Should every rental real estate property have its own LLC?
When you venture from owning one, into owning many real estate properties, you begin to question how protected you really are.
Should you just own the property in your personal name and have a general liability umbrella with your property named in the declaration documents?
Can you group multiple properties together into one LLC? But then, when do you know to separate the LLC interest?
Do you keep every real estate property in its own LLC?
Should you have a series LLC? Where each real estate LLC interest is owned by another holding company LLC?
There’s tons of options & no shortage of opinions - let’s look at the facts:
To begin:
Risk management happens before the risk, not after.
Meaning:
You should be considering what to do BEFORE you buy your first property, not after.
If you just bought your first property and are now thinking about an LLC - you may be too late.
When you own an LLC, for the LLC to do its job (similar to a trust) the asset must be titled in the name of the LLC.
So if you have a rental property you purchased in your personal name and open an LLC to deed the property to the name of the LLC, you’re running into the due-on-sale clause written in the loan agreement from your bank.
This agreement states that if you transfer the deed of the home to another party, the bank has the right to make the note payable effective immediately.
From the bank's eyes, this is an added risk that they didn’t take into consideration when they first did their underwriting.
Banks lend to credit worry borrowers who they believe will have a high probability of repaying the loan back with interest.
In addition to this, if you had originally gone to the bank and asked for the loan in the name of an LLC (specifically newly formed), you will be paying a higher interest rate to account for the greater risk the bank is taking on.
Lastly, thinking that you’re going to conceal the deed transfer from your personal name to your LLC from the bank and they will never know (because you think as long as you’re paying the loan, the bank has no reason to look into the loan) this is wrong.
This could very well be subject to federal felonies to include false statement (HUD/Conventional loan), concealment, conspiracy, or racketeering - not something you’d want to deal with.
In this scenario, your best bet is to get a liability umbrella policy (that names your rental property in the declaration documents) then upon the payoff of your mortgage, you’re free to create an LLC and deed the ownership of the property to the LLC.
Provided you have the option of evaluating the use of an LLC for your rental property or using a personal umbrella, I’d first ask yourself:
What’s your objective with rental real estate as a whole?
If this is your personal property that you owned, you’re going to have a year-long or more lease from whom you know and don’t have the expectations of them moving out and they’re low-risk and you only want to deal with this one property - then an LLC may not be necessary.
On the other hand:
If this is the first of many properties expected that are going to be short-term rentals with high-turnover in tenants in a highly appreciating real estate market - then creating an LLC is a great idea.
Outside of either extreme, much of this decision comes down to personal preference.
I’ve seen it done both ways but you only need to hear one horror story to make you want to put everything in an LLC (here’s 13 horror stories, if interested).
When you start dipping your toe into having 5+ rental properties, you may begin to wonder what the best approach for structuring the entity will be, as what worked prior may not continue to work into the future.
The goal here is to maximize savings, efficiency, and protection.
It’s important to note that an LLC isn’t just a piece of paper that you get from legal zoom in an afternoon and now all your legal worries are behind you.
Your LLC is the formation of a company.
In doing so, you need to justify that this company is actually a doing what companies do, such as:
Having an operating agreement
Documenting corporate minutes and annual reports
Having a bank account number
Tax ID number and/or business license
The whole point of the LLC is so that if you get sued for everything that the LLC, you have documentation to prove that the LLC wasn’t just a personal hobby to help shield assets, rather, a business ran to protect the owner.
The plaintiff will be trying to pierce the corporate veil of the LLC, basically trying to prove that the business and you (the business owner) were the same so they can go after your personal assets.
Further, it’s best practice to incorporate where the rental property is located.
Yes, you could set up an LLC in Nevada or Delaware due to their favorable chancery court but for owning a rental property, this is more headache, compliance, and hassle that isn’t worth it.
If you’re a fortune 500 company, that’s a different story (as many of them do incorporate in Delaware).
That said:
Having every property be in an LLC is cumbersome & may be overkill but having one LLC to hold all your properties probably isn’t the right answer either.
In splitting up real estate interest, I would split this into 3 buckets:
Amount of equity in each one of your properties
Risk involved with the type of rental
Location of your properties
The amount of equity at risk is something that’s different for everyone (& partially out of their control as market forces come into play).
I would consider having a max number of rentals being 3-5, considering how much appreciation is built in or you’d expect to build up in the rentals.
This should also be contrasted with the type of rental.
If you have a bunch of short-term rentals in a party town, this may warrant yourself to reduce the number of properties in each LLC as the risk grows based on the number and type of tenants.
This can also be considered through the nature of the real estate, be it commercial, land, apartment complexes, single family units, duplexes, etc.
Lastly, it’s more affordable and convenient to have properties in different states in their LLC by state.
When you start acquiring 10+ rentals with plans of further expansion, you may want to consider the use of a series LLC.
To have a series LLC, you have to be in a state that allows for series LLCs which are Alabama, Arkansas, the district of Columbia, Delaware, Illinois, Indiana, Lowa, Kansas, Missouri, Montana, Nebraska, Nevada, North Dakota, Oklahoma, South Dakota, Tennessee, Texas, Virginia, Utah, and Wyoming.
The series LLC acts as a holding LLC company that can have sub-LLCs that all wrap up to the holding company LLC.
This allows the following:
Gaining liability protection within each of the individual properties (like single LLCs)
Reduce the LLC tax filing fees
File on one tax return
You will still have to have different bank accounts and names for each underlying LLC but this would allow you to gain liability protection similar to having each LLC in its own name.
This can increase the level of complication and potential confusion where existing real estate deeded to the series LLC would want to specify the series number inside your Series LLC established through the internal operating agreement of the Series LLC.
Each state will have nuance associated with the proper establishment of the Series LLC but when done correctly, this can be a great tool for serial investors.