very high level discussion on some benefits of forming an LLC. While forming LLCs can be done by laypersons, you should consult an attorney or CPA before taking that step.
TAX TREATMENT – When an individual forms an LLC, the feds disregard the entity and tax the individual as if no LLC existed. If more than one unmarried persons form an LLC, again there is entity protection like a corporation and the individuals are taxed as partners by the feds. So, instead of filing a separate corporate tax return, the members file form K-1s as part of their individual return. The benefit of this is that there is no double taxation as there would be if the investor(s) had created a C-Corp. Moreover, the members can have a much more flexible relationship than had they formed an S-Corp.
LIABILITY PROTECTION – This is the main reason to form the LLC. Say you want to purchase a rental house. If you purchase it in your own name, all of your personal assets are subject to risk in the event that something goes wrong. If you and your renters get into a lease dispute, they may sue you and your individual assets are on the line. What if someone gets hurt on the property and your insurance coverage is not enough to cover the loss? Again, your assets will be at risk. If you form an LLC, you have just created an entity that is separate from you. Its assets are only those that the LLC owns – usually the property. Thus, if something goes wrong, usually only the property is at risk and not your life savings. This can be worth a lot of sleep at night.
While LLCs may not be for every real estate investor, they are certainly three letters that need to be discussed when buying investment property.
goog stuff Russ. I worry about our place being in the asset path of our small business.
The following is some information from the Company Corporation that address how a lender views an LLC when evaluating a loan.
“Will a mortgage company lend an LLC or corporation money? Is it easier for an LLC or a corporation to get a loan or mortgage?
If it otherwise qualifies, an LLC or corporation can obtain a loan from a mortgage company. Before applying for a loan or mortgage, it is important to determine the proposed amount of the loan, how the loan proceeds will used by the company, and the company’s expected source of the funds necessary to repay the loan. Typically, lenders, such as a mortgage company, will grant loans only if they are satisfied that the borrower has the ability and resources to repay the loan. Also, keep in mind that the real estate purchased by the LLC or corporation typically must be pledged as collateral for the loan.
Normally, the criteria that lenders use to evaluate a company’s loan application include a thorough credit check of the borrower (in this case, the company and any guarantors). A lender may also look at the company’s cash flow (past and projected) to determine if it will be able to repay the loan and also continue to operate its normal business operations. Lenders may also ask the company’s owners to personally guarantee the loan and/or provide additional collateral (other than the property owned by the company) that the lender can take if the company fails to repay the loan according to the required terms.
Typically, lenders will use the above criteria regardless of whether the loan applicant is an LLC or corporation. Stated another way, a company’s ability to obtain a loan generally will depend on the resources and financial condition of the company and its owners, and not the legal form of entity (i.e., LLC or corporation)”.
I’ve been told by lenders that an LLC cannot get a consumer loan, like an individual can on a 1-4 unit property. Commercial loans are harder to qualify for and the terms are not as favorable. For us, this has made the LLC idea a little too costly.
If I already own investment properties, can I start an LLC and transfer ownership from myself to the LLC?
Rhonda,
Yes, you can transfer property into an LLC after purchase. There are some things you want to watch for when you do this. You should consult a real estate attorney to help you. Wish I could but can’t give out legal advice via a Blog.
Russ
definitely stuff to look out for. most if not all conforming loan contracts include a due on sale clause causing the loan to become payable in full immediately if the owner on title changes. A transfer from an individiual to an LLC can trigger the due on sale clause. Conforming loans are those you might associate with Fannie Mae and Freddie Mac. Conforing loans may be sold off, packaged, and securitized for investmet on Wall Street. Some portflio loans do not contain a due on sale clause. Portfolio loans are those funded by a bank and held on the bank’s balance sheet as an investment.
WaMu will lend to an LLC for a residential loan (1-4 units) so the buyer does not have to transfer title after close on the property to the LLC. the interest rate is a bit higher to compensate the investors for the additional risk. the loans are portfolio loans. the underwritng requires more paperwork regarding the LLC. the individual remains liable for the loan even though the LLC holds title to the property.
residential lending (1-4 units) is mostly based on the borrower’s assets, credit, and ability to pay the mortgage. Commercial lending (5+ residential units) is on LTV and/or Debt Coverage Ratio (DCR). DCR is the asset’s ability to generate enough Net Operating Income (NOI) to pay the Annual Debt Service (ADS). Some commercial loans are non recourse which usually requires a higher down payment and/or a higher interest rate. in hot markets commercial lending is rarely done on LTV. Most of the lending will be based on DCR. the Cap Rate drops to a point where the DCR requirement may result in a transaction with a LTV less than 50%. yes, I said 50%.
Cheers,
Michael P. Lindekugel
Financial Analyst
RE/MAX Commercial
Team Reba – RE/MAX Metro Realty, Inc
This is not tax or legal advice of any kind.
Tax Treatment
An LLC has additional tax treatment advantages over other entity types. The Passive Activities/At Risk rules have special rules for real estate even though it is generally considered a passive activity. An allowance up to $25,k of passive losses from rental real estate can be used to offset earned income such as your paycheck and portfolio income to reduce your taxable income. Individuals generally meet the active participation test to enjoy the allowance. LPs cannot meet the test. A LP who tries to actively participate may expose them selves to more liability. Members of an LLC can meet the active participation test.
Cheers,
Michael P. Lindekugel
Financial Analyst
RE/MAX Commercial
Team Reba – RE/MAX Metro Realty, Inc
I just started a business under an LLC. Will a bank loan to an LLC under a year.
Can you recieve a residential loan for 8 units if they are under 4 different parcels.
Can anyone suggest lenders who make non-recourse loans to purchase investment property ( 1-4 units) by an LLC which is owned by my self directed IRA? Thanks.
I can help you with non recourse IRA loans.
Josh Turpin
Citywide Mortgage
913-907-4656
jturpin@citywidemortgage.com
Can ownership of an LLC and all of its assets be transfered from an individual to a corporation? And what are the tax implications?
My Brother In Law wants to fix and flip properties, he is willing to do it on his primary residence. What are the benefits of doing it under an LLC?
Jason
Under certain circumstances, an LLC can provide protection to the LLC members for liabilities of the LLC. Whether this will apply to your B-I-L will depend on various factors. This is not the type of advice you should get on a blog and suggest B-I-L talk to an attorney well-versed in this stuff for specific advice.
Russ
I Recently registered my realestate company with the State of Michigan L.L.C. Would it be a benifit to meself to tranfer my primary home from my personal ownership into the L.L.C.?
I purchase property at a tax sale – there is a morgage against the property – will I claim the property or will the morgage company come after me for the remaining morgage
Hello,
Currently my friend has a house that was given to them when their parents passed away, she and her 2 brothers formed an LLC about 3 years ago, since then one brother has passed away due to illness, now his children want to bought out of the LLC and be given their share of thier passed father. What is the best way for her and her brother to go about getting a loan? Can a LLC get a loan? ID so, what type of loan? They check with a local bank and they said they never heard of this type of situation. There is no mortgage and they want to get a loan for 1/3 of the value of the house. Please e-mail me any suggestions to albopooh@aol.com. Thank You!
Allan,
She and her brother would not be the ones getting the loan. If they want their respective 1/3 share paid as cash, the third owner (the heir(s) of the deceased brother) would be getting the loan to buy them out with, not them. The owner who doesn’t want to sell, would get a loan to buy out the two who want out.
Or all three would agree to sell the property, and no loan would be involved. I think the two owners can force the sale, since they have a majority interest. But the two of them getting a loan doesn’t accomplish the objective of “getting out”. It just creates a debt.
Their cominbed 2/3rd interest doesn’t convert to a cash asset unless the property is sold, or the remaining owner buys the two of them out, with a loan obtained by the owner who isn’t the two of them.
Hope that helps. I’m not a lawyer, but I used to be a trust officer for many years. I’m pretty sure that’s how it works. If the third person doesn’t want to sell or get a loan to buy them out, they need to see an attorney, if they want to force the third person to sell or buy them out. I think they would get a court order to sell, and then the third owner may have a short time to get a loan to buy them out, especially if the deceased brother’s heirs live in the house.
My parents have a commerical building that is currently rented.
The property is free and clear. They need money to keep the building up and pay taxes they owe. Can they borrow money against the building as an LLC? They thought about borrow against their primary home for the money. Which loan would be better ? I know the rate on the primary would be better, but which loan would be better as far as protection and taxes ??
I would like to move title of an investment property into an LLC without the ‘due on sale’ clause triggering. Has anyone done it with a trust as a transfer vehicle? Any experience here and cost would help! The lender allows transfers to a trust but not an LLC. Lender is proposing that I refinance the existing loan to transfer property in the LLC.
Can I get a small loan for like $10-$20,000 under an LLC to buy my first investment property without any type of personal guarantee?
My credit is very bad right now. What are my options besides and in addition to fixing the credit?
I want to transfer title of two properties I own, both 4 units each, but I am not sure if the bank I am with National City Mortgage allows this to be done. Has anyone done this with National City Mortgage? Please email me with suggestions.
PhilEdBrook@gmail.com
I have a rental property in Anchorage alaska and one in downtown denver. I should put them both in a separate llc, right? can you help me with this.
Can I transfer my personal loan to my LLC business loan? What’s the steps for this?
My siblings and I have have just purchased an old school bldg, located in Morgantown, WV. Plan in the near future to tear down the bldg. and build townhomes. We are going to form an LLC. Any advice on what type of LLC?
Also I have a question regarding liability. We have boarded up all windows, shut off all utilities, gated off the entrance, posted private property and no trespassing signs and we ar in the process of removing all playground equipment. Is that enough to protect us if someone gets hurt on something (who knows what)?
Also please feel free to offer any other advice that may be helpfull.
Thanks so much to everyone.
I have 2 properties that I am currently renting out. I have mortgages on both, but I want to sell one to pay off the other property which will remain a rental. Can I create an LLC and buy my own property and avoid some of the complications of selling a rental and commercial taxation issues. The property I’m selling is in Hawaii and the property I would be paying off is in California.