I'm just getting into real estate investing and I want to begin to build my rental property portfolio. Can you let me know if I should create a business entity to purchase these properties under or if I should just purchase them without.
Here is a little background info.
I'm married, 35 years old and live down town Chicago. I have savings but only rent and my wife and I do not own our own home. Together we make about 200k annually at our full time job. We do plan to hire a property manager for all of the investment properties.
Let me know if you have any additional questions.
Also, I am based in Chicago but I will likely make some investments in other states like Indiana. If needed can I just create the business entity in Indiana? I ask because the costs are substantially more in Chicago.
Stephen's comments about liability are correct. I thought I would provide some additional details to take into consideration, since I've recently been through this.
- I used to live in Chicago, and I have, in the past, brought a lawsuit against a developer. Cook county courts are *easily* abused, and often abused. Just food for thought, so be careful.
- In essence, the best approach is as Stephen mentioned. You want to create *separate* LLC for *each* property. Therefore, if a lawsuit is brought upon one property, your other properties are not at risk. If they are all under one LLC, then they are all fair game in a lawsuit.
- I would suggest creating your LLC *before* acquiring a property.
- Some will say that it is not work incurring the secretary of state fees and additional tax headache. If you do not acquire a property during the tax year, this is true, but the tax forms are simple, and the fees are not that much.
- If you purchase a property under your name, and then transfer it to an LLC, then you have additional headaches which I believe outweight the aforementioned expenses. First, transferring title is a nightmare in most states. Second, you will need to perform two title searches. Third, any tax work will have been done under your social security number. After the transfer, your tax documentation with the IRS will need to be changed to your Employer Identification Number (EIN) - which is an additional pain which your accountant will be happy to charge you for. Whereas if you form an LLC first, you will have an EIN (Employer Identification Number) which you can use throughout the life of the asset you are holding. Also, attaining an EIN is a five minute process on the IRS website.
- Once you have multiple properties, it may make sense for your to create a holding company for all of your LLCs. It is an LLC for your LLCs. It becomes more cumbersome for tax filings, but you can create the holding company LLC in Deleware, which provides you a second state's LLC laws. Any lawsuit would then have to deal with two sets of state laws. This can significantly reduce your liability and increase your asset protection. But this is done further down the road.
I would not do this yourself, or use one of those online services. A business formation attorney will only charge you approximately $800, but they will make sure everything is done correctly, which is critical if your LLC is multi-member, and also important given the attorney will be an expert in your state's laws. State laws vary dramatically across states, and the money you save doing it yourself does not outweigh costs you could possibly occur if you are sued, or have a dispute with another member.
Furthermore, everybody assumes (including myself before I actually did this) an LLC protects you no matter what. This is NOT true. If a frivolous lawsuit is brought against you, and the litigator can prove that your business does not function as a real LLC, or maybe you unknowingly didn't do certain things you should have, or did things you should NOT have, then your own personal assets can be at risk. This is called "Piercing the Corporate Veil." If you request an S-Corp designation to pay less taxes, which is totally legal, but you do not have at least one shareholders meeting, for example, you are not running a real LLC. It can be something as stupid as that. By merely creating a multi-member LLC, instead of a single member LLC, provides you and your wife further protection, but your attorney needs to advise you in this regard. Building off of the S-Corp example, if one member possesses 99% of the ownership units, and the second member only possesses 1%, a judge can accuse you of not running a real LLC. How you use an Illinois LLC vs an Indiana LLC due to expenses can also be questioned as potentially abusing the protections of an LLC (not saying you are trying to, but you'd be amazed at what people can accuse you of).
Many people setup their own LLCs, and attain an S-Corp designation, and nothing bad ever happens. However, in my opinion, if you are going to invest in multi-hundred thousand dollar, or higher, properties, spending the extra money to do things the right way, and having an attorney just in case, is worth it, but again, in my opinion.