Archive for February, 2008

The Best Investment Property Holding Entity is the LLC

It is amazing how often I am asked by people starting in real estate investment: “What type of corporate structure is best for owning investment property“. I hear that question more often than I am asked how to find tenants or how to finance the property. Here is some information that I have compiled and [...]

It is amazing how often I am asked by people starting in real estate investment: “What type of corporate structure is best for owning investment property“. I hear that question more often than I am asked how to find tenants or how to finance the property. Here is some information that I have compiled and learned over the years.

Disclaimer: Right up front I need to remind everyone that I am not an attorney nor do I play one on television. You should seek competent legal advice in your area, regarding this topic. These details are simply what I have learned through reading, executing, and talking with attorneys.

Best entity for Investment Property

Although there are many different business entities (LLC, C-Corporation, S-Corporation, partnership), the easiest to set up and cheapest to maintain, for real estate investments, is an LLC (limited liability company). Additionally, an LLC is very flexible and can have any number of owners (technically called ‘members’). Each member can own any percentage of the company (as long as the total equals 100%). Lastly, members can be other LLCs, corporations, and trusts. This flexibility allows you to customize the configuration to suit your tax situation and liability protection goals.

Tax Implications for the Investment Property LLC

C-Corporations pay taxes on profits generated by the corporation, first. The owners pay taxes again on the profits they receive as dividends. Although, S-Corporations avoid the corporate tax, their corporate structure and number/type of owners is severely limited (S-Corporations can only be owned by individuals, not LLCs or trusts). Fortunately, unlike corporations, LLCs do not pay any corporate tax. All profit and losses “pass through” to the member’s tax returns at the percent that they own the company. This is especially helpful if you own multiple LLCs as the profit and losses from each roll up to your personal taxes (a loss on one can offset a profit on another).

Liability Protection for the Real Estate Investor

As the name implies, an LLC provides limited liability to its members, meaning that any liability created by the company is limited to the company. The members’ personal assets are protected from all claims against the company. Partnerships and unincorporated businesses do NOT provide liability protection. It is critical that you protect your personal assets as a 2005 Congressional study stated: “small businesses bear 68 percent of business tort liability costs”. A properly set-up and maintained LLC can protect the owner’s interests in the assets of an LLC from the owner’s personal creditors.

Setting up an LLC for your Investment Properties

I recommend that you consult with a qualified real estate attorney when you set up your first LLC (or purchase your first investment property). Pay them to establish the LLC on paper and with the state. Have them teach you what should/must be done on an annual basis to maintain both the legal entity of the LLC and the litigation protection of the LLC. This may cost up to $1000 per LLC.  Some attorneys may offer a discounted price.

How Many Properties per LLC?

This is where a good attorney can weigh the liability protection versus the costs. Many advisors will tell you to set up one LLC per property. Practically speaking this is easy when you own 2-4 properties, but it will become increasingly cost prohibitive when you own 15 properties. Not only does it cost about $360 (in Minnesota, using BizFilings.com) to set up an LLC initially, but each year your CPA will charge you to prepare and file the tax return for each LLC (this costs me about $400 per LLC-you can imagine your tax bill if you had 15 LLCs!). Most real estate investors will put 3-5 properties in each LLC (grouping them based upon geography, age, liability risk, or equity position).

Moving your Properties into your LLC

A common misconception is that you must buy the investment property in the LLC’s name. Unfortunately, you would need to use commercial financing (with a 20% down payment) to have your LLC buy the property initially. A “Quit Claim deed” is all that is required to legally transfer the property from your personal name to your LLC. The mortgage(s) will stay in your personal name and it will remain on your credit report, but you will gain the liability protection mentioned above. This Quit Claim deed process requires a simple one page document signed and notarized by all owners of the property and it is then mailed with the appropriate filing fees (about $50-75) to the County recorder where the property is located.

Property Management Considerations

Technically, each LLC should have its own checking account, corporate credit card, and Quickbooks file. Again, as above, this may be possible with a limited number of LLCs, but it can be overwhelming to think about 15 checkbooks, 15 corporate credit cards, and 15 LLCs signing leases and performing evictions. Many real estate investors will transfer their properties into “ownership” LLCs which simply hold the properties. They will then set up a “management” LLC that signs all leases, pays all bills (including mortgages), contracts for all repairs, and retains one or two corporate credit cards. To keep the liability protection intact, you should have a management agreement signed by both the “ownership” and “management” LLC. Send me an email at scott [at] ficekinvestments [dot] com, if you would like a copy of a sample management agreement.

Using the LLC

All the work and cost of establishing the LLCs can be wasted if a judge agrees with the lawsuit plaintiff, that the LLCs are just shells. Follow your attorney’s advice, but generally, you should hold meetings (and keep written minutes of the meeting) on a bi-annual to annual basis. You should record decisions and “vote” on changes to the company. Lastly, have your attorney review your work annually to insure you are maintaining your legal protection in the event of litigation.

As you can see, an LLC has many benefits over other corporate entities (or no entity at all). Having an LLC for your real estate investment is an important step in providing protection for both your personal and corporate assets. Consider the creation and use of an LLC as important as learning how to find tenants.

Have you always wanted to buy investment property, but never knew where to start? Don’t Wait! Get Started now.

Tenant Screening Checklist

In my posts Tenant Applications-Red Flags and Tenant Applications-Part 2, I write several times about the different items that I am looking for when I meet and then process a tenant application. I have heard of more than one seasoned real estate investor actually developing a points based system for tenant screening, but I have [...]

In my posts Tenant Applications-Red Flags and Tenant Applications-Part 2, I write several times about the different items that I am looking for when I meet and then process a tenant application. I have heard of more than one seasoned real estate investor actually developing a points based system for tenant screening, but I have not seen one until now.

Connie Brzowski guest writes an excellent post, on BiggerPockets Blog, outlining a tenant screening checklist/scoring system. It is simple, but effective as it screens each tenant by the same standards. There is very little room for someone to claim discrimination. I would argue that it also keeps you and I from bending or breaking our own rules because the prospective tenant was nice, had a great sob story, or appears to be well intentioned.

Check out tenant screening criteria.

Don’t Wait! Get Started now.

Reduce Your Past Due Rent

Every December, I see the past due rent amounts on my investment properties increase. Tenants will call and say that they are going to be short for some reason or another. The honest ones tell me they are going to be paying only part of the rent as they need the rest for Christmas presents. [...]

Every December, I see the past due rent amounts on my investment properties increase. Tenants will call and say that they are going to be short for some reason or another. The honest ones tell me they are going to be paying only part of the rent as they need the rest for Christmas presents. If they are a long time tenant and pay rent on-time (and in full) typically I will give them some latitude.

Now that we are in the new year and April 15 (tax time) is nearing, here is your chance to reduced or eliminate your past due rent balances. Many of your tenants will be getting tax refunds. In fact, some of my tenants filed their taxes in January and have already received their refunds.

Here is my suggestion: Start pressing your tenants more often to pay off any past due amounts in full (figuring that they are getting a refund). I actually started pressing my tenants at the beginning of the year. It was one of my investment property new year’s resolutions. You can suggest (strongly) that they use their refund to pay off their balance. You will be surprised how many times the tenant already has that refund spent on some new toy instead of on the rent they owe you!

Need help figuring out where to start? Don’t Wait! Get Started now.

Minneapolis Investment Property Slumlord

When I get asked what I do for a living I tell people that I am a real estate agent and I own Investment Property. Probably 50% of the time the listener (trying to be funny), makes some joke about me being a “slumlord”. Truthfully, I can’t stand that term. I believe I am a [...]

When I get asked what I do for a living I tell people that I am a real estate agent and I own Investment Property. Probably 50% of the time the listener (trying to be funny), makes some joke about me being a “slumlord”. Truthfully, I can’t stand that term. I believe I am a responsible and conscientious landlord and rental property owner. I also never use that term to refer to my peers (no matter how bad they are).

Well, I have to say that after reading the article in City Pages about this Minneapolis Investment Property owner, I am making an exception. In my opinion, this guy is a slumlord. It is amazing that he can continue to fill his apartments and has not lost all his rental licenses. I suppose, in a way, he actually makes the rest of us hard working, normal landlords look fantastic to tenants. Read the full article about The Slumlord of South Minneapolis.

Are you an accidental Landlord and want to expand your portfolio? Don’t Wait! Get Started now.