Moses Kagan on Real Estate

Lots of buyers ask me about holding properties within an entity like an LLC, instead of in their own names. I’ll share the advice I give them with you, but only if you promise to remember that I am not a lawyer and this is not legal advice.

First, let’s be clear about why someone would want to hold a property in an entity. The advantage is mostly liability protection. By creating a separate entity to own the real estate, you are theoretically placing a shield between the property and your personal wealth. The idea is that, if something bad happens to the property, the badness stops at the entity level, rather than getting to you personally.

Now, let’s consider the downsides:

1. Tax headaches. If you hold properties in separate LLCs, each one needs to file state and federal tax returns and issue you a K1 each year. That’s a lot of accountants’ time and, therefore, a lot of your money.
2. Administrative headaches. In order to preserve the liability protection afforded you by the LLC, you need to be careful not to create the impression that there is no distinction between yourself and the LLC. This means separate letterhead, checking accounts, etc. – in other words, more hassle.
3. Minimum LLC tax. In CA, an LLC with no revenue still owes the state $800 / year in taxes. This number goes up once revenue exceeds $200k (I think).
4. Incompatible with owner-occupier mortgages. Banks are VERY familiar with the trick of putting an entity into bankruptcy in order to avoid foreclosure. While they’re willing to tolerate (and often encourage) LLCs for commercial properties (in this case, apartment buildings with 5+ units), they don’t like to see them on residential properties (1-4 units).
5. Dubious liability shield. Courts have sometimes found that there is no distinction between an owner and the LLC (particularly if you screw up #2 above) and thereby allowed plaintiffs to “pierce the corporate veil” to go after the owner’s other assets. The law is somewhat unsettled on this point but you should be aware that the liability shield is far from absolute.

For most starting investors using owner-occupier mortgages, #4 above means that using an LLC is off-limits. If you’re just starting out by buying a small property for investment purposes with cash or an investor mortgage, I still don’t think I’d bother. But once you start getting into multiple properties, I’d try and move them into one LLC (if they’re small) or into separate entities (if they’re large).

For larger investors, funds, syndicators, etc., the gold standard is having each property in it’s own LLC (a so-called “single asset entity”).