Before you decide to use an LLC for a rental property with a mortgage, it's important to understand how using an LLC can impact your application for a commercial loan.
An LLC is more of a financial vehicle than a legal entity. That's because the structure of an LLC does not change the liability and taxation status that comes with purchasing real estate as an individual. For example, if you are buying property as your sole proprietorship, then this becomes your only legal form of business organization for all purposes- from taxes to liability considerations.
In the case of an LLC, this means that the LLC's lawyer will have to modify the application for mortgage financing to include the full name and address of each member of the LLC. In addition, he will need to provide information on how much money each member has invested in and/or borrowed from this project.
The good news is that this modification can be relatively straightforward since all members are required to sign an agreement acknowledging that they must share their financial data with others if a loan is involved. This may seem redundant- since nearly every business property purchase incorporates a mortgage– but it's important to note that members must provide this information when applying for any type of personal financial assistance.
Additionally, the application for mortgage financing should be updated to reflect the fact that an LLC is a legal form of business organization. In other words, your lender will be asked to confirm that you are applying as an individual. This may seem like an unnecessary step, but it's important to maintain proper legal status with your lender at all times- even if doing so means losing out on lower interest rates.
Lastly, the title policy of an LLC must be reviewed. Depending on what state you live in, this may mean that the title policy of each member (and spouse) must be reviewed and personally approved before you can buy a property with a mortgage. The good news is that this can be done by an attorney free of charge since an LLC's title policy is not required to be filed with state or federal authorities.
The bottom line is that using an LLC as a business vehicle for real estate purchases does not make you any more or less financially liable than if you were applying for a loan as the sole proprietor of your firm. In other words, you are still responsible for providing the same documentation and legal formality as if you were just applying for a single-family home mortgage.
Incidentally, many real estate investors prefer to use an LLC to purchase property since this structure allows them to avoid paying state and federal taxes on their rental income- without further government interference. This is because federal and state income taxes are not imposed on LLC income. This is the case regardless of the number of members in your LLC, which can include both individuals and spouses.
This means that an LLC can help to give new investors a quicker path to achieve financial independence from their day jobs- since they do not have to pay taxes on the profits received from rental property investments like a corporation would. It also means that you will be able to deduct your annual rental expenses for tax purposes- if necessary. However, this would only be a benefit if you were paying yourself for working in real estate as an employee rather than being paid as an independent contractor.
In short, using an LLC to get a rental property mortgage is not legally or financially risky. However, it's important to ensure that you are properly documenting your financial situation with your lender. Incidentally, if you are the sole owner of an LLC and are applying for a loan as an individual, then you may want to consider discussing this option with one of our other staff members who will help you to find a highly qualified mortgage broker.
Top FAQs on LLC for a rental property with a mortgage
Should You Use An LLC To Get A Rental Property Mortgage?
Another bank has decided that, yes you can use an LLC to get a mortgage. In fact OCFC – Orange County Federal Credit Union has just announced that it will now make loans to an LLC. This was great news for us but not as great news for the banks I would imagine. They had been very clear all along that they would not.
Even though we could have gone to a different bank and gotten our FHA loan through an LLC, we were delighted with this news because OCFC is close to our home and we already do business with them in other aspects of our lives.
Why Not Use An LLC?
I know that there are many people who have asked why you would put the property you want to buy into an LLC if it were not required by the lender. So let me try to dispel that myth for you right now so you can make the best decision on how to purchase your property.
About 2 years ago there was a big study released by the National Association of Realtors which surveyed 1000 investors. The study showed that people who purchased the property in an LLC not only did so to protect themselves against lawsuits or accidents on their property, they also did so to protect their personal assets and income from being attached.
Other people wanted to keep their commercial and residential properties separate so that they could get a mortgage for one while not having the other one affected. It was clear what their intentions were when using this method of ownership.
So what does this mean to you if you are looking at real estate in any form? If you want to purchase and live in it, then use an LLC. If you want to rent it out and live in an area where the rents are going up quickly, then use an LLC. If you plan on flipping or rehabbing it then you might not want one. It is all about the intended usage of the property to be purchased.
The purpose of buying real estate is typically for three reasons: A personal residence, a rental property, or investment/flip property.
If you are going to live in the property, then the benefit of using an LLC will be felt more by you. If you intend to rent the property out and want to buy a higher-end rental property that will attract higher rent and/or one that is located in a nice neighborhood, then an LLC is also useful for this purpose.
If you are looking at buying an investment/flip property, then you should not use an LLC for two reasons:
- If it fails to sell after 90 days or
- It sells but you have decided that it must go through a foreclosure process because the new owner owes more than what they paid for it. If this is true then there is a risk that you will have the LLC's assets attached by creditors, especially if it was not properly formed, and your personal assets will also be at stake.
In the event of a bankruptcy proceeding or any other judicial proceeding where it may be determined that your LLC's assets are going to be liquidated and used to pay the creditor or claimants in the case then all of your LLCs assets including real estate will be at risk.
However, if you are using an LLC solely to protect yourself against lawsuits from tenants or accidents on property, then using an LLC is still a good idea. There are many companies out there that can help you form an LLC and one of them is even free. That company is lllc.com and it is operated by the same people who run my website, biggerpockets.com, which is a huge online community of investors and real estate professionals.
It's All About Your Intentions
If you decide to use an LLC then it would be important to form that LLC in a state that does not tax income from real estate. The reason for this is because if your LLC owns rental property and you are paying yourself a salary from your LLC then you will have to pay state income taxes on that salary. This will reduce your net profit and therefore increase the amount of money that it takes for you to get into your desired property.
There are a few states that do not tax income from real estate, most of them are located in the northeast and they include Arizona, Florida, Nevada, Washington.
If your LLC is formed in any other state then you will have to pay state income taxes on both the rent you collect and any salary that you pay yourself. The benefit of having an LLC, for this reason, is that all salaries and rents go through the LLC which will most likely reduce the amount of rent/salary tax you pay as well as increase your net profit.
For more information, you can visit Real Estate Calculators.
