LLC in State or Out of State?

[Andrew Hinspater]

Hi everyone, my business partner and I have just purchased our first rental property, and are now thinking of the best way to manage the property from a business perspective. We've looked into and are pretty convinced we would like to make an LLC to manage the property (although if anyone has any reservations about that, we're open to other perspectives), however we aren't sure if we should make the LLC in the state we are buying the property in or if we should make an LLC in another more "corporate friendly" state. What advantages do we have by making the entity in the state our property is in that we wouldn't get anywhere else? Does the state your LLC is in really matter with only a handful of investment properties? Google searches on this subject haven't proved to be succinct or clear, so any help would be appreciated!

[Stuart Udis]

To be clear you are contemplating an LLC for management purposes, not as the deed holder given you already acquired the property? Not only will this add no additional protection, it will merely add operational costs. Most fail to understand the mechanics of the court system and how litigation works. Most of what is proposed on Bigger Pockets in terms of layering of entity structures will not prevent plaintiff attorneys from bringing claims. In fact, more times than not they are case studies for alter ego theories that can be brought by plaintiffs attorneys. In the event you were to proceed with what you are suggesting & there is a claim brought by a plaintiffs attorney, they will likely bring both the management company and the deed holder in as defendants making the litigation more complexed for you, the defendant. This is because plaintiffs attorneys first objective is to take inventory of who has insurance. It's the path of least resistance and the most certain payday for their client and themselves. Knowing this, the most prudent things to do are:

1. Have the deed holder be an entity (the exact entity and state of filing should be determined by your legal counsel with input from your tax professional). 

2. Have appropriate forms and levels of insurance in place

3. Focus on performing your day to day operations in a manner that will reduce the risk of claims in the first places such as hiring reputable service providers, sign contracts each time you engage a 3rd party vendor & collect insurance certificates where you are listed as additional insured from everyone who performs work on a property you own or provides a service related to a property you own. If they are not willing to sign a contract or provide an insurance certificate remove them from your vendor list.

4. Operate your business in accoordiance with your operating agreement/partnership agreement. This is what makes your entity an asset to you, not the filing which is worthless if you fail to follow the  partnership/operating agreement. 

If these steps are completed consistently, you will be fine without the headaches or expenses that most think are necessary. I find most invest all of their money and energy on formulating complicated entity structures and then obtain insurance because their lenders require it, not necessarily because the borrower/investor values the benefits. Meanwhile, my suggested steps 3-4 are completely ignored despite offering the greatest preventative measures not to mention providing huge cost savings over time.