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Wednesday, May 1, 2019

Why Getting An LLC For Your Rental Properties Is A Big Mistake!

So last February I refinanced one of my three out-of-state rental properties.  There was a glitch in the underwriting process of my new loan that caused a closing delay.  This meant I didn't get my cash when I was supposed to.  Wells Fargo bank apologized by sending me a $2,500 check.  I kid you not!  They literally sent me what I was due from the refinance in cash-out, PLUS an additional $2,500.  Lucky me, right?

So when talking with my EA at tax time in late March, he recommended I use that money to finally get a trust written up.  Very important by the way!  You don't want to die and not have clearly laid out how your kids get your assets, etc.  Anyway, I agreed.  "But first I'm going to set up an LLC for my rental properties and protect my personal liability," I said to him.



I got right on it.  My EA gave me a recommendation to use his friend (no, he doesn't get a kickback) to have my LLC filed properly with the state of CA.  Now, I've read threads online before that were in favor of setting up LLCs for rental properties, and I've also read threads that mentioned investors not needing them.  Those in the camp of leaving the assets in their name provided a solution: Get an umbrella insurance policy of upwards of 2-3 million coverage.  If something happens at the property, and the tenant sues, the easiest money is the one the insurance can offer.  This was the extent of my understanding.  By the way, I currently have an umbrella policy for my rentals and the coverage is 3 million.

Why did I think I had to change things?  Many of you that own 1-3 rentals may be in the same situation, wondering if setting up an LLC is the right course of action.  I'm in the middle of buying a fourth rental property...loan app is done and I'm waiting on the rehab work to completed.  I thought: Well, I'll just add this latest property to the LLC I have formed...total of four rentals in an LLC seems like a good number.

I paid $750 for Gomez Legacy, LLC to be formed and filed with the state.  I was super excited to get the articles of incorporation in a nice binder, courtesy of the person I hired.  Then it hit me...

Wait a minute.  How do I transfer title from my name to the LLC?  I emailed my guy.  No response.  I went on Google and typed: How to transfer title from personal to an LLC.  A few articles came up.  I thought it was going to be simply a matter of listing the property addresses on some form or something.  Boy was I an idiot.



While in theory keeping rental properties in an LLC to grant you some protection from personal liability is the right call, it's not feasible for most investors.  Most new investors don't outright own their rental properties; they've procured them through conventional financing.  For each of my rentals, including this fourth one I'm about to get, I applied for conventional financing, using my credit, income, evidence of being in good financial standing, and down payment funds.  The bank took a risk on me, not some unknown Limited Liability Corporation!

You see, a new LLC has no credit history and no income.  You didn't apply for your investor loan using the LLC, so why would a bank allow you to transfer title to one?  In fact, most banks won't lend money to an LLC.  There are strict lending regulations already!  The loans we get as investors have investors behind them.  Risk of default is no joke to them!  For my loans, the investors were Freddy Mac.  The notes are held by Chase, Wells Fargo, and Mr. Cooper.  I called them up one by one.

Chase:  Sorry, we don't allow transfer of title per Freddy Mac.

Wells Fargo:  Sorry we don't allow transfer of title under any circumstance.

Mr. Cooper:  We don't do checks for title change.  So long as you keep paying the loan each month, that's your prerogative.  Use a quit claim deed.

Well, my new LLC had been rendered useless.  I'm not spending $800 a year (CA LLC fees) to keep one rental property in an LLC.  Even if the fee is tax deductible!

So, those are the issues you too will face, especially if the loans you got were procured by you, and NOT your LLC.  Transferring title is mostly not allowed by lenders.  Why would they want to risk it?

When Should I Get An LLC?

1.  If you own the property outright.  It's easy to "donate" your property to your LLC.

(That's it!...Sorry to make you think more things were coming)

You can try talking to a real estate attorney before you commit to paying $2-3K, and see if they have a solution on this titleing quagmire.  If you have other ideas, please comment below!

In the meantime, keep the properties in your name.  Keep using the bank's money as often as you can to acquire more properties.  Just make sure you insure the crap out of them.  People are greedy and will settle out of court for a large amount of cash.

I spent $750, but I learned a powerful lesson.  Finally, if you think having an LLC is better for taxes, you should know that for tax purposes an LLC is a pass through entity treated like a person, meaning, it's the same as you filing.

Thanks for reading!

2 comments:

  1. Thank you for sharing! That is great information. I thought I had to form a LLC. Sorry you wasted $750, but happy you handled establishing a trust.

    If you don’t mind me asking, how much does three million dollars worth of insurance run you annually?

    ReplyDelete
    Replies
    1. Hi! It actually depends on the value of the property but not that much! I'm paying between $720-$900 annually for each property.

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