One of the most common questions people ask about being a landlord is how you should hold your properties. Personally? An LLC or series LLC? Some kind of fancy corporate structure? Most of the time, people are worried about being sued, but people often cite other reasons why one structure is better than another.
Now, I’m not a lawyer, but I’ve talked to one about this and he convinced me that there was little reason to use a corporate structure. In fact, there are many disadvantages.
Ultimately, you should consult your own legal expert but I wanted tell you the main reasons why we don’t use an LLC for our rental properties.
When using a corporate structure, you can sometimes choose a different tax treatment. C corporations pay taxes differently than S corporations which pay taxes differently than sole proprietorship. In some businesses, like property management or flipping houses, this might be to your advantage. But with rental property, you already have very favorable tax treatment, through depreciation and exchanges, so there is very little benefit to using a corporate entity for taxation purposes.
When a bank lends you money to buy a house, they want someone to be personally liable for the debt. They want a stable source of income (a job) and cash reserves as evidence that you can repay.
When a company like an LLC wants to borrow money, the owner would typically want to use a non-recourse loan which means that if the company goes belly up, the bank can’t come after your personal assets. After all, that’s the point of using a corporation, right?
You can imagine how the banks feel about this: what’s in it for them? So in order to qualify for these loans, you have to pay a lot more for them. You need a corporate credit history and plenty of cash reserves. Often they have minimum loan amount so you might have to buy two or three and bundle them up in one loan. You can see how this might be hard for a lot of people who are just starting out.
To get around this, some people will buy the house in their own name first and then tranfer it into an LLC later. This sounds great on paper but this is actually considered a sale in the eyes of the bank. All loans today have a clause, known as the due on sale clause, which means just that: the full amount of the loan is due when the property is sold.
A lot of people claim that banks don’t enforce this but I’ve heard stories to the contrary. Either way, I wouldn’t want this hanging over my head and I imagine that you wouldn’t either.
This is probably the biggest reason people want to use an LLC: getting sued. I don’t know anyone who has been sued but the amount of protection an LLC offers will vary a lot from state to state. In Texas, LLCs are weak and the courts have shown their willingness to pierce “the corporate veil” and come after business owners who lose a case. Additionally, my lawyer made an excellent point: if someone is taking your company to court, they are probably going to sue you personally anyway.
If you are worried about being sued, you should first consider why you think you might be sued and take steps to prevent it. In my opinion, a lot of risk can be mitigated by implementing the following business practices:
- Maintain your properties and keep them in safe condition. Eliminate potential hazards.
- Avoid sue-happy tenants by doing a thorough background check including verifying and calling previous landlords
- Know your lease and follow through on your obligations to the letter. Hold tenants accountable for their part of the lease as well.
- Above all else: don’t be a dick! Pardon my language but if you treat others with respect, most conflicts can be resolved before you set foot in the court room.
For our own liability protection, we’ve taken the other approach: insurance. We have a $300,000 liability policy on each property and a $1M umbrella policy on top of that. It’s very affordable at $340/year for the first million and it’s also beneficial to us personally, say if we get into a car accident with a Lamborghini . As our networth grows, we can bump it up to $2M and each additional million gets cheaper to insure.
So There You Have It
These are the reasons that we don’t use an LLC or other entity for our rental properties. LLCs are great for a lot of businesses but it didn’t seem right for us or for this business.
As always, talk to your own law and tax professionals. And if they tell you something different, let me know!
How about y’all? Any experience with business entities? Any experiences getting sued?
Photo by r w h
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