There will always be something that bites you from time to time. It’s just the way it goes, but proper preparation can help keep this to a minimum. Things break without notice so always have cash for such things. There will always be insurance requirements and tax bills and the more you expect the better off you will be.
Create a Separate Entity
Always create a separate LLC (Limited Liability Company) for each individual property. Sometimes, if you have plenty of money and good attorneys you can combine properties under a single entity making things easier, but when you have one or two keep them separate. This is for liability reasons. If someone burns down one property killing their neighbors you don’t want them getting the rest of the properties that entity owns in the settlement. Think about your exposure and tenant stupidity.
Create Separate Bank Accounts
I cannot stress how important organization is in life. The more organized you are the more successful you will be – hands down. Organization also provides you the peace of mind to be able to sleep at night – also important.
For our rental properties we utilize three separate bank accounts for each property. This may seem like a real pain, but it’s how we fight human nature. It is human nature to spend every dime you have. It’s human nature to eat everything on the plate. The only way to make sure you don’t spend every dime is to keep it separated and allocate funds immediately.
Therefore, one account is an escrow account for holding security deposits. It’s nice to keep that money separate for legal reasons, but we mainly do it so we won’t spend it (back to human nature). That money is legally the tenants, not yours and it should remain that way throughout the duration of their lease.
The second account is the primary operating account for the property. It’s the account we draft the rent into and pay the bills and mortgage with.
The third is the deferred maintenance account. This is very important and gets back to how we allocate funds immediately. The last thing you want is a hot water heater blow up and you’re broke. By using a deferred maintenance account we allocate a certain amount of cash each month and set it aside to help pay for that unexpected hot water heater. The bottom line is: be prepared!
Do Not Intermingle Funds
Of all the small businesses I’ve seen, purchased or tried to purchase the most common “problem” is the fact everybody runs personal expenditures through their business. This is asking for trouble and should never be done. No exceptions. It’s bad business.
If you need money and the company has money to give then make it a distribution or, if you have payroll setup, a regular payroll check. As a last resort you can create a “due to/from” account and owe the company money like a loan, but never cut checks or pay personal bills using your company account(s). Regardless of which method you choose it can get out of hand. I know because of experience. I once owed one of my companies nearly 200k in the due to/from account and it took years to pay it down. In fact, I owe it 26k as of right now and plan to pay it off this year. It’s been there for nearly a decade so don’t get in that trap.
Also, the tenant security deposit escrow account is completely off limits. Do not touch that account – ever.
The taxes on an investment property will be handled differently by the governing municipality. Remember, an investment property is not your primary residence and, thus, is not subject to homestead exemption. Therefore, be prepared for your taxes to be double sometimes triple what they would be if you actually lived in the property.
Here in Rankin County my taxes were running roughly $600 a year with homestead and without it’s roughly $1500. Also, rental income is taxed (income tax) at a different rate (typically ordinary income) so your annual tax burden will change and this can catch some rookies off guard.
You must have a good relationship with a CPA to operate any business. It took years to find one, and can be very frustrating and expensive, but it’s worth the effort. Try to learn from them. I absorb any information I get from anyone I hire like a sponge. I’m paying them so I might as well learn something!
We actually just learned a lesson on Insurance recently. Investment property insurance can be a pain in the ass, and we just never took the time to shop around. Well, shopping around can same a ton of money.
One company may not handle rental property or investments very often and their rates can be significantly higher than another company that is more comfortable with it or might even specialize in it.
We recently saved half on our annual premiums by switching providers. That was a lot of money and helped with our ROI for sure. Get three quotes on everything you do from insurance to hot water heaters – no exceptions.
You will need to hire a good attorney and a good CPA. Any small business owner that tries to go without either will get themselves in trouble quickly. If nothing else, they are there to bounce ideas off of, provide opinions and to learn from. Take them seriously and listen. They may think of something you just never would having no experience. They are well worth the money and I believe you should talk to them before making any decision on anything. Sure, you’ll pay their bill, but that bill could be 1/100th the cost of a real mistake had you moved forward.