LLC for out of state rental properties?

Question

Hi All,

I have been pre-approved for my first investment property. I have set up a weekend with a real estate agent in Cleveland to look at some small multifamily properties (2-4 units) and hopefully I will find something I like. Some have mentioned setting up an LLC. Is this necessary for my first property while I get my feet wet investing in rental properties? If so, do I have time to do so within the next month and would that change my letter of pre approval situation? If I buy now under my name, can I later put it into an LLC? So many questions. I should also mention that I live in California. Any help would be appreciated.

Costin I. · Answer

@Jessica Beard Here a diagram to help you on this quest for answers:

John Corey · Answer

Check the laws of the state where the property is located. If you have the property in an LLC or some other entity, you may be prevented from filing an eviction if the entity is not registered in the same state as the property. This does not mean the entity has to be set up in the state. Just that the lack of official registration in the state where the eviction action is taking place is blocked until you register the entity there.

Example. I create an LLC or similar entity in CA. $800 a year.

Alternative, I create the entity in DE for economic or business reasons. Assume it costs less to create the DE entity and the business rules are better.

If the property is in CA and the DE LLC is going to be on the contract as the landlord, I need to file annually in CA an out of state (foreign) registration. You do this with the same CA authority who I could have registered with originally if I set up a CA entity.

The cost for the foreign registration is the same $800 a year. In this example, I would be paying and managing the DE registration and the foreign (DE operating in CA) registration.

I am not suggesting one path is better than the other. Just be careful about partial info found all over the Web when trying to decide the best place for an LLC, etc. What is optimal for some reasons might be suboptimal for other reasons.

Matt K. · Answer

Any LLC will trigger fee in ca...

If you finance it's unlikely it'd really be of much help. It'd be easy to pierce when you buy in your own name then transfer later on ....

Unless you have lot of assets or income/high net worth you probably don't need a LLC for a financed OOS property.  If you have either/both and do need an LLC it's likely your social/professional network has some trusted referrals.

Don't be a slumlord and buy high risk properties and you'll reduce your risk of a lawsuit.

Scott Smith · Answer

@Jessica Beard Congratulations on your first investment property!

When I sit down with clients, I always discuss (1) their personal assets, and (2) what their current investments portfolio and other business ventures are before discussing (3) their future goals. Each of these variables will dramatically change the advice I give the individual asking me this question. Generally though, I break it down into the "five pillars" of protecting your assets.

The first pillar is avoiding unnecessary and risky activities (don't drink and drive, insurance generally won’t cover your poor decisions) and take good care of your investments(maintain your property, etc) - these simple steps will help you prevent lawsuits before they even occur.

The second pillar is a good insurance policy as that cover the majority of your exposure. However, insurance is limited because it only protects you from one type of liability: accidents/negligence. Insurance doesn’t protect you from any part of the sale or acquisition of a property (e.x. Somebody wanting to sue for you backing out of a bad deal or accusing you of selling them a property with defects like unknown termite damage). Insurance also doesn’t protect you from misunderstandings, especially those made in writing and email. What happens in these misunderstandings is that something goes wrong either in the sale or after, and then they sue you for some statement you made that they “misunderstood”. That lawsuit is a claim for fraud, and that’s what fraud typically is...a misunderstanding and someone being “injured” and wanting to hold the other responsible for it. Insurance never protects you from these kinds of claims and they happen all the time.

The third pillar applies after you have good insurance You need to protect yourself from what insurance doesn’t cover by compartmentalizing your assets. Compartmentalization means that if something happens to one property, people suing can’t touch you or the other properties. You should use either LLC’s (the old and expensive way) or a Series LLC (the new and more cost/time effective way). No matter where you live or where you own assets, I personally recommend the Series LLC to be a great tool for the individual investor who is planning to expand their operation, as it allows for you to scale infinitely for FREE. If you’re interested in using an LLC, this article  also further explains the advantages of a Series.  (In your case a DST may be a better fit because it avoids the $800 per year but the structure is similar so the information still applies)

The fourth pillar is somewhat similar - you want to separate your operations from your assets. One company owns everything and does nothing (this is your SLLC a/k/a “asset holding company”) and a completely separate company handles all of your operations (this is a traditional LLC a/k/a “operating company”) For the operating company which serves as your face to the world and through which you do all your business, you establish a Traditional LLC to carry out the operations of your investments. The operating company takes on all of the liability that would otherwise blow back on you including: paying property management, paying contractors, collecting rent, marketing, etc.

The fifth pillar is owning everything anonymously. If people don’t know that you have assets, then they are less likely to sue because there’s no use in suing people that qualify for food stamps. This anonymity can be accomplished for free by using land trusts to own your companies as well as the assets. Trusts create this anonymity by removing your name from public record. Even if they can see you used to own a property, when properly transferred it will look like it was sold to investors. If they somehow guess you are the owner though, it still doesn’t matter because you would not be the owner. The land trust and the LLC are the owner of the asset/real estate, so even in the scenario that potential litigants guess, they would guess wrong.

If you have any questions feel free to leave a reply or send a DM.  Happy to help.

Jessica Beard · Answer

Thank you all, this is great information!

Allan Szlafrok · Answer

@Jessica Beard You can transfer to an LLC later if you want to. Ask an attorney (I’m not one and not giving legal advice) if opening an LLC in another state would still trigger that California LLC fee. A lot of people go with Delaware LLCs although most of those people couldn’t tell you why they just heard it’s a good idea. Personally I’m on team “always buy with an LLC” but ask a CPA if that makes sense for you.

James Wise · Answer

The bank is only going to lend to you so you're going to need to keep the properties in your personal name if you want to finance them.

Katie L. · Answer

@Jessica Beard

There are several considerations that can go into the analysis of whether you need an LLC or whether a large insurance policy will suffice. Will depend on several factors like the type of property, type of tenants, your risk tolerance, other assets you own, your estate planning, laws where the property is located, etc.

Any lawsuits would be limited to the assets of the LLC and not your personal assets (assuming you run the LLC appropriately and the corporate veil is not pierced). But, an LLC will not limit you from liability in total. You can still lose your investment in the LLC. If you're going the umbrella insurance route, make sure it will cover you for several things including just the routine slip and fall (like mold or earthquake). You'll also want to ensure you have a good property manager to look after the upkeep of the property if you are not there to notice anything deteriorating or which may need attention.

This article goes into a lot of the considerations about whether to form an LLC or not: https://www.mmpph.com/wp-content/uploads/2019/04/May-2019-newsletter.pdf

Creating an LLC in California would cost you a minimum tax of $800 every year. You would have ongoing filing requirements with the State and would need to keep business records and documentation.

You also want to look at whether a pass-through entity helps your bottom line and your taxes. There is a new 20% pass through deduction you may qualify for that could help you, but not everyone qualifies. You should still be able to get this even if the properties are not in an LLC, if you qualify.

These are all things you will want to discuss with your attorney and CPA. If you need references for either of them in San Diego, let me know.

*This post does not create an attorney-client or CPA-Client relationship. The information contained in this post is not to be relied upon. Readers should seek professional advice.

Ali Boone · Answer

I definitely wouldn't for your first property. It's putting the cart before the horse and not really for any gain. Plus if you're in Long Beach, it would trigger the $800/year LLC fee California would charge you.

Here's extra info:

https://www.biggerpockets.com/blog/2013/08/17/rent...

Mike S. · Answer

In my view LLC are a necessity in real estate for asset protection. However, they create some additional burden and cost. Fort instance, your lender may not give you the same loan condition it you are taking title of the property into an LLC. Some may even refuse to even give you a loan in that condition. There are some strategies to mitigate it, but they also add complexity and cost.

Liability insurance is not a replacement for proper asset protection. Both are needed.

Now, based on your specific situation, you may or may not decide to use asset protection strategies. Like everything else in life, you need to make an informed decision taking into account all the factors. Is the risk worth the additional cost? Only you can answer that. In my case, I decided that asset protection was a must.

Whatever decision you will make, you have however a duty to get educated on it to understand your options.

LLC for out of state rental properties?

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