To LLC Or Not To LLC?

Attorney Brad Jacobson Answers That Question

Do I Need An LLC?

A List Of Pros and Cons As Reviewed On the Replace
Your Income Podcast


Pros of LLC

Potential Liability Protection:

The "LL" in LLC stands for limited liability, meaning that an investor's liability is generally limited to the amount invested in the property. This protects personal savings and assets from risks associated with property ownership.

Business Deductions:

Real estate investors can enjoy deductions on normal business expenses before allocating income to members. This helps in reducing taxable income and increasing the overall profitability of the real estate ventures.

Perpetual Existence:

The life of an LLC is not tied to the life of its members. This is advantageous for real estate investors who plan for the long term. The LLC can persist even if a member decides to exit or if the property is transferred.

Ownership Flexibility:

Real estate LLCs allow for flexibility in ownership. Investors can bring in partners, such as other investors or family members, without the restrictions imposed by other business structures.

Cons of LLC

Straw Buyer Scenario:

Changing the ownership of a property via deeding into an LLC is considered loan fraud—can be considered a “straw buyer” scenario. This was a major component to the Great Recession. Investors would get their friends to purchase a property in their own name and then they would get paid a few thousand dollars to deed the property into the name of an investor owned LLC. When the crash happened and banks went back to the original buyer they found that a new entity was now on title and their recourse became fuzzy. In the end, the original buyer was left with a property they didn’t want and payments they couldn’t afford and the threat of loan fraud to boot.

Due On Sale Clause Trigger:

Mortgage company could enforce “due on sale” clause—not very likely. I have never seen it happen. But it exists in part based on the previous bullet point. If they see that property ownership has changed they can call the loan due to protect their investment. But as long as payments are being made it’s not likely. I have a saying “everything is good until it isn’t.”.

1031 Exchange Problems:

An LLC cannot take advantage of the tax code allowing an owner to defer taxes via a 1031 exchange upon sale of the property.

Ease of Lending:

If you set up an LLC first and try to purchase property in the name of the business, it can be very very difficult and you will not get the same benefits of acquiring a loan in an individual’s name. Typically, a commercial loan must be paid over 15 years instead of 30 years and interest rates are typically 1%-4% higher and often with higher closing costs. One of the benefits of purchasing single family residence properties is you get these benefits. Commercial real estate requires commercial loans. Commercial real estate typically is any property with more than 4 units.

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