This is part 3 of our series on Entity Structuring Questions and Answers.
QUESTION: I have a rental property in Colorado and have created a Colorado LLC to hold it. However, I bought the property under my own name and have a small mortgage under my name. The mortgage company won’t let me transfer the title to the home to the LLC with the mortgage in my name. I could pay off the mortgage, but that would leave me more cash poor than I care to be. A friend suggested that I lease the property to my LLC (it’s a single member) and that would give me the legal umbrella of the LLC and still keep the mortgage company happy. Has anybody ever done this or heard of it being done? Thanks.
ANSWER: Usually, the mortgage company will not let you transfer the title without triggering the due on sale clause. I have usually just transferred without getting them involved and as long as the mortgage is being paid, then you are fine. Going on almost 10 years of my properties being in an LLC still with a mortgage in my name. Leasing the property to your LLC is good in dealing with tenants but no protection in dealing with creditors as it will still show your name on the title.
QUESTION: Ultimately, I just want to qualify for a cheap conventional mortgage, and buy a property. My W2 income, personal debts, and credit score are extremely better than they were when I purchased my first property. The first property is now a rental. My big snag is that the rental expenses along with all the expenses associated with my LLC got put on a Schedule C for my taxes.
All those business expenses/deductions lowered my personal income, and hence my purchase price.
It also ruined my ability to purchase personal property because, in the eyes of the underwriter, I already have one. They do not see my first property as a rental because the rental income is in my schedule C.
How do I need to structure this convoluted mess of a rental property business to accomplish the following:
-lower my overall tax liability
-increase my purchase price with a conventional loan
-not mingle personal and business assets so as to keep the corporate veil strong
I would assume that to lower my tax liability I would need to deduct business expenses, but where do I put the business expenses? I don’t want them counted against my personal W2 income by mortgage underwriters. Would putting the business expenses under Schedule E work?
I was told that the rental income goes on Schedule E too. I need it to count toward my personal income to counter the mortgage that is under my personal name.
I was also told the LLC’s business expenses go on a schedule C. That does not sound right to me, because it still leaves me with a really low income for purposes of calculating my maximum purchase price.
ANSWER: You would need to file an amended return and report on schedule E. That this is being done through an LLC does not change the character of the income. Its rental income and rental expenses and so should be taken on schedule E or 8825 if a partnership LLC. Treating this property as a business property will require that you transfer the property into an LLC and not keep it in your name. You still get the same tax benefits but with an added layer of protection. Moving the property from a Schedule C to a Schedule E or partnership form 8825 will show that this property is a passive income asset and therefore will not be considered as active income.
QUESTION: What would be the rationale for making a loan with a promissory note from your personal name to your LLC instead of just making a capital contribution? Is there some tax advantage to doing that? It seems simpler to just make a contribution.
ANSWER: It’s whether we want to show the company as highly collateralized or with high equity. Showing a loan has certain protection in that debts need to be satisfied first before anyone else is paid off which includes this loan. Having it just as equity means that if there are any lawsuits, you the member are out whatever you invested.
QUESTION: When investing through an LLC, if you invest outside your state of incorporation, do you need to file a DBA (Doing Business as) or anything similar in the state you want to invest in? Or is it better to start another LLC in the new state?
ANSWER: You do not need to file a DBA but it will be important to file the LLC as a Foreign LLC in the new state. There is no need to form a new LLC
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