You should also remember that there are significant disadvantages to buying a property through an LLC before you take this route. Consider the initial and ongoing costs, difficulty getting a mortgage, lack of preferential capital gains treatment and a few other disadvantages, which we'll go over in detail. Setting up an LLC can cost quite a bit due to legal fees. A major part of the cost involves filing your LLC's articles of organization, which can cost $40 – $500, depending on your state guidelines. You may also pay for business licensing and permit fees. Once you get your LLC up and running, you may pay special minimum annual LLC taxes, annual report fees, registered agent fees and business license renewal fees.Cost
Make sure you get good legal advice when you form your LLC – you don't want to take the do-it-yourself approach with this.
Difficulty Getting A Mortgage
The most difficult part of attempting to get a mortgage with an LLC structure is that residential lenders don’t like to lend to LLCs because of the limited liability it offers.
Banks know that LLC members and shareholders can't become personally liable for the LLC or corporation's debts. In this case, many lenders will only extend a mortgage loan to a small LLC or corporation if the business owner volunteers their own personal assets to back the debt.
Again, Rocket Mortgage doesn’t loan to LLCs.
You’ll Pay More
Attempting to buy a property with an LLC gives lenders an unequivocal tip-off that the owner has attempted to purchase the property for investment purposes instead of purchasing a primary residence. This means that because a first mortgage takes priority, an investment property will take a backseat in the event of financial trouble.
In turn, this makes investment properties carry slightly higher interest rates compared to interest rates on a primary mortgage.
You Won’t Be Eligible For Most Types Of Residential Loans
You cannot tap into all types of residential loans if you want to buy a house with an LLC. For example, you can't get Federal Housing Administration (FHA) loans with an LLC. In addition, you also cannot get a conventional loan sold to Fannie Mae and Freddie Mac with an LLC.
As a first-time real estate investor who wants to buy a duplex or multiplex unit, you might be better off taking advantage of the FHA’s low down payment options instead of setting up an LLC. You also give up certain tax perks when you get an LLC. You can deduct the mortgage insurance on home loans on your personal income tax.
You’ll Give Up Preferential Capital Gains Treatment
You pay capital gains tax when you sell your house for more money than you paid for it. Normally, you would receive special treatment on capital gains tax when you buy a primary residence. You pay no capital gains tax on the first $250,000 of profit if as a single individual. Married couples enjoy a $500,000 exemption. However, you forfeit this treatment when you own property for investment purposes.
In order to qualify for the capital gains tax exemption, you have to own the home for at least 2 years out of the 5 years preceding the sale. You also have to have lived in the home as your primary residence for at least 2 years of the previous 5 years. They don’t need to be the same 2-year period.
