Real Estate FAQ

I am considering re-titling some rental houses with each having its own dedicated single member LLC whereby the LLC’s lone member (owner) would be my existing consolidated taxpaying multi-member LLC (partnership). The houses already have their own bank accounts and could easily include EIN numbers as well. Hopefully this would give me asset protection and natural flow-through. Does this layered configuration make sense, and how do I insure the process does not ‘dirty’ the property titles for subsequent disposition of the houses?

In my state – Georgia, LLCs are relatively inexpensive $100/$30 if self-created, however Foreign LLCs, i.e. Nevada Series LLCs which look good on paper are expensive to register here. TIA

– Jack, Georgia

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Answer

LLCs are excellent for real estate. Your “layering” concept is very good as well. This is how many of the big players do it.

Some of them have separate entities for 1.) holding the real estate and 2.) managing the real estate. This makes particularly good sense in states that don’t charge an annual LLC fee/tax (sorry Californians–you have an $800 annual LLC tax).

They are superior to corporations in that the paper losses generated by real estate’s depreciation deduction flow through to the individuals that tax year, rather than staying within the corporation and having to be carried forward.

A tax deduction now is worth more than one in the future (time value of money 101).

The best way to keep the process “clean” is to use a good law firm that does real estate. In a city like Atlanta, there are plenty of firms of under 50 lawyers (which would be a small firm in Atl) that specialize in real estate. Don’t go to a family law (divorce) or criminal lawyer!

You can form the LLCs yourself an save a few bucks, then go to them to make sure the transfer of the titles is done correctly.

This also gives you a chance to test drive a law firm.

In commercial real estate, you’re going to need a good law firm.

From transactional work in negotiations in financing, permits and variances, and leases to litigation with tenants, contractors, insurance companies (yes, insurance companies don’t always pay just because you make a claim!), and condemning authorities….there is a lot of legal work generated from commercial real estate.

I don’t see any advantage in going for a foreign (i.e. Nevada) LLC.

You wouldn’t avoid any taxes (unless you were taxed as a corporation, which is generally a bad idea for real estate), you’d still have to register in Georgia (extra cost, loss of privacy that many seek by going to Nevada), and you’d still have to litigate in Georgia because your property is located there and the opposing party in litigation involving your property could put you in a Georgia court on that basis

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I am interested in putting my assets–thus far two parcels of land–into an LLC as a holding company. I would also like to open my own advertising business, and put that into an LLC. Additionally, I would like to roll over my current 401(k)plan into a self directed IRA LLC. Can all of these be housed under the same LLC umbrella?

I do not want all of the funds I have, obviously, to be in the name of a retirement fund. I’m thinking that I need at least two LLCs legally. Can you please offer advice or an opinion?

– Lou, California

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Answer

I don’t give legal advice here, however, I can answer a few of your questions.

But first, I need to ask why do you want your IRA in an LLC?

Your assets in an IRA are fairly well protected against creditors, and in bankruptcy. Did someone suggest to you to put your IRA in an LLC for estate planning or other purposes?

As far as your land and advertising business, you definitely want those separated into two LLCs.

You almost never want real estate (particularly developed real estate, but also land) in the same entity as your operating business.

The risk of liability crossing from one business/asset to the other is very great.

A problem in your advertising business can result in your losing your land, or vice versa, if all those assets are in a single LLC.

Land can be contaminated, for example, and the environmental laws hold the owner responsible even if the contamination is the result of other people dumping toxins on your property in the middle of the night! I once had a client who was threatened with millions of dollars in cleanup costs from the state government because the city had once operated a landfill, which leaked, on my client’s property. Even though the city was at fault, the state forced the client to pay for remediation, and it was up to the client to seek reimbursement from the city. Fortunately we worked out a settlement, albeit after significant legal fees. The last thing you want to do is expose all your assets to that type of risk

If the real estate is to be used by your business, the simple solution is to have your real estate LLC lease the land or building to your business LLC. This also allows you to move money around between entities for tax purposes, although that is a more advanced topic to discuss with a CPA.

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Can an Illinois LLC be formed with members from both Illinois and another state for the purpose of owning real estate located in New Jersey, or does the LLC have to formed in New Jersey where the property is located?

– Amy, Illinois

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Answer

You are asking two questions, really.

1. Can an out of state LLC own property in state?

2. If an Illinois LLC can own property in NJ, does it have to jump through any additional regulatory hoops, such as registering as a foreign corporation in NJ?

The answer to 1 is yes. An Illinois LLC can own property in NJ.

The answer to 2 is whether your Illinois LLC must register as a foreign corporation in NJ because it is “transacting business”.

Here is what NJ law says about what constitutes “transacting business”:

• (2) Without excluding other activities which may not constitute transacting business in this State, a foreign corporation shall not be considered to be transacting business in this State, for the purposes of this act, by reason of carrying on in this State any one or more of the following activities

• (a) maintaining, defending or otherwise participating in any action or proceeding, whether judicial, administrative, arbitrative or otherwise, or effecting the settlement thereof or the settlement of claims or disputes;

• (b) holding meetings of its directors or shareholders;

• (c) maintaining bank accounts or borrowing money, with or without security, even if such borrowings are repeated and continuous transactions and even if such security has a situs in this State;

(d) maintaining offices or agencies for the transfer, exchange and registration of its securities, or appointing and maintaining trustees or depositaries with relation to its securities.

NJ law also has this interesting statute that might apply in your situation:

• 14A:13-1. Holding and conveying real estate

A corporation organized under laws other than the laws of this State, whether or not constituting a foreign corporation as defined in this act, shall have the same powers with respect to real property located in this State, or any interest therein, as a domestic corporation.

Seek the advice of a NJ attorney to determine if your Illinois LLC must register as a foreign corporation in NJ.

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I wanted to form a llc in a state with a cheaper filing fee–I’m in Pennsylvania. Is this legal, and will I have a problem operating in Pennsylvania if the llc was formed out of state? This is for a property management company.

– Michelle, Pennsylvania

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Answer

Yes, it is legal to form an LLC out of state.

In Pennsylvania (as in most states), an out of state LLC (called a foreign corporation) is permitted to do the following:

§ 4122. Excluded activities.

1. Maintaining or defending any action or administrative or arbitration proceeding or effecting the settlement thereof or the settlement of claims or disputes.
2. Holding meetings of its directors or shareholders or carrying on other activities concerning its internal affairs.
3. Maintaining bank accounts.
4. Maintaining offices or agencies for the transfer, exchange and registration of its securities or appointing and maintaining trustees or depositaries with relation to its securities.
5. Effecting sales through independent contractors.
6. Soliciting or procuring orders, whether by mail or through employees or agents or otherwise, and maintaining offices therefor, where the orders require acceptance without this Commonwealth before becoming binding contracts.
7. Creating as borrower or lender, acquiring or incurring, obligations or mortgages or other security interests in real or personal property.
8. Securing or collecting debts or enforcing any rights in property securing them.
9. Transacting any business in interstate or foreign commerce.
10. Conducting an isolated transaction completed within a period of 30 days and not int he course of a number of repeated transactions of like nature.
11. Inspecting, appraising and acquiring real estate and mortgages and other liens thereon and personal property and security interests therein, and holding, leasing, conveying and transferring them, as fiduciary or otherwise.

Foreign corporations are also permitted to:
——————————————-
§ 4143. General powers and duties of nonqualified foreign corporations.

(a) Acquisition of real and personal property.-Every nonqualified foreign business corporation may acquire, hold, mortgage, lease and transfer real and personal property in this Commonwealth in the same manner and subject to the same limitations as a qualified foreign business corporation.
——————————————

What is the penalty for doing business in PA as a foreign corporation?

————————–
§ 4141. Penalty for doing business without certificate of authority.

(a) Right to bring actions or proceedings suspended.-A nonqualified foreign business corporation doing business in this Commonwealth within the meaning of Subchapter B (relating to qualification) shall not be permitted to maintain any action or proceeding in any court of this Commonwealth until the corporation has obtained a certificate of authority. Nor, except as provided in subsection (b), shall any action or proceeding be maintained in any court of this Commonwealth by any successor or assignee of the corporation on any right, claim or demand arising out of the doing of business by the corporation in this Commonwealth until a certificate of authority has been obtained by the corporation or by a corporation that has acquired all or substantially all of its assets.
————————-

In other words, you can’t sue in a PA court if you’re a foreign corporation acting without a certificate of authority.

I would check with PA attorney to see if the exception under 4143 includes property management activities. He or she could probably quickly find some PA caselaw on that issue.

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My Husband and I live in Texas and would like to form an LLC to be able to buy and rent homes and maybe commercial real estate in the future.
What are the steps required to form the LLC?
I know that we need to fill and send the certificate of formation with $325 (in Texas).
Can our home operate as a registred agent location?
How do we get an EIN?
Do we need an operating agreement?
Thank you.

– Sara, Texas

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Answer

Here’s a 30,000 ft. overview of forming your LLC:

1. File Articles of Organization in Texas (Texas calls it a certificate of formation, but it’s the same thing).

2. Obtain your EIN from the IRS by filing form SS-4.

3. Draft an Operating Agreement for your LLC.

Yes, you can use your home as your registered agent address. A couple of things to consider before doing so:

• Registered agent addresses are public record–you will get a ton of junk mail at your home
• If your LLC is ever sued, the sheriff or process server is going to show up at your house. Using a registered agent service, the summons will go to your registered agent and then be forwarded to you in the mail
• Anyone can find your home address by looking up your company’s registered agent information on the internet

Texas law permits you to operate an LLC without an operating agreement.

However, it’s generally a bad idea to do so. Without an operating agreement, you are subject to Texas’ default LLC statute (the Texas LLC Act). For example, under Section 101.107 of the Texas LLC Act, “A member of a limited liability company may not withdraw or be expelled from the company.”

So, if you want the ability, in Texas, to expel a member of an LLC or to have a member withdraw, you need to have a written operating agreement that provides that ability.

I would strongly recommend you obtain an Operating Agreement when you form your LLC.

Good luck with your new venture!

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My goal is to acquire 3 new properties a year and then rent each property to tenants. There are 7 other members of this LLC. What is the best way to arrange taxation on this LLC?

As a standard LLC? Or, arrange taxation as a Corporation? No dividends will be given to the members at least for 5 years.

– Anthony, Pennsylvania

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Answer

You generally want taxation as a partnership, not a corporation, for the type of real estate venture described in your question.

A corporation is generally a bad idea for this type of real estate venture. The only time a c corporation would possibly be recommended is if you planned on forming a REIT (Real Estate Investment Trust) to be traded on public stock exchanges. Even then, not all REITs are c corporations–many are arranged as limited partnerships.

As a limited liability company taxed as a partnership, you and your partners would be able to tax the depreciation-caused losses as personal deductions on your personal tax returns. As a corporation, you would not, and would have to carry forward the losses against future gains.

Our firm does a lot of real estate work, and I don’t think we’ve formed a corporation for this purpose (owning real estate for lease) in years. Before LLCs, people used general or limited partnerships, in order to deduct depreciation losses on their personal returns during the early years of ownership.

In fact, this is a huge advantage of real estate investment–the ability to deduct non-cashflow losses (e.g. depreciation) — during the early years of the venture. Combined with borrowed money, the tax advantages to owning depreciable real estate in a pass through entity like and LLC or partnership are substantial.

A major consideration as well is whether to use a separate limited liability company for each piece of property. By doing so, you can put a legal “firewall” of liability protection between each property.

Most investors will form a separate entity for each property. Occasionally they will put several similar properties (such as multiple buildings that are part of a single apartment complex) in a single entity.

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If I was to form an individual LLC for each house I buy, how does it work in the big picture. Is there one company above all the individual LLC’s?

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Answer

Delaware (and some other states), have something called a “series LLC“, which is precisely for this purpose.

On the other hand, you can simply be a member of many LLCs.

We have major developer clients who are members of literally hundreds of LLCs. They (and their accountants) kill a lot of trees each year at tax time…..but it does work to keep liability for each property isolated.

It’s no different than owning stock in a whole portfolio of companies.

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Hello. Great website with a lot of information.

Here’s my scenario: I have not yet created my LLC yet. I am attempting to buy a small multifamily property – 16 units. For the down payment, I have 8 investors (mainly family members and close friends) that are each going to put up $10,000. I will pay them back with a lump sum including a nice interest rate. They could be silent partners but I do not wish to include them in the LLC. Do I need to? Should I set up a separate LLC just for them? What other legal form or documentation could be set up so that they are at ease with loaning me the money? Any advise is greatly appreciated.

– Rob, Texas

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Answer

If you want them to actually own a percentage of the property, then they should be members of the “main” LLC. There is no need to create a separate LLC just for the investors.

On the other hand, if they are merely lenders, then you’ll need signed promissory notes by which the LLC agrees to repay the loans plus interest.

From your description of the business arrangement between you and your friends that you’re going to repay the principal plus interest, it sounds like this is a lender-borrower relationship and not a co-ownership situation.

Texas is a deed of trust state, so your lenders might insist on a deed of trust on the property to secure the promissory notes.

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I own a couple of homes that I rent out to long-term tenants. I’d like to form an LLC to protect myself from lawsuits by the tenants. My question is regarding ownership of the homes. Should ownership be transferred to the LLC rather than myself, as it is now?

On one hand it seems that doing that would put the homes as assets at risk because they would no longer be behind the corporate veil. But on the other hand if I maintain them in my name, would that present a co-mingling problem that might be used to pierce the corporate veil?

I would try to get around the latter by taking the rent in and putting it in an LLC account, and then using those funds to pay the mortgage, property tax and insurance payments.

How should I proceed?

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Answer

If you own the rental property now, in your own name, you are entirely exposed to personal liability for anything arising out of the ownership of the property. This means tenant lawsuits, environmental cleanup, code violations, etc.

Both the rental property itself is exposed to judgments, and you are personally liable (e.g. they could garnish your wages from a job you have outside of owning the rental homes).

If you transfer the ownership to an LLC, then you have a layer of insulation between you and liabilities from the property.

The homes themselves, of course, would be exposed to judgments.

In order to make that layer solid, you need to treat the rental property as if it is actually owned by the LLC, meaning that the LLC:

*Collects the rent;
*Pays the utilities, taxes, etc.

There is no veil-piercing issue if the rental homes are owned by the LLC, the rental income and expenses are received and paid by the LLC, and the LLC’s assets are kept separate from your own (except for distributions of LLC’s profits to yourself, obviously).

Followup Question

How do the potential costs weigh against the lack of protection, for using a single llc to cover multiple properties?

Answer

Costs of multiple LLCs are:

1. Annual filing fees (depends on your state–California has a notoriously high annual filing fee for each LLC).

2. Preparation of tax returns for each LLC.

3. Cost of preparing annual reports (this requirement varies by state–some states do not require annual reports).

4. Cost of accounting for each LLC.

Benefit of multiple LLCs is that risk from one property is isolated from other properties. This benefit is harder to quantify until you have some liability arising from your property, such as environmental contamination.

In my experience, most serious investors form a separate LLC for each property. In many cases, lenders will require that a separate entity be formed for the property and that no other properties are owned in that entity, so as to protect their collateral from having other claims attached to it.

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I am forming a real estate LLC with my wife. Do we need an operating agreement? We split the ownership 50%-50%.
Thank you

– Francisco,  Texas

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Answer

You really ought to have an operating agreement for your limited liability company.

While Texas law does not require you to have an operating agreement (they are called “company agreements” in Texas), it is nonetheless a good idea to have one.

Many banks will require you to show a copy of your operating agreement in order to open an account. If your LLC tries to borrow money, a lender will almost certainly want to see that the LLC is authorized to do so under its operating agreement.

When you form an LLC with Legalzoom, they include a customized operating agreement in the price of forming your LLC.

While you can have an attorney draft an operating agreement for you, it will be far more expensive than having one made as part of an LLC formation package from a company such as Legalzoom.

If your business operations become very complicated and you need a more customized operating agreement, you will save money by having your attorney modify your existing agreement rather than trying to create a document from scratch at the beginning when cash is tight and you’re not 100% certain what provisions you need anyway.

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When would be the best time to form an LLC, after first property? Should I purchase with personal credit then quitclaim to the LLC to start out? Does it help business credit to do this? Any recommendations would be great.

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Answer

Even in good markets, for most LLCs, banks are going to require your personal guarantee regardless.

However, having the property in an LLC is good liability protection for you personally for liabilities other than the mortgage debt.

Here’s what I mean. If you own the property in your own name, if someone slips and falls on your property, or if there’s an environmental problem that insurance doesn’t cover (and they don’t cover much–read the “pollution exclusions” in your policy), then you are personally on the hook. Environmental laws are particularly nasty, and the EPA and state agencies don’t care who caused the problem, if you own it, you are liable.

On the other hand, having your property in an LLC will protect you personally from the slip and falls and environmental problems (assuming that you weren’t personally dumping stuff on the property yourself).

In terms of the right order to do things in? Either way will probably work. If you’re interested in building business credit, I would suggest having the LLC take out the loan. Understand that you will have to personally guarantee it, but at least the LLC will be building a credit record, and you will have insulated yourself from all liabilities associated with the property EXCEPT the mortgage note you personally guaranteed.

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We have a 10 member LLC used for Investments.
We file the 1065, with K-1’s sent out to each member.

This year, 2 members got a Loan, purchased a Rental House as an Investment.

Question
1. What Tax forms do we need to use to figure their portion of the LLC?

2. What Tax Forms would they need to use in their own Personal Tax Returns?

I have really enjoyed your Posts… I hope this one isn’t over the Edge.
Be Blessed Investors,

– Randall, Iowa

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Answer

Your multi-member LLC is taxed as a partnership.

Form 1065–which you have already been using–is the proper form for your partnership’s tax returns.

The individual LLC members will use the K-1 they receive to record their income (or loss) on their personal tax returns.

Is this new rental house the member’s purchased part of the LLC, or a side venture outside the 10 member LLC?

If it’s outside the LLC, and they own it in their own name, then it would be recorded on Schedule C. Schedule C is part of your personal 1040 return.

If the investment was inside the LLC, then the members need to decide among themselves how to allocate income, expenses, profits/losses, and distributions.

LLC law is very flexible when it comes to these decisions, which is both good and bad. It’s good because you can pretty much devise any profit sharing scheme you want. It’s bad because you have to make these decisions, and these decisions have tax and other consequences.

When it comes to multi-member LLCs with complicated tax issues involving loans to the LLC, uneven contributions of property from a subset of members, and so forth, there’s one piece of advise to give:

See an attorney.

I know you’d like to get your answer from “some guy on the internet”, but trust me, you don’t 🙂

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