Podcast 114: Should Landlords Create an LLC?

When entering into the real estate market and becoming a landlord, many people are unsure whether or not to create an LLC. There are definitely pros and cons for doing so, but everyone’s situation is different. In this episode of the RentPrep podcast, we’ll review the reasons why it may be a good idea to form an LLC as a landlord.

Transcription of “Should Landlords Create an LLC?”

Man: Nothing will crush a real estate investor’s spirit like landlord stress. The difference between being successful and miserable in managing properties is education. Welcome to Landlord University, where landlords learn. Landlord University is recorded from inside the RentPrep office where Stephen White and Jeff Pearson share the lessons learned from working with some of the most successful landlords.
Jeff: Welcome to Landlord University Night School. I’m Jeff Pearson. I’m here with my co-host, Stephen White. Hello, Stephen. How are you doing this evening?
Stephen: Hi. I’m pretty good, Jeff. So today’s episode is really brought to you by Kyle Meacham who is a listener of the RentPrep podcast. So we’re obviously really thankful for that and Kyle actually reached out to me and said, “Hey, I listened to the podcast and I’ve got a suggestion for a show.” And he said he’s been considering creating an LLC to help protect his personal assets and protect himself in the event that he gets sued by a tenant. He said that a friend recommended it to him, but he’s having a difficult time assessing whether or not it’s worth it.
So he wanted us to cover the topic on the show. And so Kyle, we’re certainly glad to oblige, and I think Jeff and I both have plenty of experience when it comes to business, and LLCs. And you know, we’re going to help give you a good clear understanding in how would affects you as a landlord and hopefully, you’ll get some good information out of this to be able to make your decision.
Jeff: And we have to do the normal disclaimers. We are not lawyers. We’re not giving legal advice. We’re going over our opinions on what LLCs are and how they might or might not benefit you.
Stephen: And I think for the most part when you’re talking about LLCs and landlords, you’re really talking about two really main issues, legal liability and tax liability. And as a landlord, you’ve got to make a decision on is forming that LLC going to protect you from a legal aspect and from a tax aspect, as well.
And all the research I’ve done, all the experience that I’ve had, it’s really easy to sum it up and say, “There is no definitive answer.” There is no, “This is exactly what you should do.” It really is based on your own personal situation and especially when it comes to taxes. I mean, legal liability, we’ll go over that and we’ll talk about how LLC can certainly protect you and how there’s also some gaps there as well, and there’s some holes. You know, it’s not completely rock solid, but really, it’s the tax liability aspect that may or may not be beneficial to you.
And ultimately, I think discussing it with your tax professional, accountant, preparer, whatever you’ve got, to find out if your specific tax situation, if it would benefit you to have an LLC or not.
Jeff: Exactly. In LLC, for the people who might not know, it’s a Limited Liability Company. It’s kind of like a corporation. You can incorporate a business and there are number of different types of corporations that you can put together. And an LLC is kind of like a simple version of a corporation where essentially it separates you legally from that business. You’re essentially creating a business and putting your property or properties into that business, and they actually own it.
In fact, I’ve heard there’s a TV show called…it’s on HGTV Dream Home or something like that. And my understanding is they build that, and put it into an LLC and then somebody wins the house. And when they win the house, they essentially transfer the LLC to that person.
So they don’t have to go through the whole rigmarole of selling it to them or transferring title. They transfer the business, the LLC, to the person who wins it, and then that person owns it in an LLC.
Stephen: It makes a lot of sense because depending on how the LLC is structured, it is a lot easier to transfer in an LLC situation. And like you mention, an LLC is a much simpler form of a corporation. If you’re a single member LLC, you don’t have to worry about monthly minutes and all those type of things that you do with a larger corporation.
So it’s generally a lot easier to manage, and so it’s a lot easier for, you know, from a legal front and certainly limits on paperwork and things like that. So I could see why…and it’s super interesting. I never knew that, but I could see why HGTV would do something like that. It would make sense.
Jeff: Sure. When you think about it, all of the utilities are in the name of the LLC. The property taxes, the legal, you have the deed, everything is in the LLC. So when it comes down to it, all you’re signing is one document that transfers the LLC to that person.
Obviously, you have to transfer the bank account to that person so that they become the contact on the bank account, but ultimately, it’s a pretty simple procedure when you get down to it.
Stephen: And we’re definitely going to double back on that because that is one of the aspects of the LLC. If you’re going to create LLC that transfer of ownership could play an interesting part in your decision process if you’re carrying a mortgage, though. A lot of banks don’t like that idea of being able to transfer it and they have a specific clause in your mortgage, the due-on-sale clause.
And so we’ll get in to that hearing a little bit on how that could affect you as an investor or property owner. And why an LLC may not be the right thing for you because of that it’s easy to transfer, but banks don’t always like the transfer if you’re still carrying any kind of mortgage on that.
Jeff: Right. All right. So let’s dig down. Let’s start with the cost. What does it cost to setup an LLC?
Stephen: Yeah, I think a lot of landlords base their decision on the cost because, you know, you have to pay filing fees to your state. And usually, whether you go with an attorney, of course, there’s always the do-it-yourself route. But any way you look at it, it’s not going to be free, and a lot of that means not necessarily cheap either. If you go the do-it-yourself route which I have done personally, so I can give you some my own personal experience. I’ve done it.
Jeff: I’ve done it as well.
Stephen: Yeah. Did you use LegalZoom?
Jeff: No. We actually contracted with a company that sent us the documents and we filled them out based on their starting point then turned them in.
Stephen: Now, if you can remember, how long was it about?
Jeff: That was 1999.
Stephen: Do you remember roughly what the cost was? I’m sure that they had their own fee that they were charging you and then you pay the state fees on top.
Jeff: I think the fee we paid them was $100 or so.
Stephen: Okay, and then the state fees. You are in California, so it was probably not super expensive, $100 or so.
Jeff: Well, no. Our state fees are $800 a year.
Stephen: Oh, wow.
Jeff: So in order to have an LLC, you’re paying a minimum of $800 a year, plus a $20 filing fee, and if your net income exceeds $250,000, you’re going to pay at least $865 and it goes up from there.
Stephen: Wow.
Jeff: So it can be expensive to have an LLC in California.
Stephen: Yeah, I guess so. Well, in New York it was…when I did it, I looked back in our record, it was $690 to go through LegalZoom and that was when I first started federal screening. So we’re going back to 2007, but from my research and I just look, you know, within this past week on the site for LegalZoom and the price has really haven’t gone up pretty much at all.
So I got to imagine, they’re going to be around the same. The one nice thing about LegalZoom that I personally really like is…which shouldn’t necessarily be a selling point, but I liked it. They sent everything in a really nice binder. It had the name embossed on it with the company, and it was just really well-organized that had a stock certificates in the back that you can fill in.
It had everything really well-organized and when I had recently setup another LLC this past year through my attorney, we didn’t get any of that, and it cost twice as much. But the nice thing was an attorney…you know, I just told him basically the name and he came back with everything and an invoice. Everything was done for me. I didn’t take any time or effort necessarily on my end. He had done everything and at that point, it was just a matter of me, paying the fees for it.
So the cost has going to vary greatly obviously based on your state, but what I estimated the costs to be, if you’re do-it-yourselfer, you’re going to look anywhere between $400 and $800. I would say when you start paying for the service, if you go through a service like you or I did, they’re going to want to fee. Usually, you have to pay a registered agent fee if you don’t already have one.
In the case for my attorney sets our LLC if he’s the registered agent so I don’t pay any additional fee for him to do that, but if you don’t have an attorney that you’re a registered agent, you probably going to pay…I think there’s an association called “The National Association of Registered Agents,” and you could pay in to that and they will be your registered agent and it’s usually about $180 a year, something like that.
So estimated cost do-it-yourself, $400, $800, depending on what state you’re in. Estimated cost to use an attorney, I was basing this on my experience, it’s anywhere between $1,000 and $1,500 to set that up. The biggest notable difference is the amount of time and energy you put into it.
If you take the attorney route, they’re going to take a lot of that off your plate. They’re going to have it done for you. You’ll pay a little bit more, but they’re going to go through and make sure it’s done correctly for you. If you do-it-yourself, there’s going to be some time put into it. You’re going to do a little bit of research, I’m sure and you want to make sure that everything is set up the correct way and you’re going to go through the steps, one step at a time, versus having an attorney who just do it for you.
Okay. So aside from the cost, one of the other really big points that you want to consider is the protection that an LLC gives you from a legal perspective. So what’s your legal liability in how good is an LLC for protecting you legally and we just had Dani Alexis on our show who is an attorney. And I mentioned her and I asked her specifically for Kyle, what her opinion was on it and she had said, there was definitely some legal protections that the LLC was good for, but there was also some holes in it that it wasn’t necessarily completely rock solid.
So a couple of examples of how…even if you have an LLC you may still be personally responsible for something such as in a lawsuit or a tenant sues you is if you were specifically responsible for something that was neglected. So let’s say, snow removal or pool maintenance, something that resulted in a tenant injury. You would likely be responsible, versus the LLC because it was your responsibility to remove the snow or maintain the pool. That was your job personally. You’re the person that’s individually in charge to that. If you’ve failed to do so you could be held responsible.
So another situation where you’re sort of limiting your coverage protection in an LLC is a situation where the law was potentially broken. Or if you have any kind of deceptive business practices, obviously, that LLC is not going to protect you and you will be personally responsible as the person who let the LLC operate illegally or wrongfully. So in both of those cases, you want to be aware that the LLC is not going to protect you in those cases.
Jeff: Right. Now, the flip side of that when it comes to an LLC is if you own properties, rental properties, and you put them into an LLC and separate from your properties, you get sued and somebody sues you for everything you own. They take your house, they take your car, they take everything you own through a lawsuit. They can’t take the LLC necessarily, if I remember correctly.
Stephen: Yeah and that’s a good point. I’m not an attorney so I don’t know the legalities behind it, but I definitely think that you’re right. I’ve seen similar situations in business where somebody will personally file bankruptcy and there are ways around having it affects your LLC in your business as well. So I would assume it kind of falls under a similar situation where you can make it at a distinct separation between the LLC and anything that you have personally.
Jeff: Right and if it that’s a concern, certainly, confirm with your lawyer how that works and whether or not it actually does, but I seemed to recall that’s one of the protections that you have available to you.
Stephen: Another key point to really pay attention to. This is just good landlord/business practice, something we constantly preach here anyway is to really be sure that you keep your finances separate when you have an LLC. You don’t want to be paying groceries with your business banking card because what can happen is in a lawsuit, a plaintiff could make the case step because you were paying for personal things that there is no separation between the LLC and your personal life.
And so you want to be sure that you’re not co-mingling any funds. You want to keep everything completely separate. Easiest way to do that is to setup a separate bank account, obviously, for the LLC and it certainly makes accounting and record keeping a lot easier as well if you just have everything related to that property or that LLC strictly go through that bank account and that’s it. Don’t use that bank account for anything else.
Jeff: Yeah. That’s the important part. Don’t use that bank account for anything else, but if you happened to pull out your personal credit card at the local hardware store that get something for your business, then you can reimburse yourself from that account. Make copies of the receipt, keep the receipt in your files, do everything as you normally would if you were at work, and you bought something for work and you submitted that to be reimbursed, you would do the same thing with that bank account.
You know, I would create a little form, reimbursement form, I would attach the receipt to it, put it in the files, I would write myself a check and have a clear record of that transaction. You never want to use the business card for personal stuff, but you can use your personal card for business stuff. That’s not a big deal as long as you have those records.
Stephen: Exactly, and if you’re using pretty much any record keeping software, QuickBooks, whatever, that’s usually a really simple journal entry to make, to just point out what it was that you bought and you’re being reimbursed for that and yeah, great point with that.
So when it does come to banking…so we’ll talk about banking and in double back to what you had mentioned before about transferring upon a sale and things like that. The one thing you want to be aware of is if you own your rental property and you setup the LLC, and now you transfer the ownership of that property to the LLC, what you may be in violation of is the banks due-on-sale clause.
So most lenders will look at the transfer from your personal site to the LLC as a sale, and according to the terms of the mortgage, they can accelerate that loan and cause you to have to pay the whole balance or refinance it, so you could lose the low interest rate that you have. I’ve heard of horror stories of landlords not being able to refinance, maybe they had the property or whatever and then on refinance that the bank determined that they were no longer qualified. So you put yourself in a real scary situation in that case.
So absolutely, if you still carry…if you still have a mortgage on your property, you want to be sure that you know how your lender is going to react to the LLC because you don’t want to do something that is going to put you at financial jeopardy and cause you to have to remortgage the house or refinance, lose the low interest rate and it can really turn into a mess.
Jeff: Yes, and this is a situation where having an attorney setup the LLC and manage that process with the bank would be really important. If you’re setting up an LLC and then buying a property into the LLC, so your mortgage is already there, that’s not so much of a problem. But if you’re moving a property that has a mortgage, I would seriously consider paying the extra money to have an attorney do it and I would ask them specifically about this particular piece to the puzzle because the last thing you want to do is accelerate that mortgage.
Stephen: Right, and I think this is something that’s probably really widely overlooked because you just don’t consider that a lot of times. I think a lot of landlords do get themselves in trouble when they move things over to the LLC. So you know, it’s pretty simple and like you said, just make sure that you specifically point this out to people, you know, to your attorney, to the lender, if you’re doing it yourself, whatever the cases. Specifically, ask because you don’t want to do something that…you’re just creating a whole mess for yourself down the road.
Okay. So aside from the banking, we’ll talk about insurance. Insurance policies on an LLC are not very costly. To not have one is certainly more costly than to actually pay the cost of having a landlord policy, but the one thing I’ll point out about it is it’s so important to actually have a landlord policy. If you have the LLC, you’re more likely to have the landlord policy, versus just the homeowner’s insurance policy. But the homeowner’s insurance policy is to certainly not going to cover you for as many of the things as a landlord, as the landlord insurance policy may cover you.
So one of the things that I’ll point out immediately is attorney’s fees. If you have a landlord policy, your policy will likely cover any attorney fees that you may incur in the event that you do get sued. Your homeowner’s policy probably not going to cover that.
So you want to make sure that you’ve got the right coverage and then also it’s never a bad idea to require your tenant to carry renter’s insurance. Some states mandate it, the majority do not, but every landlord has the right to require rental insurance. They can make that a part of their lease and I certainly recommend it. It’s extremely inexpensive. A lot of insurance agents will strike up deals with landlords so that if you direct the tenant to go directly to them they’ll give them a deal or a break on the policy, or have things already setup to make the process easier for them.
So it’s a good idea to create a good relationship with an insurance agent that can give you renter’s insurance coverage for your tenants, and have your tenants go straight to them and say it’s part of lease agreement, you have to have this coverage because that renter’s insurance is going to cover a lot of the gaps that the landlord insurance policy might have.
Jeff: And there’s a good possibility your homeowner’s insurance policy will not cover your home if you’re renting it out.
Stephen: Exactly.
Jeff: So you don’t want to be in that situation, and if you don’t require your tenants to have tenant insurance and you want to, I would suggest look at when their lease is up. I mean if they’re on month-to-month you can change that anytime. You can just give them written notice, give them 30-days notice and require them to get it. But if their lease is coming up, I would give them, you know, at least two or three months advance notice saying, “Hey, look. I’m going to make these changes in the lease. I think it’s important for you and for me to protect your property with a good tenant policy.”
And I’m going to be adding that to the lease when it comes up in three months and I would send that, at least, through email, if not, through the mail. Just to give them a heads-up so that they know and then be sure to give them a copy of that lease, at least, 30-days before you need them to sign it and return it to you.
Stephen: Yeah, and there’s a great article on the RentPrep blog and I believe the article was titled, “Can landlords require renter’s insurance?” so if you have any further questions or issue with that, you want to find out more about it, I definitely recommend checking that article. Definitely a good resource. It was written by, if I’m not mistaken, Dani Alexis who is our attorney contributor. So she gives a really good perspective on how that works.
All right. So tax liability, that’s probably the other really big drive for landlords to look to an LLC. They want to make out better on their taxes, who doesn’t? The issue is it depends on how your taxes are filed whether or not it’s going to help or hurt you to have that LLC, and I hate taxes.
So if anyone who knows me could certainly attest that and say that I don’t like them. I’m not a tax expert. I’ve been through an audit before. I find it very difficult to keep up with tax laws, certainly, business taxes, things like that and I found a long time ago, it was well-worth my money to pay a good accountant to help with that side of things.
So you know, a lot of landlords are do-it-yourselfers and a lot of our listeners are do-it-yourselfers. But when it comes to the LLC and making that decision, I would not recommend doing that without consulting your tax professional first and finding out if it works for you personally, because my situation or Jeff, your situation may be totally different. And something that works for me and gives me a tax break may end up being a bigger tax liability for you and hurt you in the long run.
Jeff: And one of the things that when you talk about sitting down and talking to a tax accountant or somebody to help guide you in this decision from a tax standpoint, to me, the simplest way would be to go to them and say…go to the person who does your taxes and say, “Look. Can you do this for me in both the current situation as a sole-proprietor or if I were to do it as an LLC and show me what the differences would be?” And then you can determine from there.
It may turn out that there isn’t that much difference in tax savings. If you just have a single property, you may or may not be able to write things more things off or something like that. They’re going to be able to help guide you. The question is going to be, “Do you want to have all of the benefits that an LLC brings?”
It certainly brings a few more headaches. Your taxes are going to be a little bit different. You have to file one more form and if you have multiple owners, you have a separate partnership tax that you have to file and some things like that. If you have somebody taking care of your taxes for you, it’s not going to be that big a deal for them to do it. As long as you keep your records then it should work out well.
Stephen: Right. Again, like you mentioned, the biggest difference I see with the taxes is how you’re filing. Are you filing as a single owner LLC or did you set up that LLC as like a husband and wife or a partnership? And like you mentioned, you know, there’s a separate partnership tax that has to be filed.
One way to avoid it if you’re on a marriage situation is to have one person be listed as the owner and gives the spouse the right of survivorship. Meaning that in the event of your death, the spouse will become the owner. May be a good tax strategy. Divorce attorneys probably hate that, but it’s possible.
So there are some ways and again, a good accountant will help navigate you through that, but in my opinion in my experience, in my own business experience not just with properties and things like that, the single owner LLC is definitely a lot easier to manage than a multiple owner LLC, for sure.
Jeff: Yes, and that makes a lot of sense.
Stephen: So final thoughts, Jeff. Does an LLC makes sense? Is there really a right answer for that?
Jeff: There is not a right answer. Everybody can choose to do it or not do it. Is it going to make a huge difference in the way you run your business? Not necessarily. Are there potential benefits? Yes. Is there always a benefit? No. So why would you do it?
It can be a tough call and that’s where you really need to sit down with an attorney and with a financial adviser who understand this, and hopefully, who know you and your situation or, at least, can get the information from you that will help them to give you the best advice as to how it works for you. I’ll say one thing though. We talk all the time. It’s a broken record. Run this like a business and if you really want to take that step into running your landlord business as a business, I would create an LLC because all of a sudden, it feels like a business. It’s not just the house that you own or an apartment complex that you own, but it’s a business because you have an LLC.
You have the separate bank account and it forces you to think like a business in a way that just you’re moving out of your house and renting it. You buy a new house, you keep the old house or your parents willed their house to you so you just rent their house. That doesn’t feel like a business, but the minute you create an LLC and you have that legal entity, it changes your approach. And that’s a good thing for all of us as landlords because the more we run this as a business, the better it is for us, and the better it is for our tenants.
Stephen: Yeah. I agree completely and I think it comes down to three major points when you’re talking about considering an LLC and that’s going to be taxes, insurance, and legal liability. And for that reason, I have very good relationships with my accountant, my insurance agent, and my attorney. And these people help me navigate the structure of my business and how things should be. They help protect me and I trust them to have my best interest.
So if you’re going to make friends with anybody in 2015, it needs to be your accountant, your insurance agent, your attorney, and the only situation I could imagine not having the LLC or not being a good thing for you is if there were some major tax advantage that your accountant just telling you, “You listen. You’re going to get crushed if you do this or maybe on an insurance coverage level.” But I think for the most parts, having the LLC, certainly has more benefits. And like you said, if nothing else, just to have that structure in place and they put you into that mindset that this is my business.
Jeff: Yes, and one of the things that you probably want to ask about is successorship. If you die, how is this handled if it’s in an LLC or not in an LLC because most of us as landlords are not in our 20s or 30s? We’re a little bit older than that and we’re thinking about what we’re going to be doing with our assets when we pass away. And you can take that into account as well and talk with the attorneys, and the accountants as to how this would affect that. And I think it would make it a simpler and better process, but again, I’d talk to the professionals about that stuff.
Stephen: Yeah. So Kyle, we always appreciate the feedback and we appreciate you’re listening with the show. And I hope this helps give you a little bit of clarity, but really, the answer, the right answer for you is check with your professionals, the people that you trust to look out for you and make sure it’s right for you. And you know, I think that it probably would be, but again, make sure that from every aspect from tax, legal, and insurance that it is the right decision for you.
Jeff: Perfect. Well, great, Stephen. This was a good topic and hopefully, people will have a better understanding of how LLCs can work for them as landlords and I look forward to talking with you tomorrow evening.
Stephen: Thanks, Jeff.