Should You Use an LLC for Your Real Estate Investing? Probably--and Here's Why

Should you use an LLC for your real estate investing?

Accountants and attorneys love limited liability companies. But do limited liability companies—LLCs for short—really make sense for real estate investors. Probably they do for two almost unknown reasons.

The Big Legal Benefit of an LLC: Limited Liability…

The big legal benefit of an LLC is that limited liability companies provide all the same liability protection as a corporation—but with much less red tape. A regular corporation, for example, requires regular stockholders meetings, a board of directors, regular board meetings, and of course records of all these activities and bodies. But a limited liability company doesn’t.

This legal liability protection provided by an LLC can be extremely valuable. One local attorney I often collaborate with, for example, tells his clients that an LLC protects real estate investors from the worst case scenario—which in his mind is a “slip and fall” accident on the investor’s property.

With an LLC as the property owner, so says my attorney friend, the “worst case scenario” is liquidation of the LLC. That liquidation means the people who own the LLC wind up with nothing—which isn’t good. But all the owners lose is what they’ve invested in the LLC.

In comparison, without an LLC, the real estate investor’s “worst case scenario” if there’s a “slip and fall” accident is that the owner or investor can lose almost everything they own. In other words, the business owners or investors could lose not only their investment in the real estate property but many other assets.

Let me issue a caveat here, however. You may not get as much legal liability protection from an LLC as you want or hope. Say, for example, that you’re repairing the roof on your apartment house and that, unfortunately, you happen to drop a hammer onto the tenant’s head during the roofing project. Your LLC probably won’t protect you from that sort of tort liability. In other words, the tenant can probably look not only to your LLC for payment of damages related to the dropped hammer but also to you personally.

And here’s another example, which unfortunately makes things even murkier. What happens if someone working for you, one of your employees or subcontractors, drops a hammer on the tenant’s head? The LLC may offer you some protection in this case. But you may still be personally responsible. The tenant might reasonably argue that you should have done a better job managing the employee or subcontractor, for example.

If you’re extremely concerned about the asset protection features of setting up and operating an LLC, get an attorney involved in your real estate investment planning. An attorney knowledgeable in LLC and real estate law can help you increase the liability protection that you gain from using an LLC for your investing. And this consultation doesn’t need to be particularly expensive. You may be able to buy an hour or two of time from a good local attorney and get all your LLC- and liability-related questions answers.

The Big Tax Benefit: Enormous Tax Flexibility…

A second benefit of LLCs relates to the income taxes that investors pay on profits and capital gains. A limited liability company can be almost whatever tax entity it wants to be for income tax purposes. A limited liability company that is owned by one person can be a sole proprietorship, a C corporation, or an S corporation. A limited liability company that is owned by two or more persons can be a partnership, a C corporation, or even an S corporation (if the LLC meets the S corporation eligibility requirements). This second benefit of the limited liability company means that an LLC can choose to be taxed in whatever way is most favorable to the investment or the owners.

For example, a very small real estate business with a single member (LLC owners are called “members”), might decide to be treated as a sole proprietorship for federal income tax purposes. This decision to be treated as sole proprietorship would keep the business’s accounting very simple—and it would also mean that unique tax planning opportunities available to sole proprietorships can be used.

A larger real estate investment fund—perhaps one with several partners—might decide to operate as a C corporation or as an S corporation in order to take advantage of some of the unique tax planning advantages of these entity choices. A C corporation, for example, often lets businesses provide rich tax-free fringe benefits to employees including shareholder-employees. And an S corporation often lets a business dramatically reduce the self-employment, social security and Medicare taxes paid on the owner’s profits.

Note: While a limited liability company is not difficult to set up by yourself—you can have the paperwork done less than a quarter hour from now—you should be aware that paying a few hundred dollars to an accountant to pick the right taxation for your new LLC might be the best investment you ever make. It’s common that the right taxation choice for a new LLC can save the owner or owners of a small business $10,000 to $20,000 annually.

The Drawbacks of the Limited Liability Company Choice

When you consider the two big benefits of a limited liability company—limited liability but with less red tape and tremendous tax flexibility—you have almost the perfect investment entity choice. So an obvious question is “Why wouldn’t every investor use an LLC or limited liability company?”

Perhaps predictably, there are some costs and headaches associated with operating as an LLC.

An LLC may increase your banking, accounting and insurance costs. For example, while the bank account for a sole proprietorship or informal partnership may be free if you keep a large-enough balance, the bank account for a limited liability company probably won’t be free. The bank may charge $10, $20, even more each month.

While a sole proprietorship or informal real estate partnership may be able to keep its bookkeeping and income tax return preparation very simple, an LLC probably needs to file its own tax return if the LLC operates as a partnership, a C corporation or an S corporation. And this LLC tax return may cost anywhere from a few hundred dollars to a few thousand dollars annually.

Finally, it’s worthwhile to note that an LLC may involve several hundred or even a few thousand dollars of startup expense. For example, you may spend money on publications like this. You may buy the services of accountants and attorneys. You will need to print new letterhead, business cards, and envelopes (if you use these) that use the new LLC’s name in order to show the world that you’re now operating as a limited liability company.

So where does all this leave you? How should you balance the big benefits of forming an LLC with all the costs and drawbacks? Unfortunately, I can’t give you a one-size-fits-all answer. You’ll need to carefully consider the benefits and costs as they add up in your specific situation.

I will share these thoughts, however. In my opinion, an LLC is uneconomical for very small real estate investments—unless there is only a single owner. For example, a real estate investor who owns one single-family home may not want to shoulder the hundreds of dollars of cost (or more?) incurred in setting up and operating an LLC. (Remember that this investor can use liability insurance to reduce his or her risk, too.)

On the other hand, any time you’ve got a large real estate investment—say multifamily housing—or any time you’ve got substantial wealth, an LLC economically reduces investment risk and as an added bonus can even save the owners thousands of dollars a year in income or payroll taxes.

About The Author

Stephen L. Nelson, CPA

Bellevue WA accountant Stephen L. Nelson is the author of both Quicken for Dummies and QuickBooks for Dummies and an adjunct tax professor for Golden Gate University’s graduate tax school.

steve@stephenlnelson.com

Descriptive Terms in Real Estate Ads – More Definitions

If you are buying or selling a home, the chances are good you struggle with the meaning of descriptive real estate terms. Here are explanations and definitions for more terms.

“Shed Dormers”

These are often seen in Dutch colonial style houses and are flat roofed dormers. Sometimes these dormers are single windows, but often they are two or three windows side by side with one flat roof.

“Blind Dormer Window”

Sometimes builders construct fake dormer windows to add architectural interest to new houses. They are at attic level but can’t be seen from the attic because the roof of the house covers access to them.

“Oversize Garage”

Ads often say how many cars a garage will hold. Then they add the word “oversize” as in “oversize 2-car garage.” What is usually meant is that there is room for storage, or a work bench in addition to space for the cars. Occasionally it simply means you can open a car door wide enough to actually get out with both cars in the garage!

“Gourmet Kitchen”

This phrase is intended to convey the idea that a very good cook can happily work here. That may or may not be the case, but it does usually mean that the kitchen is fairly large and attractive.

“Great Room”

I’ve seen this used in two distinctly different ways. The first is to describe a living room, dining room, and kitchen in a very open floor plan. The area typically has a high ceiling. The second way I’ve seen it used is when what we’d normally call a family room has a high, often coffered, ceiling, a fireplace with a dramatically massive mantle, and perhaps an upstairs balcony overlooking it. I think this may stem from the idea of a “great hall” in old English houses.

If you can get the verbiage down, you’ll be way ahead in the real estate game. Look for future articles on this subject or visit our site to read more terms.

About The Author

Raynor James is with the FSBO site - http://www.fsboamerica.org - homes for sale by owner. Visit our home buying page at http://www.fsboamerica.org/buyer.cfm to see homes for sale by owner.

A Secret to Real Estate Profits – Follow The Builder

As the real estate market cools, the profit potential of home ownership has cooled as well. Here’s a strategy called “follow the builder.”

It is relatively easy to make a profit when you sell your home if the market is rising sharply like it has been in most of the country for the last three years. It becomes more difficult when a hot market slows down. It’s very difficult to make a profit on the sale of your home when prices are falling.

Is there a way to be relatively sure you’ll make a profit when you sell your home? There is under all but the most negative market conditions. In fact, I’ve seen young, energetic couples use this maneuver multiple times when they don’t even need to move.

Follow That Builder

In many areas of the country, there are builders who build hundreds of houses each year within a fifty mile radius of each other. They build entire communities or are one of three to five builders who build entire communities around big employment centers. This present you with an important opportunity.

New Community

Builders will typically sell first phases of communities for significantly less than later phases. On one hand, they need to get the cash flow moving. On the other, it is harder to sell at high prices because the community typically consists of dirt lots and construction equipment. Put the hands together and you have a great profit opportunity.

The idea is to get in on the first phase of the build out. You will purchase the home at a discount, which gives you built in equity. As the community is built up, you sell the home for a profit at a higher price. While you’re doing this, you keep tabs on the builders projects and find another location where you can do the same thing.

You’ll end up living in each house for a year or more and picking up nice profits along the way. The only real downside is you have to move repeatedly.

Tax Consequences

I’ve seen this work well for a number of people who have done it more than once. However, you need to be aware that generating profit this way can have tax consequences. You need to discuss your plans (including projected timing and profit potential) with your tax professional so that you are prepared to deal with any tax consequences.

About The Author

Raynor James is with the FSBO site -http://www.fsboamerica.org - FSBO homes for sale by owner. Visit our home buying page - http://www.fsboamerica.org/buyer.cfm - to view and buy homes, houses, condos, land and real estate.

Rental Property Investment - Finding The Properties

Rental property investment starts with finding the best deals. To do this, you can increase your odds by finding more deals. Who's more likely to get a cheap apartment building, an investor that looks through the MLS listings and calls it a day, or the one that uses ten resources? Here are those ten:

1. Look in old papers to find "For Rent" ads. Call if they are a few weeks old. The landlord may be ready to sell, especially if he hasn't yet rented the units out.

2. Look up old FSBO ads. Call on two-month-old "For sale By Owner" ads, and if they haven't sold, they may be ready to deal. Owners often give up the effort, but still would love to sell. Help them out!

3. Drive around looking for "For Sale By Owner" signs. Owners often don't want to pay to keep the ad in the paper every week, so you won't see all properties there.

4. Find abandoned properties. That's a pretty clear sign that the owner doesn't want to deal with the property. He might sell cheap.

5. Talk. Let people know you are looking and sometimes the properties will come to you. There are a lot of owners out there who want to sell, but haven't yet listed their property.

6. Talk to bankers. You might get a foreclosed rental property cheaper if you buy it before they list it with a real estate agent.

7. Offer someone a finder's fee. There are people that always seem to hear about the good deals. Have such people coming to you.

8. Eviction notices. If your local papers publish eviction notices, or if you can get the information at the courthouse, it can be useful. A landlord who just went through the procees of evicting tenants is a likely seller.

9. Use the internet. Go to a search engine and enter the type of real estate you are looking for, along with the city you want to invest in. You never know what you might find.

10. Put an ad in the paper. "Looking for rental properties to buy," might be sufficient to generate a few calls.

There is a lot more to learn to do it right, but finding good properties is a good place to start for rental property investment.

About The Author

Steve Gillman has invested in real estate for years. To get a free real estate investing course, and see a photo of a beautiful house he and his wife bought for $17,500, visit http://www.HousesUnderFiftyThousand.com.

Real Estate Team - Building One

I didn't understand the concept of a real estate team at first, so I had a hard time with real estate investment. I tended to be a "lone wolf," trying to do too much myself. I have since learned that in real estate, you need a team of people you can trust and rely on. Here are some possible team members, and what they need to be on the team.

1. A mortgage broker or banker. A broker can offer many options, but a banker can make the loan decision. They each have their advantages, and you could use both on your team. In either case it's important they understand what you want (fast closings, lower interest, corporate loans?)

2. An accountant or bookkeeper. To keep proper books for real estate investments is getting more complicated with all the tax-law changes. Find someone that understands the law, and understands what you want.

3. A real estate attorney. Find someone familiar with the laws and legal customs of your area, and that has experience with the type of deals you intend to do (If you are buying rentals, she should be familiar with doing evictions, for example.)

4. A good real estate agent. An agent with experience in the area you invest in and access to the MLS (Multiple Listing Service), can be a great help. If she is a seller's agent, she can still ethically bring the best deals to you once she knows you're a serious buyer.

5. An appraiser. A good appraiser can give you an accurate valuation of a property, but they can also suggest ways in which you can most efficiently raise the value of a property. Find someone that will talk to you.

6. An inspector. Some states make it too easy to become an inspector with little experience. You may want to find one that is or used to be a contractor, so he can find the problems AND give you some idea of the cost of repairs.

7. An insurance agent. Good ones will understand what you want, and find ways to save you money. Insure all your properties with one agent, and you're likely to have discounts available, aas well as better service.

8. An escrow officer. They'll usually be with a closing company. Find someone that's efficient, and can explain things clearly to both sides. If he is confused by a slightly creative contract, he should educate easily or be replaced.

9. A cleaning person or crew. When you have a trusted person or crew ready, it means a fast turn-around when you buy a rental or rehab project.

10. Rental property manager. Be certain that the company you hire has exerience, is responsive, and will have time when you call. Good property managers can tell you what you should get for rent in a given area BEFORE you buy.

Start building that team. Investing in real estate is a whole lot less stressful and more profitable with a good real estate team.

About The Author

Steve Gillman has invested in real estate for years. To learn more, get a free real estate investing course, and see a photo of a beautiful house he and his wife bought for $17,500, visit http://www.HousesUnderFiftyThousand.com.

Categories of Real Estate Investment

Below are ten categories of real estate, and different ways to invest in them. The best one for you is something only you can decide, according to your particular needs. To help you do that, I list a couple good points and bad points for each type.

1. Renting single family homes. Good points: An easier way to get started, and good long term return on investment. Bad points: Being a landlord isn't much fun, and you typically wait a long time for the big pay-off. You also lose all your income when a house is vacant.

2. Fixer-uppers. Good points: Fast return on your investment, and it can be more creative work. Bad points: More risk (many unpredictables), and you get taxed heavily on the gain.

3. Low income housing. Good points: Similar to any other rentals, but with higher cash flow. Bad points: Similar to any other rentals, but with more repairs and tenant problems.

4. Selling rent-to-own houses. Good points: If you buy, then sell on a rent-to-own arrangement, you get higher rent, and the buyer is usually responsible for maintenance. Bad points: Bookkeeping can be tricky, and most tenants don't complete the purchase (this can be an advantage too, but it does mean more work for you).

5. Commercial properties. Good points: Multi-year triple-net leases mean little management and high returns. Bad points: A tough market to break into, and you can lose income on vacant storefronts for a year at a time.

6. Land, split and resold. Good points: Simpler than some real estate investments, with the possibility of great profits. Bad points: It can be a slow process, and you have expenses, but no cash flow while you wait.

7. Boarding houses. Good points: You'll generate more cash flow renting a house by the room, especially in a college town. Bad points: You'll generate more headaches renting a house by the room, especially in a college town.

8. Invest cash, sell with terms. Good points: A high rate of return is possible by paying cash to get a good price, and selling on easy terms to get a high price AND high interest. Bad points: You need a lot of cash, and you tie up your capital for a long time.

9. Invest, live in it, sell it. Good points: The tax law lets you fix it up, and sell it for a big tax-free profit after two years (if you live in it), then start the process again. Bad points: You may become attached to your investment, and you'll have to move a lot.

10. Pure speculation. Good points: You can make large profits buying in the path of growth and holding until values rise, and it is a low-management investment. Bad points: Growth in value isn't always predictable, you have expenses with no income while you're waiting, and transaction costs can eat much of the profits.

There are many ways to invest in real estate. These ten are just to get you thinking about what is possible, and what type of investing suits your personality. Once you figure that out, you may want to look into other categories of real estate investment.

About The Author

Steve Gillman has invested in real estate for years. To learn more, get a free real estate investing course, and see a photo of a beautiful house he and his wife bought for $17,500, visit http://www.HousesUnderFiftyThousand.com.

Refinancing Real Estate Investments

Why should you consider refinancing real estate investments instead of selling them? Maybe you've owned a rental property for years, you've paid down the mortgage, the value is up, and you want to cash in on that equity. You will do better to refinance. Here's why.

There are two problems with selling. First, selling means paying a large capital gains tax. You can avoid this if you reinvest through a 1031 exchange, but then the point is that you want your money, right? Second, you'll be giving up your inflation-indexed retirement plan. A good rental property generates more income as rents go up.

Refinancing Real Estate Investments Is Better

If you refinance, you can get much of your gain out of the property, without paying a penny in taxes. You see, borrowing money is not a taxable event. Take your loan proceeds and spend them however you want, and still keep your rentals. Doesn't that sound better than losing a big chunk of your equity to taxes?

Now, let's look at an example. We'll suppose you have owned a small apartment building for several years. Let's say you bought it for $340,000, with a down payment of $80,000. Interest rates at the time were at 9.5%, giving you a payment of $2,106 monthly on the balance of $260,00 (30 year amortization).

The property is now worth $560,000, and you owe $220,000. Your cash flow is around $2000/month. Now, how do you get at some of that equity? If you sell, you will give up the income, AND pay a big part of the profit in taxes. What happens if you refinance?

If a bank will loan you 70% of the value, that would be $392,000. Pay off the first mortgage, and you are left with $172,000. You can spend it any way you want, and no taxes are due.

It gets even better, especially when interest rates are low. If the new interest rate is 6.5%, your new payment will be $2295. In other words, you get $172,000 to spend any way you want, and you still have over $1,800 cash flow each month, from an inflation-indexed retirement plan.

Here is an even better scenario: Spend $50,000 of the loan for high-return upgrades to the property, such as carports and a laundry room, and raise the rents. You could have $122,000 left over to spend any way you want, AND have higher cash flow than before! Isn't that sound better than selling your retirement plan? When you want that cash, consider refinancing real estate investments.

About The Author

Steve Gillman has invested in real estate for years. To learn more, get a free real estate investing course, and see a photo of a beautiful house he and his wife bought for $17,500, visit http://www.HousesUnderFiftyThousand.com.

FSBO Real Estate

Buying FSBO real estate, or houses for sale by owner, has its own particular problems and opportunities. Dealing with an uninformed seller who thought he knew enough to handle everything by himself can be frustrating, but it can also be very profitable if you are prepared. First you need to understand the FSBO seller.

People try to sell a house on their own for one primary reason: To save the sales commission. Unfortunately for them, they usually underestimate the cost and complexity of going it alone. They'll often get frustrated and tired of the process, and be ready to drop the price and be done with it. If you help them solve their problems, your reward can be a good price on a good investment. Just keep the following in mind:

1. A seller isn't an agent. You have to be more careful in what you say and ask. Avoid negative comments about the house. Like it or not, the truth is that it's difficult to get a good deal if the seller doesn't like you.

2. Sellers think they're being smart. If you encourage that belief, they'll be more open to your offer. If they have a good idea, tell them so. It's not unethical to make people feel good about themselves when negotiating.

3. FSBO real estate has often been on the market a long time. Seller's are usually tired of the process, and want it to be done. This means you'll get a better price if you are willing to close quickly and easily.

4. Seller's usually don't have a plan. They don't know where to close, where to buy a title policy, where to keep a good faith deposit, etc. Have simple solutions ready for all these problems. If you walk the seller through the process while letting him feel in control, you'll both be happier.

5. Skip over problems and return later. After a seller has invested more time with you in a negotiation, he'll be more inclined to give you what you want.

6. Sellers have often spent more than anticipated. Classified advertising and other costs have already eaten into their imagined extra FSBO profit. You may want to be generous in negotiating the many closing costs - as long as you get your price and/or terms.

Real estate professionals will tell you that most houses "for sale by owner" net the seller less than those sold by an agent. By the time a seller realizes this, it's often too late to recover his money and time spent. At this point, he usually just wants to get the thing sold as easily and quickly as possible. If you help sellers with that, you can get a good deal on FSBO real estate.

About The Author

Steve Gillman has invested in real estate for years. To learn more, get a free real estate investing course, and see a photo of a beautiful house he and his wife bought for $17,500, visit http://www.HousesUnderFiftyThousand.com.

Best Investment Real Estate Locations

Where are the best investment real estate locations? If you have enough experience investing in real estate, you can make money almost anywhere, but there are always places that are better or worse for real estate investments. For maximum profits, you want places that have a better demand/supply ratio. You can use the questions below to find them.

Real Estate Demand

1. Does the area have decent job growth? Ask local authorities and use census information. Ideally, you want to see job growth equal to or exceeding population growth. You also want areas with professional jobs moving in. It is estimated that for every professional job created, there are four service jobs created, and all those employees need a place to live.

2. Is the population growing? You can check the US Census figures online, or ask the local government if they have the statistics. Stay away from areas that have little growth.

3. Is there a decent quality of life? It's subjective, but important. Are there theaters and bookstores? Count coffee shops and cafes. Trendy areas usually have increasing demand for housing. It's also a good indication of a high quality-of-life if people are willing to take lower-paying jobs just to live there.

4. Is there wealth in the area? It's a good sign when there is some degree of wealth in a town. Look for nice homes. Wealth means everything doesn't die when the economy slows.

Real Estate Supply

1. Number of homes for sale? Lower supply of homes for sale means upward pressure on prices. This indirectly drives up rents as well, which makes for better investing.

2. New construction? Census figures can tell you what's happened over the last ten years. Check with the local authorities to see if the the number of housing units they've issued permits for is more or less than the expected population growth.

3. Rent and vacancy levels? Rents have to be high enough, and vacancies low enough to justify investing. When we first came to Tucson, every building had vacancies We saw a man holding a sign that read, "Apartment - $250 Per Month." A great place for renters, but not so great for landlords.

4. The available land that is buildable? Of course, less available land is better for future appreciation. When the land runs out, the prices start accelerating upwards.

When you use these questions to compare various towns and cities, you'll see the differences more clearly. You'll have an idea about how housing demand compares to supply in each. This will help you pinpoint the best investment real estate locations.

About The Author

Steve Gillman has invested in real estate for years. To learn more, get a free real estate investing course, and see a photo of a beautiful house he and his wife bought for $17,500, visit http://www.HousesUnderFiftyThousand.com.