Protecting Your Assets HOW LLCS CAN HELP OR HURT YOUR REAL ESTATE INVESTING BUSINESS, PART TWO.
by Clint Coons, Anderson Business Advisors
ast month’s article discussed how a separate tax-paying entity can help the real estate inves- tor appear more bankable. Here are two more import- ant considerations. #2 Using Disregarded LLCs to Hold Multifamily or Commercial Real Estate It’s tempting to set up an LLC for asset protection and at the same time treat it as a disregarded enti- ty for tax purposes (a disregarded LLC is ignored for tax purposes) so you can avoid the annual CPA cost of filing an additional tax return. This penny-pinching investing strategy will cost you down the road when the time comes to exit your investment. When selling commercial/multifamily property held in an LLC, the buyer’s lender will ask for copies of the entity’s two tor of making this loan increases. You may find your buyers fall out of financ- ing and as a result, you are forced to owner carry. This is never a good move because it prevents you from engaging in a 1031 and it runs the risk your buyer does not know how to operate the prop- erty and you end up taking it back and starting the rebuilding process anew. This same issue will come up if you seek to refi- nance. When setting up your LLC you should be thinking down the road and keeping your plan flexible and your options open. #3 Not Keeping a Clean 1040 Schedule E Any investment real estate you own in your personal name or in a disregarded LLC will show up on your 1040 Schedule E on page one. If you hold real estate through an LLC treated as a partnership or S-Corpo- ration for tax purposes, it will appear on your 1040 L last filed tax returns. The underwriter will use the tax returns to verify the property’s income and expenses. If you set up a disregarded LLC, you will not have a separate tax return to provide the underwriter so the risk fac-
Schedule E page 2. What is the distinction and why does it matter to you? The difference really comes down to how underwriters calculate your income or how institutional lenders evaluate your experience. From the lenders’ perspective, the simplest way to explain the difference is k-1 income from rentals is typically calculated at 100 percent while rentals held in your own name of through disregarded entities will be calculated at 75 percent. This difference can make or break your debt-to-in- come ratio. From the institutional lender perspective, when you are seeking to put together larger deals you want to look like an experienced investor. Number of properties owned, length of investing, and how your tax returns and overall structure looks can make these deals come together. Experienced investors typically invest through partnerships (LLCs taxed as partner- ships) and this is carried onto their tax returns. New investors or accidental landlords typically hold rentals in their own name. So how do you want to be per- ceived? When you start working on larger deals looking like the experienced investor can only help you in building your investing portfolio. These comments are generally geared toward tradi- tional lending (e.g., Freddie/Fannie products). Having a relationship with a portfolio lender will change some of the analysis for you but the purpose of entities should be to help you achieve your investing goals. How you set up your structures will have an impact and the question you should ask yourself is do you want your planning working for or against you? If you would like to attend one of our 3-Day Tax and Asset Protection Workshops for Real Estate Investors, register as a Think Realty subscriber: http://aba.link/thinkbp. •
As a founding partner at Anderson Business Advisors & Law Group, Clint Coons is a real estate asset protection expert and an avid real estate investor. He wants to help every investor create a well-bal- anced plan so they can continue to grow their portfolio and have their capital and investments protected.
82 | think realty magazine :: february 2020
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