CA Investor - Investing Out-of-State - LLC or Umbrella Policy?

Question

I'm living in California and I'm in the process of getting a rental that is out-of-state (OH, specifically). I just recently found out about the ridiculous CA Tax for a Foreign LLC operating/doing "business" in CA, which even a basic phone call is considered "business". Since this tax is $800 per year, that really eats into my cashflow. The only thing I could think of is if my brother or parents, who still live in OH, become the LLC member(s) but I don't really want to put that burden on them (and not sure if that is even "legal").

The other option it seems that I'd have to go with is an Umbrella Policy which should be cheaper, when compared to the LLC and the dumb CA tax (but I do not have an Umbrella quote yet).

Are there any other reasonable options for coverage against your personal property/financials in case of legal issues? I guess this is probably aimed more for other CA residents that have rentals out-of-state but I'm open to anyone's opinions/options!

Brian Dudash · Answer

@Katie Lepore Thanks for response and details! Based on that min. $800 tax alone is not worth it for me...

@TJ Watson I wish I was a multi-millionaire :) As you can see, I'm still learning a bit about REI and working to close my first deal and I'm trying to protect myself the best way possible. Appreciate the response and I think the Umbrella policy route is the way I'm likely to go.

Christopher Smith · Answer

I'm a CA resident with OH rentals (and CA rentals as well). The best way to protect yourself is to do your due diligence and run a responsible operation. I have B+ properties with PMs in both states who screen for responsible tenants.

I also carry solid landlord insurance and limited additional umbrella coverage, but more importantly I don't engage in unnecessarily risky personal activities.

The idea is first run a responsible operation performing due diligence as needed and likely you will never need a convoluted Rube Goldberg legal entity structure that provides dubious protections to begin with.

CA is a confiscatory state absolutely desperate for revenue so I wouldn't count on the minimum tax charge LLC going away anytime soon. They are even talking about eliminating the heretofore untouchable prop 13 for businesses taxpayers, which will make property taxes go totally out of sight.

Tom Kastorff · Answer

@Brian Dudash no worries, just giving you a hard time to think from all angles. I used to sell insurance, so I know things happen. But they are very small % likelihood. If you own property you need to protect yourself, but only if you truly have a ton to protect and don't have enough up front (insurance, safeguards) in place to protect you. Just having a true SFH rental, not many reasons to need more than $1M insurance, maybe $2M if you really are paranoid. Most accidents that happen at a property will be that tenant's issues or their own insurance (theft, slip and fall, etc.). You are really only worried about catastrophe that somehow comes back to the property owner. Really only something I would get worried about if I had tons of assets to be sued for.

Tom Kastorff · Answer

@Brian Dudash are you a multi-millionaire? Millions in assets and cash and properties? So much in the bank you cannot sleep due to paranoia?

If not, probably a $1-2M GL policy or umbrella is plenty to protect you. Talk to an insurance agent, or your CPA, whatever makes you feel comfortable. The insurance guy can tell you what typical claims in his area look like for homeowner / rental policies. Not many ways for a renter to need to sue for more than $1M unless someone drowns or dies horrifically on your property due to YOUR property or malpractice. I really think the talk about LLC and protection is overblown for the average buyer.

Katie L. · Answer

@Brian Dudash

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.

Eamonn McElroy · Answer

"The only thing I could think of is if my brother or parents, who still live in OH, become the LLC member(s) but I don't really want to put that burden on them (and not sure if that is even "legal")."

You have more power than you think...

What I'm about to say is a logical fact, not political partisanship: the reason that California puts an $800 annual LLC tax on small businesses is because the people of California either voted for it or voted for the individuals that legislated it.

Fix it at the polls and then you won't have to worry about working around egregious state law or moving.

CA Investor - Investing Out-of-State - LLC or Umbrella Policy?

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