This post is for you, if you’ve ever tried learning a subject in earnest, only to wind up more confused than when you started. That’s the case with yours truly and Limited Liability Companies (LLCs.) It could be I just have a terrible attention span, or reading about THIS subject is simply as exciting as watching snow melt in a Minnesota spring.
We have three LLCs. One for the Chiropractic practice Mrs. Cubert manages, and two for the fledgling rental empire. In each instance, it seemed like a no-brainer to establish the LLC structure for our respective businesses. If you go with what the packaging says, an LLC gives you rock solid liability protection, plus some great tax advantages. Good stuff! But it’s the fine print that gets ya.
Full-on disclaimer! Please do your very own follow up research on this fairly complex topic. I am not a lawyer. I am not an accountant. This post is simply me sharing my experience and conclusions. The intent is to give you food for thought, if you ever had any misconceptions or curiosity about this business model.
Do You Need an LLC for That?
Without a doubt, there are a variety of small business that are perfectly suited for the Limited Liability structure. Our Chiropractic business is clearly one of them. Imagine if someone gets a treatment and all of a sudden suffers a herniated disc, unrelated to the treatment. That person could opt to sue us.
The LLC provides a shield that, in a perfect world, prevents us from getting sued in the first place. And even if the patient’s lawyer did choose to sue, only the practice is at risk. The LLC establishes “limited liability”, limited to the practice only, not our personal assets (which includes our house, investments, real estate, autos, the kids, etc.)
Aside from a chiropractic business, just about any small business that exposes you to potential lawsuits is worthy of LLC consideration. That would include real estate rentals, both long term and short term (Airbnb vacation rentals, for instance), a corner bakery, or even perhaps a dog walking service.
I mean, what if Fido went charging after a passerby and bit him on the leg? Or, what if Foofy decided to reroute that leash she’s on and trip your friend, causing her to break her hip? Well, Mr. Dog Walker, what’s to say that passerby wouldn’t be inclined to sue you, as the dog walker in charge? Shit happens.
This blogger’s experience with LLCs
So far no one’s sued me. Which is great. But the way I had been running one of my LLCs, up until recently, probably left us exposed. With LLCs, you need to be mindful to avoid what’s known as “piercing the corporate veil.” Sounds pretty sweet, don’t it? Like a Pink Floyd album title.
All it means is you have to be super careful to avoid any commingling of personal transactions with transactions by your LLC. That can include some really inane and innocent seeming things, along with some obvious ones. Some examples:
Using a personal credit card or personal check to pay for business expenses
Receiving business payments to your personal accounts (or self, via say a check written out to you.)
Endorsing a business payment check with just your name
Using your business credit card to pay for personal expenses
Failing to set up your LLC properly – e.g., setting yourself up as the “owner” (bad) vs. the “manager” (good)
Keeping business assets in your personal name
Items one through four aren’t that hard to master. Just be diligent. I NOW make sure that all my rental deposits made through Venmo or via check are made out to my LLC. I deposit rent checks straight into my LLC checking account. I use business checks when I need to write a check. And bonus, I get lots of points by using separate business credit cards for a variety of business expenses.
On that last one, number 6? Oh boy. With rental properties, this gets sticky. Most of us aren’t in a position to just go out and buy rental houses with cash. And nor should we, unless it’s an auction property suited for a flip.
Applying the concept of “other people’s money“, we acquired our rentals with borrowed money from the bank. And the bank isn’t about to approve you for a mortgage in the name of a faceless LLC. Nope. It’s gotta be tied to a person.
A slightly deeper dive into the landlord side of LLCs
Picking up where we left off on good ol’ item 6 above… There are a lot of different opinions and tactics for landlords looking to get their mortgages into the name of their LLC. One option that’s popular is the “quit claim deed.”
This accomplishes the objective of transferring ownership to the LLC, BUT… And man is it a big “BUT” here… The bank will then have the option of calling your loan due, meaning they can require you to pay your outstanding principal in FULL. Ow. So, so mean.
The other not so hot part about this option is that immediately upon transfer, the quit claim deed voids your title insurance. Trust me. You don’t want to lose this insurance or your ass could end up in a sling.
Some savvy real estate gods go a different route, and transfer ownership via what’s known as a Warranty Deed. Much like the quit-claim deed, but you maintain your title insurance. (You’re still with me, right? Pete? Carl? Jay? Cait? Tonja? Brandon? tap tap tap – wake up!!!) Readers… So fickle anymore.
One last bit on the rental side, I promise
Lucky for me, I have three pretty wise friends who’ve charted a course in landlording before me. I simply get to ask questions and they give me their take. Experience is like gold. One of my real estate mentors says he avoids LLCs because they’re just another way for accountants to make more money come tax prep time. Har!
Instead, he takes out an umbrella policy on each and every rental unit. Now if you’re not familiar with umbrella policies, and you’ve got a positive net worth, and have a side gig or small business, get the bleep on this one. Umbrella policies are fairly cheap, but cover you for $1M and higher in liability.
That’s just one take. Another is kinda similar. My investment property realtor says you’ll get six different answers from six different lawyers as to whether you need to transfer the name on the asset to your LLC. He’s basically in the same camp as my first mentor. “Make sure you’ve got that umbrella policy first. Don’t worry about transferring the asset to the LLC.”
Finally, my third mentor (and colleague) is aligned with our realtor. He has two LLCs set up, one for the properties themselves, and one for property management. Clever, eh? This structure allows you to create even more of a shield around your business.
I’m still learning and researching all of this fascinating stuff. Not because I’m praying to be sued. On the contrary, I don’t want to expose my family unnecessarily just because I was derelict in doing my homework on this stuff.
The LLC construct is pretty useful from a taxation perspective. For one thing, an LLC doesn’t require a separate tax return. You can file with your personal 1040. Business losses under the LLC are factored in with your total income and taxes. This has helped me on a few occasions with the rentals.
Very basically, I take a hit the first year of a new rental property. The cost to buy and set up and improve the property generally means I’ll be taking a net loss that year. At the same time, I’m paying taxes throughout the year via my cubicle job. The LLC “pass through” set up allows the rental losses to greatly reduce our tax burden. Slick.
LLCs can also be setup to take advantage of lower tax rates for your business income. This is where your mighty accountant can step in to point you in the right direction. Generally, for small businesses, the sole-proprietorship arrangement in the LLC is more favorable than a corporate taxation arrangement.
Here’s the biggie: An LLC allows you to set up retirement funds with higher contribution limits. Woohoo! This is a huge advantage over the traditional employee-based savings plans that limit 401K contributions to $18,500 (as of 2018.) As a business owner (i.e., employer) you could squirrel away as much as $55,000 in a solo 401K, or up to $62,000 if you’re 50-plus.
(Update 6/1/18: Thanks to some useful insight from Full Time Finance below in the comments, it is possible to set up a solo 401K without an LLC. Thanks for keeping us honest, FTF!)
Granted, you’d have to be running a pretty successful business (or businesses) to be able to take advantage of this. This is not something the Cubert family is able to do today.
Belts and Suspenders
At the end of the day, the best way to protect yourself and your assets is to avoid being negligent. I regularly come across headlines in our local rags about landlords who are absolute douchebags. They rent out units that are beyond being up to code. Tenants complain about mice, and the landlord tells them to get a cat.
Point is, you can avoid a lot of problems and drastically reduce your exposure if you simply follow the rules. Go above an beyond when it comes to safety. Mrs. Cubert keeps up to snuff on her profession with continued education courses. She cares enough about patients to send them off to specialists, if a bigger medical problem is potentially there.
With the rentals (and now with the Airbnb), I make sure all of those smoke detectors and CO alarms are working. There are twice-annual inspections to check on that, among other things. And I don’t rent to idiots.
So yes, you can do quite a bit to limit your exposure, even in the absence of the LLC. But you can also do everything right, and follow the rules, only to find yourself in the courthouse. Again, shit happens. That’s why I can’t recommend strongly enough that you take out a high dollar umbrella policy at a minimum. Think of this as the malpractice insurance for any small business.
If you want to learn more about LLCs, I’d suggest picking up a copy of Limited Liability Companies for Dummies, by Jennifer Reutling. The book serves two purposes. One, it’ll teach you the basics and history of LLCs. A good way to get started. Two, it’ll help you zonk out right quick, if you’ve been running a sleep deficit of late.
I’ve also spent a good chunk of time over at the Landlord’s Valhalla, better known as BiggerPockets.com. Good gravy. Just like my realtor mentor said, you’ll get fifteen different opinions from fifteen different real estate pros there. But you can at least try to discern and distill the key pieces that may apply to your situation. I.e., good luck, Son.