10 Reasons Why You Should Not Use LLCs to Own Real Estate
Because I am an estate planning and asset protection attorney, I speak to folks everyday about the formation of limited liability companies (“LLCs”). Usually, these folks want to protect their personal assets in the event one of their tenants gets injured on one of their rental properties. I form LLCs in my law firm, so it may seem counterintuitive for me to share this list. However, over the years of preparing LLCs, I’ve learned that it is better to NOT create the LLC than to cut corners and do it wrong. When my clients don’t understand the details of responsibility creating the LLC, I find it would probably have been better for them (and me) if they had never created the LLC in the first place and simply rely on landlord insurance to protect them. The reasons, below, are not the only considerations, and I’ve listed them in no particular order.
#1 Initial Secretary of State Fees
In Nevada, it currently costs $255.00 to form the LLC whereas you won’t incur this fee if you simply use landlord insurance to protect your rental . A person could save $30 by not getting the certified copy of the Articles, but now they’re already off and running with a “cutting corners” strategy. If the LLC is worth the protection you seek, it’s worth doing right.
#2 Increase in Landlord Property Insurance
Landlord insurance is a blessing and a curse. When the injured tenant discovers you have high property insurance coverage, they are more likely to sue and more likely to sue for large amounts of money. Nevertheless, you should carry insurance. Once you form the LLC, the insurance company should be notified and you should add the LLC as an additional insured. Sometimes this will raise your premiums and sometimes the insurance company will require a commercial policy. While this is not a huge cost, for some clients it’s just too much to bear.
#3 Administrative Burdens
In addition to the annual filings, the LLC requires paperwork and it should have its own bank account. Minutes should be kept annually. Folks assume that just because the statute doesn’t require minutes that they don’t need to be kept. What kind of a decent company doesn’t have a record of its activities? Probably one that is nothing but the alter ego of owner. And if it is determined that the LLC is your alter ego then your personal assets can be jeopardized when the tenant gets injured.
Even without the LLC, as a landlord, you probably should set up a separate bank account and have a clear set of accounting records for the financial transactions of the rental. If you form the LLC, you must set up the bank account and keep separate accounting books. If you don’t, you need to ask yourself why you ever bothered setting up the LLC in the first place.
It gets worse. I often see folks who set up the LLC for their rental property and then they never bothered to transfer the ownership of the property to the LLC. So the LLC acts like it owns the property, but in fact (and in law) it’s not actually the owner. When the tenant gets injured, the tenant is going to sue the owner as shown in the county recorder’s office. If the owner is you, it doesn’t matter that the LLC is the pretended owner. So transfer the property to the LLC!
#4 Loss of Title Insurance
When you transfer the property to the LLC, you will void your title insurance unless, at the time you purchased the property, you bought what is known as an “extended policy.” Normally, the cost of the extended policy is 10% of the premium you paid for the insurance.
#5 Annual Fees
Nevada charges $150 per year for the privilege of using the LLC. Additionally, the resident agent charges a fee that usually range from $150 to $350 per year (we charge $175). You should not be serving as your own resident agent. The resident agent is the person designated to receive paperwork from the state including tax and legal documents. They should hold normal business hours and their address becomes part of the LLC’s public record. A good resident agent can also prepare annual minutes for you if you not kept your own.
#6 Initial Legal Fees
You can form LLCs yourself, you can pay a company like Legal Zoom, or you can get it done by a competent attorney. If you don’t have experience in forming LLCs and you don’t want to pay for an attorney, don’t form it at all. Seriously, just rely on your landlord insurance. As for CPAs or companies like Legal Zoom forming LLCs, there is a reason they have to disclose to you that they are not attorneys. They cannot be held to the high standards of competency that attorneys are held to and, therefore, you cannot hold them accountable if things go wrong. When you hire an attorney you are not paying the attorney to file a couple of pieces of paper for you to form the LLC. You are paying the attorney to take personal responsibility for the company in every way including the formation of operating agreements, structuring, and tax planning such that if you do get sued, it will work correctly.
#7 False Sense of Personal Liability Protection
LLCs may offer protection in the event that the tenant sues, but maybe not. This may come as a surprise because so many LLC formation companies lead us to believe that the LLC will shield us if the tenant gets injured. If the tenant sues the LLC, they are also to sue the officers of the company. That officer is going to be you because you want to control the company. Now that you are personally named in the lawsuit, your personal assets are exposed. The solution is to have your personal savings in the Nevada Asset Protection Trust. Without the trust, you have three options: (1) let someone else serve as the officer of the company; (2) hope you can get removed from the lawsuit; or (3) don’t form the LLC and rely on landlord insurance. In the past, we would have another LLC or a corporation serve as the officer of the LLC but that only increases the cost and it eventually leads back to you in the end. And you don’t want to name another person to control your company. My recommendation: form the Asset Protection Trust when you use LLCs.
#8 False Sense of Anonymity
When your LLC owns the real estate, it is easy for financial predators to discover that you are the owner of the LLC and, by extension, the property. If you initially owned the property and then transfer the property to the LLC, your name continues in the chain of title. When financial predators see the current owner as the LLC but the prior owner was you, they will infer that the LLC is yours. Plus, the LLC is discoverable by using your name (assuming you are an officer of the company—which you should be) on the Secretary of State’s website.
The only time LLCs can be used to create some anonymity is when the LLC purchases the property in cash. Yet, if you serve as the officer of the company, financial predators can still track you down. You can overcome this exposure by using a simple trust to serve as the initial officer or you can just recognize that the LLC is not going to provide you anonymity.
#9 Tax Mistakes
LLCs can be taxed in one of four ways: (1) C corporations; (2) S Corporations; (3) partnerships; or (4) disregarded entities. If you chose the wrong method you can create tax issues including increases in your taxes, penalties and an increase in tax preparation costs.
#10 Mortgage Violations
If the property you want to protect has an existing mortgage, the mortgage company will not permit you to transfer ownership to the LLC. If you transfer the property without their permission, they can call the note due and payable in full. While there are safe methods to get around this issue, it is better to be safe and not do an LLC unless you know what your doing.