Should You Create an LLC for Your Rental Property? Special Guest CPA Richard Hart!

Please note that this post is an excerpt of the webinar hosted by our sister company, The Landlord Code, where our co-founders coach DIY landlords how to avoid problem tenants and maximize rental profitability. Get access to more training like this in our (free!) private Facebook group HERE.

We are bringing on the one and only, Richard Hart. Cause we’ve been pushing this guy for the past couple of weeks. He is here today to talk to you about LLCs tax stuff around your rental property and really get you set up. I have never been so excited about numbers and taxes as I am about today.

We are going to do such an interview here with Richard, and then we have a special announcement world premiere for you in the middle. And then we are taking live Q and a. At the end, you hear that drum roll. There is a normal drama happening. So for those of you joining us on zoom, if you have a comment or a question, go ahead and drop it in the chat. If you have any audio concerns, something we need to know, let us know. And if you’re live with us on Facebook, do the same thing. Our team is watching both the zoom and the Facebook. So just let us know if you have a question and we will take questions at the end. Awesome. Looking forward to it. All right. So let’s just jump right into it.

I’m so excited. Richard, our first question is to make sure that everyone is on the same page here. What is an LLC when it comes to a landlord and a rental property?

An LLC is simply a short, it’s an acronym for a limited liability company. So a lot of people think of a limited liability company as the same thing as a corporation or an Inc.It’s not totally different. Limited liability company is very simple to operate, administer, and set up. And in specifics, in our discussion, you would use it to actually own title to a property so that the limited liability company and not you yourself would actually own the property. Okay. So if you’re a landlord and like you’re writing a lease is then the lease is written in The LLC is the landlord on your rental contract? Correct. Okay. Can you see some people taking this choice for anonymity and amenity purposes? Oh yes. A lot of people, obviously we live in a very litigious society and the more you have, the more you have to lose. So people want to make it more difficult for attorneys to find out actually who owns what?

So yes, you would S you would see, and I’ll kind of discuss that. I think this is more questions that you’ll ask that will post more details into that, but yeah, you would, there’s two reasons to have an LLC. One is for anonymity, but there’s a couple of steps you have to do to actually get that. Number two is for asset protection. Okay. So could you go into a little bit more detail? What are the main reasons a landlord would go to the trouble to putting their property in an LLC? Okay. So first off, the main reason a lot of people think it’s tax related. It has nothing to do with taxes. Your tax rates do not change if you’re in an LLC, because the IRS views an LLC, as they don’t view it as, as an entity, they view it as you yourself. So if I’m Richard Hart and I have a tax master LLC, well, for the purposes of legal purposes, tax, master, LLC owns the property. But for IRS, they’re going to say, well, no tax master doesn’t exist. Richard Hart exists. We’re going to tax Richard Hart. So most people let’s get that out of the way right away. An LLC does not lower your taxes at all. It’s a vehicle that is strictly for asset protection and basically anonymity. So if I have an LLC, you can view it as an extra added layer of insurance. If you’re a property owner, you’re going to have renter’s insurance, but let’s say you have a, a renter he slips and falls and breaks his neck. How much is your insurance going to cover? Because you know that that the lawsuit is going to be in the multi-million dollar range. So your insurance will cover X amount of dollars. But now you’re exposed to now maybe another five, $10 million. What do you do there? Well, that’s where an LLC comes into play because the, the LLC, as a legal entity owns that property. So they get that purse. Your tenant can only Sue you up to the amount of assets that are in that LLC, and that’s usually your property. So they can’t get go after any of your other personal assets.

They can’t go up through your personal bank account. They can’t go through your personal homes and so forth. So that is one of the main reasons to own an LLC is for asset and liability protection. That’s why it’s limited liability company. Yep. Are there any pitfalls to opening, having an LLC as opposed to being just a sole proprietor for your rental business? Right. Like this sounds like a lot of great protection, but we know from the thousands of landlords, we’ve worked with very few people actually have their rentals in an LLC. So what are the reasons that a landlord would choose not to do it Basically they’ve, it’s risk tolerance, to be honest with you, that they’re not afraid of really being sued.

They really don’t have any desire for anonymity, and they just don’t want the extra costs because it does cost money to set up an LLC. And then it costs money yearly and, you know, continue to licensing and admin fees from LLC. And you also have to have separate bank accounts for an LLC. And that’s, that’s the critical thing with an LLC. You cannot have a personal bank account and feeding your rental income into your personal bank account that doesn’t work. It totally destroys the LLC. You can’t pay your, your LLC bills with your personal checking account. It destroys the LLC. So you have to have a separate, dedicated bank account for your LLC. All the income and expenses have to go out of that.

So a lot of people just don’t want to go through the rigmarole of all that added paperwork and, you know, extra details. But otherwise there’s really no pitfall to having an LLC. There’s more benefits to having one and not having one. So you mentioned something really interesting there. So like the management and about LLC. So you’re talking, if you’re breaking it down a limited liability corporation, you do need to manage this like a business. So there are, there are details around, like you said, financing and putting money in there and all of that. But what other sort of things do you have to do minutes? Do you have to submit different documentation to the secretary of state or to the IRS? How does that function? No.

And that’s the beauty with an LLC. It’s one of the simplest forms of entities to set up and operate. You would have, you would have an attorney set up an operating agreement for the LLC. You don’t have to take minutes every year. It’s not a corporation has very strict rules to follow with the minutes and so forth. With an LLC, you just set up your operator agreement. You find you can change it at will. It’s so super simple. And again, the licensing and the setup is with your secretary of state. So depending on what state you’re going to set it up in, you would set it up with the secretary of state and then pay the annual fees every year.

So you said something interesting back there, you were talking about keeping the bank accounts separate. So this is sort of known as piercing the veil, right? That if you co-mingle your LLCs finances with your personal finances. So we knew a story. I think our attorney told us this story about a locally who was sued by an employee and he had a, he had a corporation. So we had it protected. But during the course of the lawsuit, there was a lot of co-mingling between his personal funds and his corporation. So that employee was able to Sue him his business and go after his personal assets. And this guy lived in Ross. If anyone watching knows where Ross is, it’s a very high net worth area to the tune of millions of dollars. The first thing they’re going to hit. You know, they’re going to look at your records and see, okay, is this person just using this LLC as his personal piggy bank?Because then that’s it, that’s the, feet’s the whole purpose. So let me ask you a question about the money part.

So hypothetically speaking, you, you set up an LLC for now it’s LLCs that are 1, 2, 3 main street. As an example. Now, the money that flows in there would only be from the rental income from once you remained street, you couldn’t do, you couldn’t as an owner. If you use your own money, just to start it up, right, you’d have to take all the money directly from the, from the rental income to, to B to infuse it. Is that correct? Or no, You can infuse capital into an LLC. And usually that’s what you would want to do to start it up anyways, because a company obviously has to have money to, to begin. So you would fuse the capital. Usually if you’re going to buy property, you would infuse the, the entire amount of capital to buy the property. During the course of that operation of the LLC, let’s say you have a property. The LLC is owns and a $50,000 repair comes in. You don’t have that obviously in there. So an elder can contribute the capital into it. So that’s not an issue contributing capital into it is not an issue taking distribution distributions from it is not an issue it’s just using it to pay your own personal expenses.

Do not pay your personal expenses through an LLC. It’s its own company. It’s its own entity, the Bank, the banking part ofthe, the, the pain part ATM part as it were the issue. Okay. And that’s a good point because I have an ATM card with your LLC know, okay, I’m going to go to my supermarket and buy some groceries with it. You’ve just destroyed your whole LLC, right? There’s no reason for that. So be smart. You know, your LLC is its own entity. It should be only taking care of its own bills. Do not use it as your personal piggy bank. So It sounds like working with a good accountant or a good CPA to help make sure you’re doing this all correctly. I mean, this is basically in line of what we teach people all the time, which is you need to treat your rental like a business, right? If you treat it casually, that’s when we start to see the most problems. But when you’re really being thoughtful and strategic about how you approach, basically every decision with your rental, that’s when you can really start to see these benefits.

And in this case, this would massive protection. In the, of a worst case scenario, I have a client who I’ve had, I’ve known since 2006, he’s actually a CPA. And he works in a lot of properties and a lot of big wineries out here in Northern California. But every, yeah, I’ve worked on probably four of his units over the past 16 years. And he has an LLC set up for each one of his units. They’re all named the streaming LLC. Now what are the advantages of that for him? And why would he want to do that? I mean, I kind of get it, but why, you know, is it just that they don’t bleed into other accounts? Like someone, like you said, someone were to get hurt on one property. They couldn’t bring in all the other properties. No, that’s exactly it. It’s, it’s your risk tolerance. So you don’t necessarily need a separate LLC for every property. Let’s say you have five properties, you have one LLC, and they’re all in there. The problem is if you have a tenant and property, and they sue you and they see you for $50 million, well, where can they get that money from? If they win, if you have five properties in that, LLC, they can get it from all five properties. Cause that LLC has all those assets that it owns. So therefore, if you only have one property per LLC, if the tenant a in property sues you, they can all go after that one property, they can’t go after any of the other properties. So it’s risk tolerance. And a lot of people, again, it comes to costs, right? A lot of people have dumped just a whole bunch of properties in one LLC, because they don’t want all the, all the licensing fees.

Cause it does add up. Then you also have the tax preparation fees. You have to get attorney fees. So it does add up, but I always tell people, well, just think of it as added insurance. If you had an insurance policy, you’d be paying depending on the amount of insurance, it could be paying a high premium. Your LLC is basically an insurance policy and it’s worth the more you have. The more it makes sense to sub separate, separate, and aggregate everything into its own LLC. It’s it’s worth it. So Itseemed to me the lower cost, the lower value your rental properties might make more sense to put together. If you own say a hundred thousand dollar rentals or $200,000 rentals versus in a high cost area where we are, where you might own $2 million rentals, it might make more sense depending on the value and essentially how much, how much asset you have at state. That might be how you would decide to divide up your LLC. If you’re looking into multiples, Right? And again, it’s, there’s no one size fits all. It’s your personal tolerance for risk. Some people have a high tolerance for risk others, very low, right? So if you, if You’re looking at it like sort of business perspective, just to take your, your, your scenario is someone who has trying to buy multiple properties and limit their risks. They would probably want to spend extra money to get multiple LLCs, no matter how much the rental property was purchased for. So that actually brings up another question. Generally speaking, I know it varies state to state and county to county, but how much does it cost to set up an LLC? Ballpark range Depends. Honestly, you have two fees, you have the attorney fee, who’s going to set it up for you. And then you have the actual fees from the state. Your attorney is going to bundle those together.

So you’re really not going to know what’s what, but on average, you know, your actual licensing fees from the states can run anywhere from three 50 to $800. And then the attorney fees on top of that. But certain states also charge a tax on an LLC just to actually have it. For example, California, you’re going to pay a flat tax of $800 minimum per LLC per year as the file. It’s separate tax return for LLC. So you have your personal income tax returns and you have your separate LLC tax return. And like I said, it’s a minimum of $800 per year, depending on how much income the LLC owns gets per year, it could be higher, but a minimum tax, 800 bucks a year. Interesting. So that, so on the topic of taxes, you mentioned, there’s not really a tax advantage, but I thought there was some kind of pass through or some different advantage of, of holding property in an LLC. No, and I’m glad you brought that up because pass through that, that’s all that simply means.

So in other words, there’s two ways you’re going to have an LLC, either as a single member, LLC, the IRS calls that disregarded or as some multi-member LLC, maybe your you and your spouse or you and your children. So let’s take the first one, a single member. That means it’s just you. So you’re not filing a separate tax return. Everything that that LLC earns is going on, your schedule E and your personal tax return. So with the exception of California, that has to file its own LLC tax return, no matter what, if you’re in any other state, you’re just going to be usually filing just the one, your personal tax term. If you are a multi-member LLC, then you have to file.

What’s called the partnership tax return. And that’s a separate tax return. It’s basically what’s called an information turn. It just tells Cyrus how much the LLC earned and self who owns it and so on and so forth, but it doesn’t pay taxes. It, whoever it breaks down the membership and who gets, how much of the income or expense, and then on your personal tax returns, that’s where you pay the taxes. So that’s what I mean when it’s, when I say it has no tax advantages, because at the end of the day, you’re still paying taxes at your own pace. Profit is profit, regardless exactly where it came from, right? So, and it’s based on net income or net loss. So even if I have an LLC,

I make a hundred thousand dollars in it and I decided I’m not gonna take out the money. I’ve made a hundred thousand dollars of net income that year. I still have to pay taxes of a hundred that on that a hundred thousand dollars, it’s not like a corporation where if I don’t take out the money, I don’t pay taxes on it. So that’s why I always tell people, don’t get confused with a limited liability company in a corporation. They’re two totally different animals. Got it. And then just going into that real quick, my next question, it’s always, the question I ask is can you deduct the cost of setting up the LLC and the cost of filing? Sure. It’s a business expense, right? I love that answer.

Oh, that’s a good question too. On the federal return, you can, but on the state returns, you can’t because you can’t like, like if you’re filing your personal income tax return, right? The feds allow you to deduct state income taxes paid, but the state is not going to say, okay, you can deduct income taxes. You paid, you paid through us. It’s like, it’s a double dip. So no, it was A small one. It’s a small one in California, 1002. All right, Switching gears a little bit. When it comes to buying an investment property, can you purchase the investment property and the name of this LLC? Or do you buy the property in your own name and then set up the LLC? Like what’s the sequence of events Depends on how much cash you have. And the reason I say that is if you’re intending on taking the loan banks general avenue yet to see a bank that will loan money to an LLC outright, they generally will not. You have to take out the loan out of your own personal name. So if you have, let’s start with this, let’s say you have cash. You buy the property, totally 100% cash and you buy it in your own name. At that point, you canjust switch it, the title into the LLC with no problem, right? Because it’s, it’s 100% owned by you. Or you can open up the LLC first capital, capitalize it and then have the LLC buy the property.

And it’ll be titled to that. So that’ll just be one step and you’re saving probably title transfer costs. However, if you buy the property using a loan on your personal name and you decide, Hey, I want an LLC. The banks usually have in their verbiage do on demand clause. So if you do that right away, the entire loan becomes payable. So kind of keep that in mind, banks, generally speaking, do not loan to LLC. And you cannot generally speaking transfer a title that has a loan on it into an LLC. Okay? Just, just at that point, you guys, when you viewed, if you do that, you may get away with it for like four months. But as soon as the Bain catches that you’ll get a really neat letter from them that says, Hey, we need all your, all our money. So just cause they’re always switching, banks are always telling them stuff like theload’s off, lease the smaller ones. So where are you trying to get tricky? It’ll probably catch up to you whenever You, have you ever actually seen, have you ever had a client have their loan be called due from doing this or,

Oh yeah. Yeah. I’ve got a client here in Nevada. Fortunately he has the cash to pay off his loans, but that’s what happens, you know, when he went to the switch and they got called on, it would Seem to me that’s a pretty big hurdle because a lot of people have loans on properties, right? Yeah. That’s a pretty big hurdle to putting a property into an LLC. If you can’t do it, when you have a loan on the property, Right. There’s again, very few banks will do it because, and then I’ll see, usually you’re just setting it up. It has no history. So the banks obviously are going to look to the person as the, as the one who’s going to collateralize it right now. We’ll see it’s for asset protection.

So they’re not going to make a loan to an LLC and the LLC falls and now they’re stuck high and dry. Right? So what about, isn’t there a work around like you can get commercial loans, something like that. You’re usually going to pay a higher rate. You have to have a lot more down. Like there is a way to do it, but you’re probably not getting nearly as attractive terms as you got as individual Purchases again, banks, and it depends on your personal relationship with your bank. The more money, honestly, the more money you have in the bank and the better relationship you have with your bank, the more they’re going to be willing to work with you. If you’re starting up with a new bank and you know, you really don’t have any track record, it’s gonna be harder to kind of wheel and deal. But there are, again, there are banks that have, like, we’re talking about risks. They’re a bit more banks that have risk tolerance. So you want to shop around. But for the most part, it’s, it’s quite difficult to get a bank to loan to an LLC directly.

So let’s say, am, I’m going to go out there. I’m new to this rental landlord game. I want to, I want to go out there. I want to do it. Ryan wants that, or right. I want to get my first rental property in an LLC. What would be my first step? And just going down that path, what I call, what kind of paperwork would I want to file? Like, what’s the best way to post this. Finally Find an attorney. You want to work with an attorney. Who’s going to work with your tax accountant because the two have to go hand in hand, come up with three names in order of preference, because the first name you might want might’ve already been taken, right? So going with the names of the LLCs that you want, again, find a good attorney that knows what they’re doing. Once you have, You need an attorney that specializes in LLCs, I would do that. They’re going, and a good attorney is going to actually do all the work for you. They’re going to, they’re going to be the ones that set up the, with the secretary of state and make it legal. They’re gonna, your tax accountant will help you get the EIN for your LLC. At that point, then you can go set up your bank account. So those would be the steps. The attorney will set it up. Your tax account will get you the tax ID numbers. Then you can open up a account depending on what state you’re in is how fast everything can work. Certain states, for example, the state of Nevada, you can open up an LLC in literally an hour. Other other states, We alsoget married in Nevada. I heard, I mean, I heard and divorced. You can get married and divorced in Nevada and under an hour. So all of that comes into play just a quick side point. Some people talking about California, because if you live in a high tax state again, where I’m saying that TAC an LLC is really not a tax play. Some people think that I can open up an LLC in Nevada with no state income tax. And I don’t have to pay tax to California. Well states all states, not only just California, but all states will tax income at the source. So even if the LLC is set up in Nevada, because the property is in California, I still have to pay tax to the state of California for the, for that property. So just kind of remember that because I’m opened up an LLC in a different state, doesn’t mean I’m avoiding the state tax. It doesn’t, it doesn’t work. That’s your personal income level.

Wouldn’t you still be taxed in your state or you’re saying your personal income is taxed at whatever rate of the state that the properties It’s taxed at your purse, it’s gonna be taxed at your personal rate, but on your personal return. I mean, you have, let’s say I live in Ohio. I have bought property in California. Well, I don’t live in California. So I’m assuming, and I have an LLC and that’s what I was my property in California. So I’m assuming, okay. I don’t have to pay taxes in California cause I haven’t. Oh, hi and Ohio, LLC, that owns it now because again, the LLC is just an illegal entity. It’s not a taxable entity on your personal level, you’re paying tax. So now I have to file my Ohio state tax and claim the income that I’m paying there. I have to now file a California state income tax. So let the, you know, pay my income taxes on the property earnings over there. Good thing is the state taxes that I pay to California. I’m going to get a credit on my Ohio return. So it’s not like you’re getting double taxed, but people think that they can kind of get around paying state taxes, you know, forming health, seasoned different states. It doesn’t work that way. I was going to tell me. So just in terms of hiring the right people for the people, for our audience today, Darcy and I had to set up an LLC recently, not, not with respect to a poverty, but we did contact a group, an attorney, an attorney group that specialized in setting up LLCs. And then he’d tell you how painless it was. It was just a series of qualifying questions. They took that. They ran with it. Two days later, they filed it. Five days later, we had our LLC with our EIN number and is just, it just worked out that way. And I, and I just highly recommend spending it was, it wasn’t cheap, but I would recommend if you’re going to go down this path that you do hire someone who’s specialized in it. Because number one, they won’t make the mistakes. And number two, they’ll make it super easy for you. And I will say one of our, on a top show we did with Richard, one of the top mistakes, Richard says that he sees is landlords living in different states, not paying the right taxes and working with a CPA who doesn’t understand what really needs to be done. And this really is a big deal for our California properties that we manage that our company manages is that they’re paying the wrong taxes and then California really wants to share. And they’re not going to let that go. And other states, there are other high, plenty of other high income tax states, but that’s one of the biggest mistakes that you see landlords who have properties and live in different states, let alone live outside. The country also is another big one, right? You get the FTB involved in the franchise, the franchise tax board, the IRS, and it becomes a big, hot mess. Okay. Exactly. We’re required just in California as a property management company, we’re required to report to the IRS and to the FTB because if we don’t, then we get charged that money.<inaudible> California is about Gator, their money. It’s surprising that we’re so in debt with all these Hawks out there, it’s not to get out and get paid. Right. So that’s actually a good point. So the way we met Richard, so I don’t know, Just, just for the audience out there, sorry, Richard, you weren’t our first choice. Unfortunately. I wish you were. We wish hecould have fallen in love right out the gate, but we did get the data few dogs before you find your friends. Right. And then frogs. All right, well, Hey. Okay. My, my, my, my fairytale game is a little bit off this morning, but we did work with somebody who was a professional, right? A friend, a friend, a friend. I mean, raise your hands out there. If you’ve ever raised looking and worked with a friend and you were felt pretty good about it, probably cause you’re like, yeah, I’m giving you business. You helping me out and help you. I’m scratch. You’re not charging me, not charge me as much. Right. And then we Started to pay the price. When we found out that she was double claiming like a hundred percent of our residents, we weren’t married yet on each of our taxes enough so that it was a major red flag for the IRS.

We got flag. We got and yeah, well, We got, we got audited three years later after that. So it happened and we thought we got away with three years later, we didn’t know, three years later, Darcy’s eight months pregnant. We’re walking up the steps to this attorney to help us get out of this nightmare of an audit and right. It’s raining. It’s like six o’clock in the evening in San Francisco is ridiculous. And he’s like, yeah, it’s going to cost you a $40,000. Can I see your credit card Audited by the IRS? So here’s the fun thing. If you’ve been following us for a while, you also know we’ve been audited by the Dre, the department of real estate. It just happens. You deal with high dollar amounts. It’s going to happen. It’s a part of life. These two things for us happened to happen very quickly. I were both related to this friend of a CPA who we’d hired, but here’s my point. We didn’t know what we didn’t know. We thought we were doing the right thing by hiring a friend who we trusted to do our books. And we just didn’t have enough knowledge at the time. And we weren’t, we didn’t know who to ask for questions for who to be asking the question. Cause we were asking the questions of her. So it was one big, hot mess that ended up costing us $40,000 personally, a hundred thousand dollars professionally. Like we paid the price all because we didn’t know what we didn’t know. In addition to that, we just to just to put it in perspective, we met another frog who was really expensive. We thought, Hey, your cost, a lot of money. You’re going to help us out. And every phone call, every email was like $250. In addition to the tax bodies, it was ridiculous. And it, and they didn’t know specifically about property management or specifically about Ygrene properties. They’re just charging us the charges. Right? And then what happened? We saw Darcy saw an ad In a specific property management company, owner trade magazine. Richard was a speaker at one of the national events, spoiler Alert. There was this picture on there. And I was like, is this good looking chap, give him a call. And so it was like a light bulb went up, went off for us. Like we legit did not know you could work with the CPA who like had a very specialized knowledge in property management. And then we started talking to Richard and he’s amazing. And he’s not only helped us personally, professionally he’s been able to help our clients. But the point we bring this up is not only of course, to talk about how amazing Richard is, but it’s to really say that, like, we didn’t Know what we didn’t know. And we didn’t know how to ask the questions. And we had no idea. It was not even on our radar, that there was a solution that would help us be more profitable and like not have tens of thousands of dollars, the IRS and these other, You can imagine we crawl to Richard sort of like a beaten dog or at least I did. I had a lot of questions cause now I’ve been hurt a little bit. And I was like, Hey. And he’s like, no, this is what you can do. And this is this other solution that I have for you. And by the way, here’s some other information that you might not have asked me before. And then all of a sudden the lights went off and we were like, we have a path. Right? So having the team, having the right team was our big lesson that we learned out of that.