The 3 Reasons to Own Rental Properties Within an LLC

Jun 25, 2017

If you want to be a military real estate investor, you need to protect yourself. Most people never think about investing within an Limited Liability Company (LLC). Years ago, I definitely thought it was not necessary. In my imagination, it was an incredibly difficult process that was something that only big companies had to do. This is simply not true. 

LLCs are a fairly new legal business entity created in Wyoming in 1977. The unique aspect of an LLC is that it provides a combination of liability protection and also acts as a “pass through entity” for tax purposes. It is the perfect entity for real estate investing.

LLCs have exploded in popularity since their beginning and are the new standard for Real Estate investing.

The three big reasons for owning a rental property within an LLC are: Tax Benefits, Privacy, and Liability Protection.

Tax Benefits:

This is one of the biggest reasons why Real Estate Investing is such an incredible wealth builder.

When properly structuring your business entities, you will be eligible for more business deductions (or write-offs).

An LLC is a “pass-through entity,” meaning all income and expenses are reflected directly upon the members of the LLC. (The proportions are determined by your Operating Agreement.)

For example, if you earn $50,000 taxable income from the military, but you also own a couple of rental properties that are claiming a $20,000 loss due to interest, depreciation, insurance, and other expenses… these deductions flow directly to you. In this example, your taxable income would become $30,000. At a 15% tax rate, you would pay $3,000 less in taxes that year.

The exact benefits and deductions available is outside the scope of this article. The tax code is full of information and it is my opinion that no single person can claim to know everything about the U. S. Tax Code. My only recommendation is that you start learning about taxes early on. It will allow you to build your own tax strategy and save a lot of money in the long run. The Military Real Estate Investing Academy goes into much more detail about taxes and how to really maximize your profits. One of the strategies I describe will be a way to lower your taxable income to $0 with the help of a civilian spouse and start building tax-free wealth for your family. Sign up here!

If you really want to expand your understanding of Real Estate Taxes, I would highly recommend reading Tax-Free Wealth: How to Build Massive Wealth by Permanently Lowering Your Taxes (Rich Dad Advisors). It is written by the founder of the CPA firm I use, ProVision.

Privacy:

Several things that can be done to increase privacy:

Layering your business entities. You will see in my business structure diagram in my ebook that there are two entity layers above each property. The first layer is for the operating company (the company that directly owns the business asset or the rental property). The second layer, or top layer, is the holding company. These often called “umbrella” companies as well. This is a term for a company that does nothing but own other companies and/or assets. It is very easy to look up a company and figure out who owns that company. Adding an extra layer increases your privacy because the owner will be another LLC instead of a person’s name.

For added protection, certain states, such as Wyoming for example, allow for more privacy simply because they do not require that the members or managers be listed in the State records. Therefore, no matter how many times you went up the ownership chain, you would not be able to find the owner’s name.

Liability Protection:

Dealing with legal matters is daunting. The big stick of motivation behind proper legal procedures is, of course, getting sued. No one wants to get sued, much less be found guilty of legal misconduct.

A lawsuit has such a negative connotation, it often changes the way we interact with each other. In fact, often times, people subconsciously start avoiding those that are in the middle of a lawsuit.

Our goal as real estate investors is to limit our personal liability. Personal bank accounts, cars, primary residence, etc., are considered personal assets that need to be protected in case a business becomes bankrupt or sued.

First of all, we need to understand that the owner of a property is liable for any injury to an individual on their property. The concerning part about this liability is that the value of those damages are not always cut and dry and their cause is almost never in our control. An injury that occurs on your property, could potentially preclude a person from working at their job. In this case, the damages would be equivalent to the injured person’s earning power. Depending on the circumstances and the injured person’s occupation, this sum could be much more than the value of your property. Therefore, paying for the damages with the value of the property’s equity could be severely inadequate. Creating a solid entity structure could separate and shield your liability.

When an LLC owns a property, the liability ends with the LLC because it has complete liability protection.

But what if you get sued as a part of a different liability tied to your day-to-day occupation or some other activity? Since you are the owner of an LLC, the properties or cash reserves held in that LLC are considered assets. If someone decides to sue you, they could try to go after your assets.

Well, it turns out, that if you partner with someone on an LLC (this can even be someone as close to you as a spouse), that those assets are no longer considered yours. Your assets now have an extra layer of legal protection because you only own an interest percentage in that LLC.

Taking it yet another step further, if the person suing you is really out to get you, they might try to sue you for YOUR ownership interest in the LLC. This is where it is important that you have a good lawyer set up your Operating Agreement when you file for your LLC. A good lawyer can make sure to add provisions to your operating agreement for increased protection. If this is implemented, it would require a signed agreement between all members of an LLC before giving up any ownership interest from any member. This is because the members of the LLC trust each other and are comfortable doing business with each other. Essentially, the power to make such decisions is decentralized.

Since every situation is unique, nothing can be guaranteed. If you ever get this far into a lawsuit, there is still one more layer of difficulty that the plaintiff might face. If a court decides that a certain amount of damages needs to be paid to the plaintiff, the court might issue a charging order to the LLC. This would require the LLC to pay that amount to the plaintiff. Well, one of the collection methods available is particularly advantageous to LLC members. It allows distributions that the LLC issues to you (or whichever member has been sued), to be issued to the plaintiff instead. This is advantageous, because as long as all the company’s distributions only go to other members (for example, your spouse), then nothing will ever go towards paying off those damages. Boom! Pretty awesome huh?

There is a LOT of information that cannot be explained in a single article. If you are interested in seeing a diagram on how I structured my LLCs, feel free to check out our course here.

On the other hand, if you simply want to get started by learning how to invest with your VA Loan and House Hack, check out our FREE Military House Hacking ebook and FREE Military House Hacking course!

 

Article written by Markian Sich.

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