CA Resident owning OOS income properties-How to structure entity?

[Keong Kam]

Hello! A question for fellow BP investors!

I am a CA resident and trying to create an LLC to protect my assets in Missouri.

My CPA says I need to create a CA LLC and then register in MO, then transfer MO properties into the LLC.

So,  basically:

1. To create an LLC in CA, there is some fee for this.

2. To register in MO as foreign LLC operating in state, there is fee for this

3. Then there is annual fee to maintain CA LLC and probably also to foreign LLC registration in MO?

4. CA LLC has min $800 franchise tax?

5. My CPA also says CA state taxes on my income from MO LLC for the portion of the difference between MO and CA state tax.

????????????

Seems like cost could quickly mount up!

How are other CA investors with OOS properties structuring the entities? 

I am searching around for real estate/tax attorneys to consult on this, but would really appreciate if someone can share what's working for them.

Thanks-

[P.J. Bremner]

@Keong Kam

I heard the exact same thing from my CPA, so I decided to go the Umbrella Insurance Policy route rather than LLC route. It may make sense to go the LLC when you start to get assets in the several millions, then the $800 is a negligible expense.

For now, I make sure all of the homeowner insurance on these properties have good coverage (I like minimum $500k liability) plus a couple million on the umbrella.  My personal umbrella covers about 5 properties, my cars, etc. and the premium is like $400 per year If i recall.  

My personal opinion is that I would rather a lawsuit take my insurance premium a little higher rather than losing everything in the LLC. I've also heard from some that out of state LLCs MAY not protect you in some instances. I'm not a lawyer, I heard this from other lawyers, so take it with a grain of salt. I would love to get some lawyers perspectives on this though.

[Keong Kam]

@P.J. Bremner

Thanks for the reply. I kind of had similar thoughts after researching...

Definitely sucks when the cost of maintaining entity cuts into your bottom line on merely a couple of properties owned... especially with the additional penalty of being a CA resident...

I think there may be some cost of entity and LLC protection that becomes less and less significant as you build up larger portfolio, but I was also told by my CPA that if I put each property into separate LLC, that means $800 CA franchise tax on every single one of them,,,, which does not really become less significant with more properties...

I read in many books especially Loopholes of Real Estate by Garret Sutton, highly suggesting to have all properties in LLCs as second line of defense after insurance policy. 

I will keep everyone posted after I have consultation with different experts.

[P.J. Bremner]

@Keong Kam

Yeah it really sucks being in CA because of the high costs. It's very unreasonable to have a separate LLC for each property when the cost is $800+ each month (you also have to pay monthly for someone to represent you in the state you are doing business, usually a lawyer or a company so that if you get served, they keep it all within the same state).

There are some states that allow Series LLCs, which would be AWESOME if they allowed it in CA, but last I checked they did not. : (

http://www.dummies.com/business/start-a-business/t...

I'm sure it's important to have an LLC to protect yourself against the "Ultimate One-Off Lawsuits" that can bankrupt you, but my opinion is that if the cost of the LLC will also likely bankrupt you because high operating costs, I'll take my chances until I get to the point of being able to absorb it.

Looking forward to hearing what your consultations come up with!

[Matt Horwitz]

@Keong Kam, I'm curious if your accountant detailed why they wouldn't want you to form a Domestic LLC in MO and disregard registration (whether foreign or domestic) in CA. Yes, apportion income and pay necessary taxes, but wondering why the CA LLC is needed. Could be something I'm missing, but would love to hear anything if he has shared or if you ask.

[Keong Kam]

Hi Matt-
I was told that even if LLC is established in other states if I, CA resident, take income from the LLC CA finds out and they still consider I am ‘doing business’ in CA and they will fine you if you haven’t registered in CA let alone that $800 franchise tax... sounds ridiculous,,,,

[Ali Boone]

Well, I would take a brief pause on your CPAs recommendations. First, read this article (and the comments with it because they contain a lot of extra info)-

https://www.biggerpockets.com/renewsblog/2013/08/1...

Then I would ask your CPA to clarify exactly the benefits to having the LLC as to why he/she is recommending it.

[Keong Kam]

Hello @Ali Boone! Read many of your blogs including that one. The blog and the discussions are totally great. 

CPA clearly stated there is no real tax benefit in having an LLC and is for asset protection, I know that. I see so many conflicting and different opinions online and I am trying to get to the bottom of this through talking to expert in person and also online researching. Your blog definitely is on my reference list.

I already have umbrella insurance policy and I understand that is definitely one way to protect assets, but as many says LLC and insurances can work together, not one or the other, to protect you. I guess I really need to weigh the pros/cons and cost/benefits to make the best decision here.

[Gary Mac]

I am not an attorney but have multiple LLCs for asset protection. Maybe you can ask your attorney if something similar may work for you. Make a holding LLC in MO or in a state that is cheaper to maintain an LLC you can put the property there. The trick would be to have another LLC where all the transactions occur. This keeps with the saying of "own everything and control nothing." When you purchase the property it will be in your "transaction" LLC and then you will quit claim it into your holding LLC. Rents should not be made to you personally or your holding LLC. Also make sure you have umbrella insurance in the LLC that always exceed the value of equity within the LLC.

The laws are confusing state to state so it would be good to consult with an attorney about a similar setup for your specific needs. If you are seeking real asset protection it is worth the money to set it up right from the get go...just my 2 cents.

[Ali Boone]

Yep, and definitely find out exactly how much asset protection the LLC really offers. It's not 100% like people tend to think it is.

[Aristotle Kumpis]

I'd be very careful when talking about this topic. Most here are not attorney's and cannot give legal advice. My advice: Talk with a real estate attorney!

[Keong Kam]

@Gary Mac, @Aristotle Kumpis

Thanks for all good suggestions. I am certainly consulting lawyers on this topic. I will update the outcome on the post.

[Jennifer Tsui]

Keong Kam Suggestion: ask your lawyer & CPA about setting up a DST (Delaware Statutory Trust) as your legal entity for asset protection. I'm facing the same scenario as you- CA resident who wants to avoid $800/yr franchise tax (which an LLC would incur) while investing OOS. The upfront cost to setup a DST is more than an LLC, but the fees are far less from that point on.

[Keong Kam]

@Jennifer Tsui

Are you using DST yourself? Does it provide asset protection like LLC? And you can avoid CA franchise tax?

If true, I am definitely interested. I will look into it. Thanks-

[Zhi Li]

Four years later anyone has an update to share on this topic?