Should I get an LLC for Rental Property with a Mortgage?

There are many controversies, especially for new real estate investors, about whether getting an LLC for a rental property with a mortgage is a smart idea. To assist minimize your responsibility and establishing credit for your real estate business, it’s typically a good idea to hold rental property in the name of an LLC. Nevertheless, if you’re getting an LLC mortgage for the first time, it can be challenging. 

The drawbacks of purchasing a home using an LLC are much outweighed by the benefits for novice real estate investors. This method of business growth may be advantageous for experienced investors who want to build a career out of real estate investing. Experienced investors, in particular, can acquire a large amount of real estate that shields them from personal liabilities.

If you want to provide your company the ability to own property or if you wish to have your LLC handle your next real estate transaction, you might want to consider the possibility of purchasing a home with an LLC. The options for your newest endeavor are endless, but they might be challenging. If you are considering making this kind of home purchase, this article will help you understand everything you need to know and discuss the specifics of purchasing a home using an LLC and the potential risk involved.

What Is An LLC?

A limited liability company (LLC) is a type of organizational structure owned by one or more persons or entities. A business owner typically decides to set up their company as an LLC to limit their exposure to the actions of the company. An LLC may be owned by its members, including people, businesses, other LLCs, and foreign entities. A single owner may also own an LLC, depending on the state such person is in.

Before considering setting up your company as an LLC, you need to learn the specific LLC laws in the state where your property is located and the other legalities involved. Unlike C corporations, LLCs do not have to file corporate tax returns. Because LLCs are ‘pass through’ entities, net income or losses are distributed directly to each LLC member, who then reports them on Schedule D of Form 1040 and is subject to their respective tax rate.

One individual can establish a single-member LLC, or an LLC can be created with numerous members, such as in the case of a joint venture established to invest in rental property. Because LLCs are created at the state level, each state has its requirements for how they should be created. However, if you are interested in knowing the legal procedure of LLC for your state, you check out the 50-State Guide to Forming an LLC.

What Are The Advantages Of Buying A House With An LLC?

You will enjoy many incredible benefits when you purchase a home via an LLC. For instance, you can maintain a separation between your personal and professional lives with ease. Let’s look at the benefits of buying a house with an LLC. The following are various advantages to holding an investment property under an LLC rather than your name.

1.    Privacy

You may want to purchase a home with an LLC because of the seclusion it affords. Purchasing a home under an LLC guarantees that public records and disclosures list the LLC’s name, not the owners’ identities. You can hide your profile and other details because LLCs let you change your name to a business name. LLC allows you to stay anonymous without anyone intruding into your personal life. In this case, you can hire a property manager to help you watch over your property and handle the day-to-day operation of your estate without tenants knowing you as a person. In other words, LLC is a simple and effective way to keep your personal life out of the mouth of others.

2.              Limited Liability

The concept of limited liability states the business owner will not be held personally accountable for the debts or obligations of the business. Consequently, the LLC form may seem quite enticing to you if you are a real estate investor concerned about lawsuits. But the limited liability structure has its restrictions. If they pierce the corporation veil or disregard the separate existence of the LLC, such a corporation or an LLC’s owners, stockholders, or members may be held legally responsible for the company’s losses even though the LLC structure is in place.

3.              Partnership Investing

Due to the LLC’s status as the legal owner of the real estate, partnerships can invest much more easily. Depending on how the LLC operating agreement is drafted, each member of the LLC may have a unique ownership stake or even a different part of the business’s gains and losses. 

4.              Pass-Through Income or Losses

The owners of an LLC receive income and losses directly, and they are subsequently responsible for paying taxes per their respective tax brackets. In contrast, stockholders of a C company pay taxes at the individual level as well as at the corporate level.

5.              Avoid Commingling Business and Personal Expenses

If your investment property is under LLC, it is easier for you to distinguish between your personal and business expenses. This one of the criteria IRS search for when auditing LLC. When your investment property is registered under LLC, it will have its distinct bank, debit, and credit card accounts. However, you can link your accounts with your investment property financial management software to help you track and manage your income and expenses.

6.              Tax Benefits

Due to the elimination of double taxation, the LLC form can provide significant tax advantages. Profits that are first taxed at the corporate level and then again at the individual level are referred to as being subject to double taxation. Instead, LLCs benefit from a pass-through tax structure, which implies that the earnings are taxed by the LLC but not by the LLC’s owner. The LLC owners’ allotted portion of the profits is subject to taxation.

7.              Easier To Invest With Partners

It is simpler to invest with friends, business colleagues, or even other investors who are not acquainted with the major owner of the LLC owing to the LLC structure. Two individuals, for instance, could partner to form an LLC. Forming a multi-member LLC is as simple as adding a second member to a single-member LLC. Just as it is easy to invest with partners, it is also easy to sell LLC shares; all you need to do is to sell the existing shares to a new member.

An LLC’s shares must be distributed in whole by its members. Your legal liability may be restricted to just the LLC’s assets. For instance, your only potentially vulnerable assets are those owned by the LLC if you ever get into a legal dispute with a tenant and receive a verdict against you. There are a few caveats to an LLC’s protection, such as when an investor engages in open fraud. The structure will not be considered legal if it lacks a genuine business objective.

What Are The Disadvantages Of Buying an Investment Property With An LLC?

After looking at the potential benefits of buying your investment property with an LLC, one must consider the disadvantages before you choose to do this. For instance, you need to take into account the up-front and recurring costs, the ineligibility for favorable capital gains treatment, and other drawbacks that will be discussed below:

1.     Cost

Legal expenses make establishing an LLC a costly process. The cost of filing the articles of formation for your LLC can range from $40 to $500, depending on your state’s regulations. This is only a significant portion of the overall expense. Also, you may pay for a license and permit payments for your business. After establishing an LLC, you may be required to pay additional minimum annual taxes on the LLC and an annual report, registered agent, and business license renewal fees. Ensure you receive sound legal counsel when establishing your LLC; you shouldn’t attempt to handle this independently.

2.              Difficulty Getting A Mortgage

Because you formed an LLC to shield your personal assets, mortgage lenders can find it challenging for you to obtain a mortgage under your LLC. Since residential lenders are reluctant to lend to LLCs due to their limited liability, this makes it one of the most challenging aspects of applying for a mortgage with an LLC form. 

Banks are aware that investors and members of an LLC are not individually responsible for the LLC’s or company’s debts, which implies that most lenders are more likely to provide a mortgage loan to a small LLC or company if the business owner offers to use their own financial property to secure the loan. A lender will examine your personal credit file, assets, investment property’s financial documents, and rent roll.

3.              You will likely Pay More

Lenders are aware when a buyer attempts to acquire a house through an LLC for investment rather than a residential home. In the case of financial difficulty, an investment property will fall behind because a primary mortgage takes precedence. As a result, investment properties have relatively higher interest rates than those on a primary mortgage.

4.              You will be Unable to Access most types of Residential Loans

If you wish to purchase a home using an LLC, you cannot access all forms of residential loans. For instance, using an LLC will prevent you from obtaining a conventional loan sold to Fannie Mae and Freddie Mac. Also, an FHA does not offer loans to LLCs.

Instead of creating an LLC, a beginner real estate investor who wishes to purchase a duplex or multiplex property might do better by utilizing the FHA’s low-down-payment choices. With an LLC, you forfeit some tax benefits and reduce mortgage insurance for mortgage loans on your personal income tax return.

5.               You will not be eligible for a Preferential Capital Gains Treatment

You must pay capital gains tax when you sell your home for more than you purchased it. When you purchase a primary property, you typically qualify for preferential treatment with regard to capital gains tax. If you are a single person, you are exempted from paying capital gains tax on the first $250,000, and there is a $500,000 exception for married couples.

However, if you have an investment property, you will not be eligible for this benefit. You must own the residence for at least two out of the five years before the sale to be eligible for the capital gains tax exemption. A minimum of two of the preceding five years must have been spent living in the house as your residential home, albeit those two years do not have to be consecutive.

Documents Needed to Finance a Mortgage under an LLC

Before you can get finance for investment property under an LLC, there are certain documents you must have to prove your eligibility for the loan. However, let’s examine the necessary paperwork and your possibilities for an LLC mortgage.

• Articles of Organization and Operating Agreement for your LLC, which includes information on all members or shareholders.
• A report from the Corporation Commission or Secretary of State’s office attesting to the legal standing of your LLC, the timely filing of all required paperwork, and the full payment of annual fees.
• Bank account information for the LLC, including the history of deposits and withdrawals, current balance, and average balance
• Employee identification number (EIN) demonstrating that the IRS acknowledges your LLC for federal tax purposes even if you do not have workers
• Financial and credit information for each LLC member or shareholder, including their personal income and debt.
• The history and details of the rental properties, including profit and loss accounts, tenant leases, and payment information.

Financing Options for an Investment Property under LLC

Financing options or mortgage loans for investment property under LLC are quite limited because of the factors lenders put into consideration that might be unfavorable to LLC investors. However, there are a few financing options you can consider for your investment property under LLC. These include:

1.    Conventional Loan

A conventional mortgage for an LLC offers the most beneficial terms, interest rates, and down payments. However, the lender will probably need your guarantee, credit report, and details about your personal finances. Although guaranteeing the loan has some disadvantages, it is an excellent approach to start establishing credit for your LLC, especially if it is a new business.

2.              Savings, Loans, and Community Banks

Another great choice for obtaining a mortgage with your LLC is local banks, savings, and loans in the community where your investment property is situated. Since you are supplying the market with much-needed rental homes, local lenders may be willing to work with you.

3.              Portfolio Lenders

If you are looking to create an LLC mortgage with conditions and terms that suit your investment objectives, you should consider portfolio lenders. While their funding times are typically quicker than those of local banks and traditional lenders, they may charge higher fees and interest rates. Since you may have to refinance later in the future with better conditions, portfolio lenders are a suitable first option to get an LLC loan.

4.              Private Lenders

Investors that need short-term loans, such as for a home that requires extensive repairs before leasing to a tenant, might consider private lenders. Private lenders may require cross-collateralization of loans with your other properties and demand greater down payments, fees, and interest rates. The good news is that private lenders are extremely creative when structuring a mortgage that meets the demands of your LLC.

5.              Recourse vs. Non-Recourse Loans

When looking for an LLC mortgage, it’s important to understand the differences between recourse and non-recourse loans. A recourse mortgage permits the lender to seize your assets if you default, regardless of whether the mortgage is registered in your LLC’s name. A non-recourse loan, in contrast, restricts your obligation to the property used as collateral for the loan.

Conclusion

An LLC provides collaboration opportunities, anonymity, restricted liability, and tax advantages. It will take a lot of work to get your first LLC mortgage, but it might be worthwhile. But keep an eye out for recurring expenses, challenges securing a mortgage, drawbacks with capital gains treatment, and a few other drawbacks. Due to the complications and extra expenses involved in purchasing a home through an LLC, newbie investors could find it more profitable to purchase real estate in their names. Even experienced investors need to exercise extreme caution. To choose the optimal legal framework for your investments, you should speak with a corporate attorney. 

If you are looking for an investment property loan, whether as a single investor or as LLC, Aurum and Sharpe offer loans to beginner and experienced investors with favorable terms and rates. Contact us at 9177404325 to book an appointment today, or use the online form to get in touch.

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