#28: Forming an LLC For Your Rental Properties

Foreign welcome to the Passive Income MD Podcast where we talk about creating your ideal life through multiple streams of income. I'm your host, Peter Kim. If you enjoy hearing about this stuff, make sure to hit subscribe so I can bring it to you every week. Now let's get on with the show. All right, everyone, this is a question I get all the time either pointed at me or in the Facebook group, the Passive Income Docs group. And that question is, should you put rental properties in an llc? Now, I just want to start out by saying that I am not an expert when it comes to asset protection, legal or financial or tax matters. I can just tell you what I have heard about and what I've learned in my research when it comes to these things. However, you should always, as always, as I say on this podcast, is for your own personal situation. You should consult an expert in that area and a professional before making any serious decisions. Anyways, the question is, should you form an LLC and ultimately put your rental properties in it? Now, if you have some rental properties or maybe you're looking to purchase some, the question of whether or not to form a limited liability company or corporation known as an LLC has probably come up at some point when you've thought about doing so. And you know, it's nice because you probably heard LLCs can be a great way to protect yourself and your assets. And as an owner of several rental properties in various states right now, I've definitely thought about it and I've definitely worked towards a conclusion. However, it's never really completely kind of dry. I mean, there are so many different factors when it comes to asset protection and taxation issues that you really need to consider the whole spectrum before making any decision. For some, it might just be better to simply increase your insurance and some people go that way. But really finding some sort of unbiased advice on this question or this dilemma of sort, it can be difficult. And that's because if you ask like an asset protection or entity lawyer whether you should form an llc, they'll undoubtedly say yes. If you ask an insurance person or insurance agent whether you should increase your insurance liability or get umbrella insurance instead or increase that, of course they're going to say yes. The old saying, as you know, if you never ask a barber if you need a haircut, and it really seems to hold true when it comes to these things. So I think that the answer is unfortunately tell you, the punchline is it depends. But you should be able to understand what the options are and understand the discussion around both sides and why one might work better than the other or maybe both. And it's one of these classic advantages, disadvantages, pros and cons situations. So let's talk about it and dive into it a bit. So let's talk about the advantages of an llc. Now I think one of the major ones is the one that we're all concerned about is asset protection. We're all high income professionals and we're trying to really make sure that all our assets are protected and they don't affect personal liability. I mean to me that was of the utmost importance. I work really hard, I'm sure you all do, to provide for your family. And you've got personal, you know, you've got assets on your own, whether it's your house and other investments and you don't want something to happen at one of your rental properties that would put all of that in danger. So that's probably the main reason why most people look to put like rental properties in an llc. They are walling off any sort of liability from, you know, within, keeping that within that asset or that rental property and then really, you know, not letting it extend to again personal or other investments that you might have. I mean the last thing anyone wants is for a tenant in a rental property to have an issue or a vendor, somebody comes on site on, you know, on your property and slips and falls and it's totally out of control. And the last thing you want them to do is try to go after your personal assets. That's one of the major advantages is that it provides asset protection and some separation in terms of liability. And the next thing is, you know, does it provide any sort of tax advantages now? It might. Now most people will get an llc. You can elect to tax it however you want. Well, the are a couple different options and most people I would say would be taking the option to tax it as a pass through entity. That means that the income and capital gains from that LLC pass directly to the owner. Then your taxes are paid as an individual. However, as an owner you still get to enjoy the protection afforded by the LLC in terms of the asset protection. Now whether you should choose to elect one of the other ways that an LLC can be taxed or in terms of like an S corp or a C corp or partnership. That's something that you should speak to to your professional about because they have their disadvantages and advantages as well. Now the third piece of, well, the third advantage that I want to talk about is something called anonymity. That kind of runs along with asset protection. Like when you own a rental property, I don't know about you, I get tons of letters. Like when I've done it on my personal name, I get a lot of letters and I've got phone calls from either brokers or agents or whoever trying to find out if I'm willing to part with that property and then maybe exchange it to a new one. And that's because whenever you buy rental property just like your own home, your name is on the deed and that becomes public knowledge. Now that's not a good thing if you're a high income professional, especially if you have an MD or do after your name. Knowing that you're a high net worth individual may change the way somebody in terms of makes a decision in terms of their behavior, in terms of if they're deciding to go after someone for a lawsuit or not. As you know, and you probably heard is try not to have in your car a license plate for your car, a license plate that has something about the MD in it. Or people say, don't have a white coat hanging in your car because it changes the way people look at you. So if you're able to create an llc, like some sort of holding company, we'll talk about what that is. In a state that provides like pretty much total anonymity, like Wyoming or Nevada, it's really difficult for someone to find out who owns that asset and sometimes figure out on the other side, like what assets you own. So it sounds great. So why would you not get an llc? What are the disadvantages? Well, it starts with cost. There's definitely a cost to forming and maintaining the entity you create. There may also be an additional cost for tax preparation. I wouldn't say maybe there is. Now I've talked to some lawyers who will charge anywhere from 300 to 600 for an entity creation. Some others will charge 2,500 to 3,000. And it all depends. And there are companies that will do it for cheaper, but honestly, you kind of get what you paid for. You know, I think it's important to structure it correctly to make sure that it's set up to really protect you and do the things it's supposed to do. Now, for maintaining and owning that LLC on a yearly basis, the state that you're, you know, filing it in or creating it in will also want to take some fees. For me, I live in California, So that's unfortunately $800 a year. I don't know about for your state. There are other states that are far less ones that, you know, cost about 25, $35 a year of which I've heard $800 can add up. And what's the benefit of doing that? You know, we would think that's for asset protection. But here's a second disadvantage. I mean, sometimes having the letters llc, it does protect well, but there are times when it doesn't. If you talk to any entity protection lawyers or asset protection lawyers, they'll tell you that it doesn't, you know, guarantee protection. There are some reasons that they might, what's called, pierce the veil and be able to try to get to your personal assets. You know, I don't know if that's in cases like fraud and things like that, but there have been ways that people have done that. So the question is, are you getting that llc? And if you're not being guaranteed, you know, is that a good thing? Now the third disadvantage is, is that you might get trouble getting financing. Like when you purchase a single family home or a duplex or anything up to four units. Yeah. Actually, the bank will not let you purch it under the name of the llc. They want you to be personally on that property. And I know that lenders, if you put it in the name of an LLC or a property, they will not want to lend to you on it. They want somebody who is responsible for it should anything happen in terms of the loan and foreclosure and that sort of thing. So if you really want to put in the name of the llc, you may have to buy the property entirely in cash, or you could try to deed the property afterwards to the LLC and that leads to something called the due on sale clause. And something you might want to know, it's quite possible that if you try to convert ownership personally of a rental property over to an llc, your lender will see that as a complete change of ownership. And part of the one of the clauses they have is that on sale they can ask for full repayment of the loan immediately. Now, I've talked to many investors who say they've actually done this conversion without any issues, but there's really no guarantee that the bank really won't ask for full repayment of the loan. At that point, really you're left to either pay it off in cash or you've got to refinance it, which might be difficult if you have it in the name of the llc or you just have to sell the property. And so that's something you have to consider. And that's one of the hurdles that you might have to deal with when trying to Put your rental property in an llc. So what's the other alternative to using these entities? And when you talk to people, it's to really use insurance or to insure it well. And the way you can do that is by increasing your liability insurance, as well as really owning something called umbrella insurance. I mean, tenants can sue you personally or at least sue the owner of the apartment building, but if you have enough insurance to cover that, then you'll be just fine. However, again, increasing insurance comes with its own disadvantages. Well, as well as advantages. Let's talk about the advantages first. It's simpler mean that, you know, we all have insurance for the property anyways. So while you're at it, just make sure that the policy covers the proper limits. Just really jack it up, add some umbrella insurance, and you're done nice and easy. The other advantage is that the cost, I mean, typically umbrella insurance especially is pretty cheap for the type of coverage that you get. It's a small fraction of whatever the primary insurance premium is. And the concept of umbrella insurance, if you've never heard about it, it's to add on, to cover you above and beyond what your typical insurance policy does cover. Now, it does have some disadvantages. Now if you're not insured properly, the worst case is that, you know, someone does sue you above the liability kind of coverage that you have, you may have to declare bankruptcy on the LLC and you lose the property. That may also, you know, if it goes above and beyond what their limits are, then you might have to dig into your pockets personally to actually pay them back as well. Also, there's something called exclusions, and you got to look out for that. Insurance premiums have things called exclusions where you have to really account for that they may not cover the situation that, let's say you're being sued for and that you absolutely need the coverage for. So at the end of the day, do you know what they will cover and what they won't? Are you willing to take that risk? So what do I do? I mean, I think it all comes down to a matter of risk tolerance. I mean, that's really what insurance is. You're paying to mitigate risk and to sleep easier at night. When it comes to my rental properties, I have them pretty much all under an llc except for one single condo that I have. But definitely all of the multifamily properties that I own are under an llc. And I'll just tell people what those, you know, the overall structure looks like. Personally, I have a holding company, meaning that there's a like, kind of like an umbrella LLC that is, you know, in a separate state that offers anonymity. And for me in particular, I have one in Wyoming and that holds ownership of the other llc and the other LLC are created in the states that the properties are in. That's really the only way to do it. So for example, I have a California property and that property is in the name of an llc, a California entity. But the owner of that is not Peter Kim or Passive Income md. It is my holding company. And so if people kind of work back and try to figure out who the owner is, they'll kind of hit a roadblock when it comes to Wyoming and trying to figure out who owns that entity. And I think that's really, really important because again, I don't want people trying to peer peering in into who is the owner. And if there is a, you know, a lawsuit or that sort of thing and they're going to go digging around first to see if, whether it's worth it, I don't want them to find out who is actually an owner. For me, that helps me sleep at night. You know, I've seen precedent where it's protected people. I feel I have asset protection lawyers and that are trusted and experienced and I trust their advice. At the same time, you should go looking around to do the same. Now, I do have one tip for you. If this is something that you're considering for your rental properties, even if you're at the point where you are thinking about buying rental properties, it's actually easier and faster if you've already had this either holding company or this other company created this llc. There is a time process to this depending on what state you're in, depending on how processing time is there. I've had entities created in three days and I've had entities created in six weeks. So unfortunately, oftentimes if you're in escrow period where your sale is about to happen, sometimes you can't get that LLC created in time. And so unfortunately you have to deed it afterwards, which becomes time consuming and there's an additional cost to that as well. So personally, I've created that holding company llc. I use it for plenty of other investments. And also it's been well worth it for me. Now also, just so you know, I also have great insurance. So I find, you know, I have good, higher limits coverage to make sure that should something happen that that property will get well taken care of and that, you know, hopefully that it shouldn't extend beyond that property in terms of the liab and again, that helps me sleep at night. So by going with both approaches, using both entities, LLCs as well as good insurance, I feel I'm as well covered as I can be. I mean, there will be lawyers who tell you it's not enough. I mean, I spoke to one lawyer, he pitched me a plan, I remember this, that would cost me close to $30,000 for that one plan, just to make my asset protection totally ironclad. And for me personally, I wasn't willing to pay that much. And I felt that my current level of coverage, after talking to plenty of experts, plenty of other real estate investors and savvy people, I felt like that was enough to put my mind at ease. But I will tell you, don't be afraid to get a second opinion and then figure out why. Ask why. Tell me exactly why you chose that. Tell me based on, you know, what cases in the past have you heard of? What's the precedent? And figure it out and learn for yourself. I mean, I'm constantly learning new things, but again, the most important thing to me is that I'm well protected and I can sleep well at night and that is worth so much. Now how about you? I'm just curious, do you guys hold your properties in LLCs or is insurance enough? Do you do both? I'd love to hear from you. Feel free to drop me a message either on the Facebook group Passive Income Docs. That's probably the best place to reach out to me or to the group. Or you know, get on our, you know, look for the comment section in our blog post or feel free to email me. Thank you so much. Take care and have an awesome week. Enjoy the show. Let me know by dropping a review in the podcast app you're listening to us in. And if you haven't already, make sure to hit subscribe. Are you a part of our community yet? 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