LLC or S Corp or Umbrella insurance?

Question

Hello -

I have 11 properties in my own name and a $2m umbrella insurance policy. I’m looking to eventually get to 20-30 units and want to be prepared.

Annoyingly, in the state of California, you have to pay $800/year on each LLC and have to file a separate tax return for each LLC bringing the annual cost to like $1200 or so. Kind of kills the cash flow if you have to do a separate LLC on each property.

What’s the best entity to have, and is there a way to set one up where the tax savings outweigh the costs?

- Josh

Megan Templeton · Answer

Hi there! @Josh Edelson

As you mentioned, the issue you will run into with an LLC while being a CA resident is that you will have to pay the yearly $800 franchise tax. The Delaware Statutory Trust (DST) is a great option to avoid the franchise fee - its is a business trust that provide operates similarly to a series LLC. You will be able to set up the DST with a one time filing fee and paperwork with DE and then will be able to create unlimited child trusts underneath the parent DST (child DSTs do not require any additional filing fees or state paperwork). By using the DST you can save on costs but also have a structure that is scalable as you will be able to put one property into each child trust so you have liability compartmentalization. DSTs can also be useful for 1031s and other assets. It also helps streamline operations by allowing you to use one bank account, on set of records, etc.

Thanks,

-Megan

Jake Wiley · Answer

@Josh Edelson - California is a beast when it comes to LLCs and the $800 fee per entity.

You don't see many folks using an S Corp with Real Estate, possibly with a management company where a salary would be paid, but not at the property level.

In terms of mitigating costs, a well-strategized insurance policy and aggregation of several properties per LLC that have similar risk characteristics and equity is likely the best way strategy in California.

Other states can utilize a Series LLC structure, but it appears that California would still consider each series LLC another entity and thus charge the $800 for it.

Darius Ogloza · Answer

I would definitely up my umbrella policy limits.  Keep in mind that several prominent umbrella carriers will not insure more than 10 properties (RLI is one that comes to mind).  Check with your carrier to make sure all 11 of your rentals are in fact covered under the terms of the policy.

California has a relatively lenient piercing the corporate veil rule so using LLC's as a liability limiting device has limited value and, in any event, absolutely strict compliance with corporate formalities is necessary.  The cost of compliance is pretty high in terms of time. Multi-person LLC's allow you to get around the FTB's tax withholding rules on sales, though, which can make the device worthwhile if you are a flipper.

John Mocker · Answer

Josh,

Generally I think it is a good idea to keep the umbrella with the same carrier as the underlying policies but if that carrier will not offer the limits you need, there are markets that will.  One of those is PersonalUmbrella.com.  You need to work through and agent to access them.  I checked their CA guidelines and they will do up to $5,000,000.  A good independent Agent should have access to other Stand Alone Umbrella markets.

Justin R. · Answer

@Josh Edelson I live in CA and have several properties and went down the research pipeline five years ago regarding asset protection. I decided on the DST structure. It’s safe, easier than an LLC to maintain good standing order (which I also use for partnerships), and much cheaper in CA over the long run. Feel free to reach out with any questions on the DST. It’s a newer structure (at least when used in this fashion) so not a lot of people have real experience with it.

Megan Templeton · Answer

Hi there! @Josh Edelson

The DST does have tax benefits - particularly when it comes to 1031s. The DST allows you to sell your rental property and defer the capital gains tax and invest into a self managed portfolio of real estate. A DST also allows you to capture business expenses because its considered a business trust.

Thanks,

-Megan

Kim Crouch · Answer

I have it in my head not to put real estate in an S Corp. I can't quite remember why, and it may be state specific. I'm in NC and think it has to do with the way franchise tax is calculated on an S Corp versus an LLC, and that it can be based on assets inside the entity, thus driving it up for real estate holding companies in an S Corp, versus a flat $200 fee for an LLC. But that's NC and I know things are different in CA. Anyway, I think your best course of action is consulting both a CPA for the tax side and an attorney for the legal protection, preferably both of whom work in conjunction with each other and can advise you simultaneously.

Tom O. · Answer

my umbrella is $300 for $1 million. So $1200 buys a lot of umbrellas.

Kevin Chubet · Answer

From a strictly tax standpoint don't put the real estate in an S-Corporation. There are many negative pitfalls - mainly if you ever sell the real estate held in a corporation it is not friendly. S-Corporations also aren't eligible for step up in basis and if you want to specially allocate anything you really can't unless you create multiple classes of stock. Every large development you can buy into is always taxed as a partnership because it makes way more sense and allows for way more flexibility.

Josh Edelson · Answer

On #5, it would be money I would have to pay taxes on, not money I would have to hand over to uncle sam.

Also, according to the internet, it costs about $100 for each Wyoming LLC to setup ($1100 for 11 properties) + $50/year for each ($550/year) totaling $1550. After that, also according to the internet, setting up a California Trust would cost about $1k or so and then an additional 1-2% of asset value ($3m) per year ($30k-$60k/yr).

Am I missing something? Seems extraordinarily expensive.

LLC or S Corp or Umbrella insurance?

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