is an LLC really necessary?

Question

Live in California and have 2 rental properties in Cleveland with a total value of 150K at most, is creating an LLC for each property a viable option for asset protection?

Patrick M. · Answer

I hold 2 multi-families in my own name. They are properly insured, as am I, and I carry an umbrella as well. If a a loss was so egregious to overcome my insurance then it would be no problem for a competent attorney to pierce the veil of the LLC.

I personally find absolutely no additional protection in an LLC. The majority of small landlord and small business owners I know that do have an LLC, co-mingle their LLC and personal accounts (credit cards, utilities, etc.) so much that a judge would not hesitate to allow the veil of an LLC be pierced.

I have also witnessed evictions halted because the tenant pointed out to the court that landlord held the unit in an LLC, necessitating the hiring of a lawyer.

I personally would not feel it is necessary for a small portfolio. But if you do it make sure you do it right and insulate it completely from your personal.

Additionally having an LLC is no excuse to be underinsured.

Caleb Heimsoth · Answer

@Alejandro Lee. I have a hard time commenting on all these LLC threads but I will try my best lol.

You don’t want to create any llcs you don’t have to.  You live in CA, which while it has great weather it also has high taxes and lots of regulation.  Part of that is you will pay 800 (May be 850 now) per year per LLC to the state of CA.  And before you think or ask, it doesn’t matter where the llc is registered or formed you still pay it.  So if you think that’s worth it, go for it, if you’re like me, I’d say that’s not worth it, nor is it very scaleable.

If you bought these with cash or conventional financing unless you have a high net worth (10 plus million) it’s not worth it

Katie L. · Answer

@Alejandro Lee

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.

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.  California does not recognize series LLCs so each LLC would be subject to this cost.

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.

James Wise · Answer

If it's a 30 year residential loan you're going to have a due on sale clause in the lease. This means that if title is transferred to another entity even an LLC that is owned by you the bank has the right to call the entire mortgage due immediately. This is a bigger risk than the liability of holding it in your personal name.

Aristotle Kumpis · Answer

You should consultant an attorney for legal questions. Unless a member here is an attorney, no one can give you legal advice. I don't mean to sound harsh, but this topic comes up a lot and many people seem to chime in with their own opinions. I have a few referrals if you want to consult with a professional.

Scott Smith · Answer

I would agree with @Katie Lepore - this is the type of decision you should talk with an experience attorney to get an understanding of what your specific situation should require. When meeting with clients the first order is to discuss (A) their personal assets, (B) break down their current investments portfolio and other business ventures before discussing any (C) future goals. Each of these variables will dramatically change the advice for the individual asking this question. I often break it down into the "five pillars" of protecting your assets.

1st 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 - these simple steps will help you prevent lawsuits before they even occur.

2nd 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.

3rd 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 they 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- check out this article to learn more. Since you are from California, then it would be worth looking into the Delaware Statutory Trust. The DST functions much like the Series LLC, but is not required to pay the $800 annual franchise fee per [series] LLC in California - for anyone with multiple properties this can save a lot of money.

4th 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.

5th pillar is owning everything anonymously. If people don’t know what you own, then they are less likely to sue. People don’t sue people that qualify for food stamps. This anonymity can be accomplished for free by using 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 still, it doesn’t matter because you are not the owner. The trust and the LLC are the owner of the asset/real estate, so even in the scenario that they guess, they guess wrong.

It really comes down to whether the risks outweigh the costs of the LLC in your situation. You gave us the amount of the property that would be placed in the LLC, but if there is a law suit against you personally (without an LLC) and insurance doesn't cover it, then they can come after your personal assets.

Alejandro Lee · Answer

@Patrick M. thank you so much for the response, i also hold umbrella too and not sure if that should be enough for those two properties. @James Wise im the only owner and got them through a bank loan.

James Wise · Answer

Depends. How are you buying these? Loan, cash or with partners?

Alan Feldman · Answer

@Alejandro Lee check the article that Brandon Turner did at https://www.biggerpockets.com/llc

Victor Williams · Answer

I am a newbie but as far as I understand if you want to protect your assets an LLC is one of the most popular( easiest/rei friendliest?) ways to do this. I believe it is 100% necessary to protect your investments. As a matter of fact some people have multiple(20-30 and beyond) llcs as a way to protect their investments. Some people put ~200k per llc others do it differently. If the property is under your name and you get sued your investments are put at risk. Also maybe they try and sue for something that happens at your rental? Thats right they come after you. People will try to sue for anything and everything. It may happen to you and it may not. That being said... why not do everything in your power to protect your investments.

PS. Do your own research IANAL(ask a legal professional) etc etc. Looking forward to hearing from all. Thanks