Financial Freedom Fighters

EP #32 - You Don’t Need an LLC to Buy Rental Properties (Here’s Why)

Jacob Sandoval & Michael Magno Season 1 Episode 32

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In this episode of the Financial Freedom Fighters Podcast, hosts Jacob Sandoval and Michael Magno dive into the common question: 'Do you need an LLC to invest in rental properties?' They explore the pros and cons of setting up an LLC, discussing liability protection, financing complications, and the misconceptions about additional tax benefits. Jacob and Michael share their personal experiences and emphasize the importance of getting started in real estate investing without getting bogged down by unnecessary complexities. Tune in to find out their perspectives and practical advice for rookie investors.

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Nancy:

This is the Financial Freedom Fighters Podcast

jacob:

Welcome everybody to the Financial Freedom Fighters Podcast, back with another episode today. I'm your host, of course, Jacob Sandoval. I have with me my co-host, my partner in crime, realtor Michael Magno. Mike, how's it going? It feels like I haven't talked to you in a in

mike:

Hey, Jacob. No, everything's good. Everything's good? Yeah, it's been a while. I know you were, uh, out of the country for a little while. Uh, doing some fun from some fun shit, so, you know, I have to tell us about that. But yeah, no, it's, uh, you know, things are good. It's, uh, you know, as we record this episode, it's late February and it's still frozen here in Cleveland, so it's kind of annoying. Um, so yeah, I'm looking forward to, to spring getting here as fast as possible.

jacob:

Yeah, absolutely. And, and speaking of Cleveland Snow, uh, one of my rental properties, the Euclid triplex Mike, my snowplow bill for that property was absolutely bonkers. I had close to$2,000 across three months.

mike:

Oh my Lord.

jacob:

and it was just because it's just such a big lot. And so for all those people listening. I have a triplex that sits on a very, very large lot. It has like a very big parking lot. It's very nice. Um, for the tenants. They have a lot of space, um, to park the cars and whatnot. The downside of that is when it comes to kind of lawn care and now snow removal, I. That big lot is kind of hurting me quite a bit, and I didn't anticipate that it would cost that much. But anyway, folks, the, uh, the real side of real estate, you know, you gotta, you gotta plan for this, especially when investing in a market where it snows like Cleveland. Just something to keep in mind.

mike:

Yeah, that's unfortunate that you ended up with that bill. this snowfall and we've had this year is more like when I was a kid, it's probably been about 10 years since we've had this severe of a winter here.

jacob:

Yeah. Yeah. So anyway, that's, that's an aside, but just, just as a reminder, folks, Mike and I we're, we're both operating rental property portfolios and it's not always sunshine and rainbows,

mike:

well, we were supposed to record last week and I canceled on you because I had a b broken water pipe in one of my properties. So yeah, so that was fun. But we, we won't even get into that, but

jacob:

We won't get into that. But, you know, gotta love real estate. You gotta, you gotta roll with the punches and we know it's gonna be a good investment over the long term, but part of being a real estate investor is kind of dealing with these little nuisances, like excessive snow and like. Pipes bursting and, and whatnot. But that's not the topic for today, Mike. Um, the topic for today is a question that I get a lot, from kind of rookie real estate investors, and one that I'm sure you get a lot as well, but it is, do you need an LLC to invest in rental properties? we're gonna dive into all of this today. Why you'd want to do this, why you might not need to do this. And I'll caveat Mike before we really dive into it. I'm not a lawyer. Mike is not a lawyer either. This is not legal advice. Consult with your lawyer on actual legal advice. We're two dudes with a podcast trying to answer a question that we get all the time, but this is not to be misconstrued as legal advice. So Mike, let's kind of just dive into it. I'll start and then we'll just kind of. Roll with it here, but an LLC, right? An LLC is a limited liability company. So let's start with why you'd want to maybe use an LLC to own your rental properties in. So the big thing is liability protection, right, Mike? So people think that if. The Jacob Sandoval, LLC, owns 1, 2, 3 Main Street, Cleveland, Ohio, that I'm fully, fully protected from all liability, if there's a lawsuit or if something happens at the property, only the Jacob Sandoval, LLC. Is liable for anything that happens. Not Jacob Sandoval the person. Right? So the idea with owning rental properties in an LLC is you separate yourself, the individual, and all of your personal assets from your rental property business. And people think by doing that, you are adding a layer of protection, which. Could be the case. Right. Um, another thing Mike, people think about, and we get this all the time, people think that for some reason having an LLC gives you additional tax benefits, those are kind of like the main ones. Mike, what, what other things do you kind of think about when people talk about, Hey, why would I want to set up an LLC?

mike:

Yeah, so you mentioned it, you know, asset protection is the, one of the main reasons that people do it. also, it can be complicating when it comes to financing a property. for the new investor understanding that you can't, you know, you cannot purchase a property in LLC and then take out conventional financing. you have to buy it in the, your personal name. there are ways to buy in an LLC, and that's through either commercial financing or DSCR financing or, or some other, some other avenue. So that's a another layer that, uh, you know, complicates it, uh, as well. you know, and then plus, plus some people want an anonymity as well, right? Um, so some, some people do it on purpose for an anonymity.

jacob:

Yeah. Yeah, yeah, yeah. So that's a good point as well. Some people will do it for anonymity, um, so that their name kind of doesn't show up anywhere. You know, what's the saying? You know, rich people, they don't own anything. Right? Because they, they kind of set up all. Of this stuff. But for the purposes of this conversation, Mike, um, I'll just kinda share my own personal views, I do not use an LLC to own my rental properties. I own my rental properties in my personal name and in my wife's personal name. And I'll kind of just talk through the rationale of why I feel, um, I don't need to have an LLC. So the first thing, and we can dispel this, uh, we had. While, while back, Mike, we had my CPA, um, shout out to the CPA dude come onto the podcast and he talked about the fact that. There are no tax additional tax benefits of having an LLC. That's just kind of like a complete misconception. Just having an LLC does not grant you additional tax benefits, so if that's the belief that you have, that's just incorrect. You have the same tax benefits whether you own the LLC in your personal name. Or whether you own the property in your personal name or whether you own it through an LLC, the tax benefits are the same, so kind of remove that, um, out the window. But I do wanna address the liability piece, Mike, because that is probably the most valid thing, um, with owning an LLC, is that you're, you're theoretically protecting yourself with liability. Here's what I kind of believe one adequate insurance is going to be. Probably, in most cases, 99.9% of cases adequate insurance is gonna protect you enough. In your rental property business, if there's a slip and fall, obviously read your insurance coverage. If there's a slip and fall and the tenant sues you, that is covered by your insurance, right? That is covered by adequate rental property insurance. And if you get really, really technical, Mike, if you look at your insurance premium, your insurance provider is going to break down. What consists of that premium? For example, if you have, let's, let's just make it up, right? Let's say that my insurance for one of my Cleveland duplexes is like 120 bucks a month, And so that's gonna come to an annual amount. They're gonna break down. What portion of that is actually being driven by potential lawsuits, right? And what, what portion of that is, covering the building, et cetera, things like that. The lawsuits piece, the, the liability piece that's covering you against a lawsuit is, is such a small portion of that premium. And what does that tell me, Mike, that tells me that the, the actual insurance provider. It's not very concerned with the potential of getting sued, They're, they're not really worried about that. So to me, I'm like, okay, your insurance can protect you against this now. That's the first thing that I'll say is that most people don't, don't understand that insurance is good enough. If you have a good enough policy on top of that too, I don't just have a regular rental property. Um, insurance, I have that, but I also have a personal umbrella policy that gives me an additional$2 million of liability that covers my rental properties, that covers my automobiles, that covers everything. So not only do I have insurance on the property itself, I have an umbrella policy that grants me. An additional$2 million of liability coverage if something happens at one of my rental properties. So to think that something happening at my rental properties is going to be in excess of more than$2 million of liability. I sleep perfectly fine at night just knowing that I have that. So that's kind of what I wanna say, Mike, is that yes, in theory the LLC can give you liability coverage, but if your insurance covers you enough and you're comfortable enough with that policy, then you really shouldn't stress out about a slip and fall lawsuit.

mike:

agree a hundred percent there. And, you know, insurance is key. Um, I also have an, an umbrella policy like you do. I mean. I've owned rental properties for a long time, and I mean, if you maintain your properties and you have good relationships with your tenants, uh, I don't, I don't see a ton of a ton of issues in that, in that regard. Now, for those who've obviously I. Don't manage their properties. Obviously you wanna have a good relationship with your property manager, and your property manager should be the one taking, you know, care and responsibility for making sure that your properties are maintained and that helps, uh, avoid problems in the future, right?

jacob:

Yeah, absolutely. And here, here's the other, so that's kind of one piece of it, right? I think insurance, an insurance policy, potentially an umbrella policy. On top of that, if you have multiple rental properties, if you just have one. Um, you're probably gonna get a decent amount of liability coverage if you just have one rental property. But if you have 2, 3, 4 rental properties, maybe think about getting, um, a personal umbrella policy to give you additional liability. So that's kind of one piece, like, I just don't, I don't, I don't stress out too much about the potential of getting sued because I do have adequate insurance. Another thing too is. A lot of people don't actually go about setting up the LLC the right way. And so what do I mean by that? Well, one, you kind of alluded to this earlier, Mike, but if you buy the property that is your holding title to the property in the name of the LLC, your financing and your insurance also have to be in the name of the LLC. And if you are. You know, Jacob Sandoval, LLCI can't get 30 year fixed rate debt. Mike, I can't get the, the financing that is afforded to people. Individuals. Why? Because banks view lending to businesses, which an LLC is a business, they view lending to a business as a more risky venture than lending to an individual. So what does that mean? That means debt terms, financing terms that are more expensive. That are gonna be, you know, maybe a five year fix, seven year fix, 10 year fix at the max with the balloon payment afterwards. So you're not gonna get that 30 year fixed rate, and that is the secret. Power of residential investing is that 30 year fixed rate debt, right? That locking in that, that mortgage rate, holding it over the long term, that's the, the true superpower of investing in residential rental properties, and you just can't do that. Now, what I see a lot of people doing, Mike and. Again, not lawyers here, but I viewed this as a mistake, They'll buy the property in the LLC, but they'll get the financing as an individual. They'll get the insurance as the individual. So what do you have here? You have title that's being held in the LLC, but you have the financing tied to that property as the individual, any lawyer. Worth their salt if they see that, right? Say you have the tenant slip and fall, you think you're covered because you have the LLC. All good. I'll have the LLC. Any if the lawyer pulls up the records and they see, okay, cool, this person's being held in the LLC. They'll dig a little bit deeper though, Mike. They'll see, oh, actually the financing is in this person's name. Then the corporate veil can be pierced. That's a term that you'll hear a lot. If a lawyer can pierce the corporate veil, that means they're just invalidating the fact that this is an LLC, they're calling foul play. If the corporate veil is pierced, all the protection that you thought you had from a liability perspective is gone. Right? So I urge you, and if you're a lawyer listening to this, um, or watching this on YouTube and you want correct me, that's fine. But my understanding is that you cannot hold title in an LLC and get the financing. Your personal name'cause that invalidates the LLC. So if you're not even going about it the right way,'cause you're trying to get the best of both worlds. You're trying to get the liability protection and you're trying to get the best financing terms, then I think you're, you're, you're as exposed as if you just never went about it in the first place. Anything to kind of add on onto that, Mike?

mike:

it can get very, very complicated. because you can have people that would buy the property in their name and then to get the financing, and then they'll transfer the ownership to the LLC after, after that. And then that complicates your title insurance policy that you have. And so it, it gets really, really muddy. So my, my advice to people when they, when they call me up and say, Hey, I want to invest in, you know, Cleveland real estate, and I ask them like, Hey, do you have any experience? And they tell me no. You know, my first, my first inclination is always to tell them to consult with a CPA and, and an attorney to figure out how they, how they want to pursue the properties. and then also too, you know, depending on their financing, right? Um, in your, in, in know, in, in your case. When you bought the properties with us, you are high income earning individual. You could qualify, um, conventionally and that would get you the best financing terms right to go. Conventional is always gonna get you the 30 year fixed rate, rate debt. It's gonna get you the best rates, it's gonna get you the best fees and points and everything that goes along with it. Um. When you have more complicated tax and, and you're, and you had, you know, clean tax returns, et cetera, et cetera, et cetera. When you're self-employed like myself, it's a little bit more difficult to get the financing pieces, you know, set up. So oftentimes, you know, I use um, DSCR type financing. I'm willing to pay more fees and points for that. For the ease of the financing piece of it. So, you know, those are other, other small nuances that we have to take into consideration when you're acquiring the properties.

jacob:

that's a great point, Mike. And, and, and we'll kind of bottom line this, you know, this is gonna be a quicker episode today, but we'll bottom line this. The reason I don't like the question, should I invest in rental properties, um, using an LLC, is that it just kind of misses the point entirely. You just need to start, right? You just need to start, you just need to pull the trigger. You just need to buy the property. And adding this little layer of should I do the LLC or not? It's just another roadblock. It's just another kind of excuse or like, oh, well I gotta set up the LLC and things like that. And it's just like you don't. You don't need to do that. And that's what I, that's what I don't like about it, is that it's hard enough to bring yourself as a rookie investor mentally to the table to invest. It's hard enough to do that. You start adding in the, oh, do I have to get an LLC? And then like, oh, is the LLC supposed to be in the state? The property's being purchased in, or should I set it up in a state where I have anonymity like Nevada or Wyoming or whatever, and then you just go down this rabbit hole. And then what? You never buy the rental property, right? You never buy the rental property and then on top, so, so that, that's what I don't like about it. At the end of the day, it's like, if you wanna do that, that's your prerogative. That's great. But if you're just a rookie, like that's an advanced tactic, Mike, that's an advanced tactic. It should be considered an advanced tactic. Don't, just don't stress about that. If you're getting your first rental property.

mike:

it's funny you mentioned it. Uh, I was actually gonna say this, but I had somebody one time contact me, had never brought a property, not even their own personal residence. But they had gone through the exercise of setting up a Wyoming LLC holding company. They had set up a, uh, Ohio LLC and the Wyoming LLC owned the Ohio LLC. Right. And, uh, I, I don't know if they ever did buy a property. They never bought a property with me,

jacob:

Yeah. And, and, and that's, and that's what I'm saying is that it's just like, if you wanna be a real estate investor, buy a house, setting up the LLC setting up your, you know, your website or whatever, setting up all that stuff, that's not real estate investing, that's not it. You gotta buy the property, you gotta analyze it, operate it, run it, manage it. That's, that's being a real estate investor, not setting up the LLC. And so that's it. At the end of the day, folks, like, I don't think, I don't think that you need to stress yourself out, and this is coming from someone that went down this rabbit hole myself, and I was like, you know what? I'm just gonna buy the properties first. And that's what I've done. That's still what I do. I do not see a need at this point in time, uh, to own my properties in an LLC. Well, might that change later on down the road? Sure. Maybe, um, maybe I, I might find the need and the, the utility, uh, to shift. Title over and, and shift my financing over and things like that, that might, that might come down later on down the road. But I didn't let that stop me from just getting started. And so that's what I just really don't like about the LLC question is it just stops a lot of people from getting started. On top of that too, Mike, it's a little bit more. It's a little bit more complex in that and it's, it's a little bit of an annoyance because in California, for example, each LLC that you have, you have to pay 800 bucks regardless of that. LLC is making money or not. You have to pay a fee if you live in California and you have an LLC and that's just a little bit annoying. It complicates your taxes as well.'cause you'll have to file taxes for that LLC and things like that as well. So it, it just complicates things. And real estate investing is. You know hard enough, so don't make it any harder with things that you don't have to do. And again, this is not me and we're two dudes with a podcast. We're not saying. Don't set up an LLC. We're just saying why you may or why you may not, and why for most people, especially rookie investors, they probably don't need to set up the LLC. Just make sure you have the right insurance and to clarify as well, Mike, this is residential rental properties, right? So one to four units. When you're in the world of commercial, it's a whole other animal entirely. If you're in commercial, five units and above, you're gonna have to get. A commercial loan anyway, right? You're gonna have to get a commercial loan anyway. And when you're dealing with commercial and you're dealing with commercial financing, then yes, set it up and buy it as an LLC. There's more complexity, there's more risk in commercial. You're already getting commercial financing, commercial insurance. So set it up, buy the commercial properties than LLC. But when you're talking about single family house, a duplex, a triplex, a fourplex, even, you probably don't need to own it in an LLC. So that's kind of my take. Let us know when the comments or you know, message us if you kind of vehemently disagree. That's really funny. When I have conversations with people, I get very visceral, visceral reactions from people to be like, no, like you're exposing yourself to all this risk and you're doing it the wrong way. And you're like giving people the wrong advice. I'm like, look, I'm not telling you one way or another what to do. I'm telling you what I do. I'm telling you what I think. Um, and. That's fine. Everyone can have their opinion in real estate investing. We're sharing ours, but any closing thoughts, Mike?

mike:

This topic does not need to make it so complicated for people. And you know, as somebody who works with investors and, and interviews and consults with potentially new investors, this is a topic of conversation that I have every single week. And I, I think people make it way, way, way more complicated than it needs to be. And uh, you know, my advice is just. Buy a property, um, the best teacher is doing a deal and we can figure out the rest, right? Um, and maybe even for a future episode, I'll have to hit up, uh, one of my local attorneys here in, uh, in Cleveland and see if we could do a follow up episode and bring him on and, uh, get his take on all of this. So.

jacob:

Yeah, that would be interesting'cause,'cause I think that a, a lot of the podcast episodes and YouTube videos with attorneys. They're all kind of doom and gloom and they're like, you gotta set up the LLC. You gotta set, set up the LLC. I think that's what dri like, a lot of that fear is what drives people to think that this is it. And all I'm saying is like, don't just, don't just accept what's being said necessarily. Right. They're like all, everyone just is like, oh, I just gotta do this. But think critically about the reasons why and then, you know, make the decision that's right for you. But at the end of the day, like Mike said, just get started. Just get started and don't over complicate the situation. but yeah. Anyway, that's the episode for today, folks. I hope you found it helpful. If you thought it was helpful, consider giving Mike and I and the Financial Freedom Fighters Podcast, a five star rating wherever you listen to podcasts. If you're watching this on YouTube, make sure to like and subscribe. If you have questions about real estate investing, you wanna reach out to me, you can find me at social. On all socials at Cashflow Saga. If you wanna hit up Mike for any questions or learn about the Cleveland realestate market, you can find him at realtor Michael Magno. We are the Financial Freedom Fighters Podcast. We will see you in the next episode. Peace.

Nancy:

Goodbye

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