Should I Put My Investment Property in an LLC?

That’s a question I asked myself years ago. I wish I was wise enough to answer it…

… NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO!!!

Or as Al Bundy from Married… with Children once said, “Run hard, run now, run silent, run deep, run like Mexican water through a first-time tourist, but the key word here is ‘run!'”

I could go on about how I feel, and I will, but before I go any further I need to pause and stress something. Much of this is an account of my situation and how I personally feel. Your situation may be different… and your answer may be different. Perhaps you’ll be smarter than I was and get professional advice before jumping in.* In any case, I wish this was one of the 1.31 million personal finance articles I’ve read over the last 15 years or so.

I was going to suggest that no one should put their investment property in an LLC, but I talked with a few people and it seems like there may be some valid reasons to do it. Let’s cover a few of those reasons first.

Why Put Your Investment Properties in an LLC?

My wife and I were looking to simplify our finances. Whenever we needed money for repairs it would come from our checking account or a credit card. Since I love to rack up credit card bonuses, I put the expenses on a few different cards. We’re not the most organized people when it comes to having receipts. Come tax time, it’s a nightmare to put together all the numbers.

It turns out that organizing your finances is NOT a good reason to put your investment properties in an LLC. It can work well for internet publishing like Lazy Man and Money, but real estate is unique. I’ll explain why in the next section.

One reason why people may put investment properties into an LLC is that it can afford some legal protection in the event of a lawsuit. What kind of lawsuit? I’m not sure, but I’ve read that it can be someone visiting the property falls over a deck railing and gets injured. (Presumably, if it is someone living at the property, they have their own insurance and you have landlord insurance.) Because this involves lawyers and specifics of the law, I’m going to defer to your legal counsel to help you with how this can work. The people I know simply get umbrella insurance. One more thing that I’m looking into is protection from liability claims.

While I like legal protection and insurance as much as the next person, I have a limited budget for it. Umbrella insurance is fairly cheap and that’s about where my budget is.

Another reason to put investment properties in an LLC is that you can give some of it away in pieces. Maybe somewhere down the line, we’ll give the properties to our kids. I think we could give away a little at a time, so they wouldn’t have to deal with a big estate tax bill. That’s something that we’d have to tackle with our financial advisor(s). Once against see the “*” citation below. For now, we’re not interested in this. Our 6-year-old lacks the maturity to manage real estate… and probably will for at least the foreseeable future.

Finally, if you are investing in some commercial properties it may be easier if you are a corporation. (We’re not interested in this.)

Why Not to Put Your Investment Properties in an LLC?

I never figured there would be a negative to putting real estate in an LLC. Lazy Man and Money essentially works the same if it is in an LLC or not. My earnings are the same. My hosting costs are the same. I have two additional costs. At tax time, I have to pay more to the tax preparer. I also have to pay the state filing fee. I have a lawyer who automates most of this (at additional cost) and it’s about $1000 a year more than when it was a sole proprietorship. That’s not insignificant, but I’ve learned to live with it.

Real estate investing is different than internet publishing. It often depends on lenders and banks. Banks and lenders complicate things. For example, we’re in the middle of buying a new property, the first since we put it in the LLC, and it is a mess. I couldn’t work with the typical bank lenders because I need to use the “corporate division.” That process is a lot more difficult. It’s harder to track down the lender. They want incorporation documents. It’s a lot more hoops to jump through (which is significant because getting a mortgage is already a hoop-jumping intensive process.)

The first surprise was when we got our lending term sheet. Mortgage rates for 15-year-fixed loans can be as low as 2% now. We know that as investors we going to have to pay an extra 0.75% more. That’s just how it works with investing. What we didn’t know is that the LLC triggering the corporate loan adds another 1%. The rate jumps up to 4%. It’s still decent, but the “LLC tax” that doesn’t give us any real benefit is starting to get costly. In addition to that higher rate, the loan is not fixed. It readjusts every 5 years. What does the lending market look like in 5 or 10 years? I don’t know, maybe the rate will be 6% or 8%. We are very fortunate that we aren’t borrowing much money and can hopefully pay it down quickly.

The LLC nightmare gets worse. We registered our LLC in Massachusetts even though we live in Rhode Island. That may sound odd, but all the properties are located there and my lawyer practices there. We’re trying to manage properties closer to Rhode Island, so we are selling them off there and buying here when it makes sense. Our Rhode Island bank at the last minute decided that we need to register with Rhode Island which is an additional annual filing fee. It also almost caused the deal to collapse.

Finally, it’s looking like we’ll have to pay our tax preparer to file in two states now doubling the tax preparation fees. The annual fees to states and tax preparation are going to be around $2000, I believe. We used to pay a nominal fee when it was included as part of our normal taxes.

Some people may say that $2000 isn’t a big deal, but I’m a person who celebrates finding chicken at $0.69 a pound. I save up for years to buy a $1300 television. It’s significant especially with the potential of more expensive loan terms.

Lesson learned: a real estate LLC can cost you.

* Whenever I try to get professional advice it doesn’t go well. I’ve spent the last month trying to get a CPA who can help with some advanced future tax-planning questions. Most seem to want to manage all your finances at a cost of hundreds of dollars a month. I had a few ask about my investable assets because taking over that aspect is part of the core of what they do. Maybe I just haven’t found the right people.

Further reading: Bigger Pockets – Why You Should Skip the LLC When You’re House Hacking