Where to form LLC for legal protection - Business in AL, Living in CA

[Mahender Bist]

I am an investor starting my real estate journey. I am about to begin purchasing rental properties in Alabama (Birmingham) and rehabbing and renting them. Based on your experience or expertise, will an Alabama State LLC or a Wyoming LLC work better from a legal protection perspective? I live in California. What is the best structure? My research guided me to form an LLC to hold the properties during repair/rehab (I am buying properties that need major fixing) and move them to another LLC where I will be collecting rent.
I am looking for any guidance from experienced investors and professionals.

[Chris Seveney]

@Mahender Bist

I believe the best structure is to save $1000+ a year for filing in California which they will have you do anyways and just own in your name with a good insurance policy.

[Nathan Gesner]

Quote from @Mahender Bist:

Why?

Pay special attention to #4 and #5.

An LLC is useful for two things: anonymity and legal protection. In most cases, neither is warranted.

Warning: I am not an attorney, and this can be a complicated topic. Please note the information provided below is a layman's definition designed to provide a basic understanding for the general audience. You should consult an attorney or CPA for your specific situation.

ANONYMITY: When you create the LLC, your name is recorded on the documents and published on the Secretary of State's website for all to see. So you're not completely anonymous. If you want to be completely anonymous, you can use a Registered Agent. The Registered Agent will record the documents on your behalf so only their name and information appear on the documents. I've done this with my properties because I'm well known in my small town and don't want people to know what I own.

LEGAL PROTECTION: By placing your assets in an LLC, you are legally separating them from your personal assets. If someone injures themselves and sues, they will be suing the LLC and not you personally. If your insurance coverage isn't enough, they could seize the LLC assets, but not your personal assets.

Additional thoughts:

1. An LLC is not free. You can spend as little as $100 to form an LLC, or you could use an attorney and spend $1,000 or more. There are also additional costs of operating and maintaining an LLC, like separate bank accounts, annual report filings, tax filings, etc.

2. There are rules to follow! If you fail to follow the rules, you may open your personal assets to a lawsuit. An example of this would be mixing your personal money and LLC money in the same bank account.

3. You do not need a separate LLC for each property or a series LLC! Don't make your life more complicated than it has to be. Most professionals will recommend a separate LLC for every $1 million in assets but I don't think that's necessary. In my case, I have residential rentals in one LLC, commercial properties in another, self storage in a third, and my real estate company operates in a fourth. Some have more than $1 million in equity while others have less.

4. The need for an LLC is grossly exaggerated on BiggerPockets and other websites. Have you ever heard of a Landlord being sued by a Tenant and losing property? I've been on this board since 2010 and haven't found an example yet. You've probably heard of big Landlords losing property, but only because they were flagrantly violating Fair Housing, running a slum, or otherwise violating the law in an egregious manner. You are more likely to be struck by lightning twice. The vast majority of lawsuits against Landlords are for wrongful eviction, security deposit disputes, and Fair Housing Violations. Your primary insurance policy with $300,000 in liability coverage should be sufficient in 99.999% of all lawsuits.

5. The best protection for you and your investments? Know and obey the law. I manage around 400 rentals with 14 years of experience and have never been sued once. Even if I were sued, I document everything and obey the law, so I won't be found guilty. Even if I were found guilty, the cost would be in the thousands, not in the millions. Insurance would cover it, I would pay the deductible, and no assets would be lost.

If you are in an area like San Diego where people are more likely to sue, a judge is more likely to find you guilty, and the payout is expected to be higher, you may consider an umbrella insurance policy. This policy will provide additional coverage above what your existing policy covers. It's easy to obtain, costs very little, and doesn't require extra, on-going effort to maintain.

[Alecia Loveless]

@Mahender Bist Just get a good umbrella policy and forget the additional LLCs and the headache associated with them.

My state is relatively inexpensive in these matters and charges $102 annually for an “Annual Report” which is nothing more than paying to verify your contact information annually. Then I have to file a tax return for my LLCs. Which is another added cost.

I had a legal team suggest I move all my properties into a much more complex structure for estate planning but I think that’s a total waste of time and money.

Simple is often better, especially when starting out.

[Corby Goade]

The best advice I can give is talk with your attorney. BP is probably the worst place on the planet to get legal advice. You'll get people spewing gospel that have never done a deal. 

There's no right or wrong way to do this, just varying levels of risk and reward and YOU need to understand what they are for whatever strategy you choose. 

@Nathan Gesner said it best, IMHO- the need for an LLC is totally exaggerated on BP. I'm not saying you shouldn't have one, but it shouldn't stop you from taking action either. If you know and follow the law, especially when it comes to PM, there is very little to worry about. When you start "picking" tenants or doing favors or acts of kindness for tenants is really when you can get yourself in legal trouble.

Best of luck!

[Stuart Udis]

@Mahender Bist I've come across a ton of loopy asset protection strategies in these forums but this is the first I've heard of someone being told to buy their property in an LLC and then re-title the property as soon as the renovations are completed. Whoever is teaching this should have their license revoked... up there with some of the worst counselling I've ever heard. Keep it simple. Nothing wrong with an LLC but know the LLC will be most helpful in simply keeping your name off the docket above all else in the event a lawsuit is filed. No need for Wyoming LLC, huge wasted expense.....topic has been discussed at nauseam in these forums.

Here's some questions for you to consider since you will be undertaking heavy renovations. Are you completing these renovations with all appropriate permits and approvals? Are all of your workers licensed and insured? If you are reliant on a GC how are you confirming all of the sub contractors are licensed and insured? Is your deed holder entity being named as additional insured under GC and sub contractor's policies? Do you know how to tell the difference between being a certificate holder and receiving additional insured status? What systems are in place to ensure all sub contracts are being paid and no mechanics liens are being filed? Who is responsible for cleaning the construction site and keeping public walk ways free and clear of construction debris since you are in CA without the ability to monitor the site? Do you have a builders risk and general liability policy? If you are truly concerned with liability, these should be your main concerns and focus, not whether to create your LLC in Wyoming or elsewhere.

[Katie Balatbat]

@Mahender Bist

California is generally more cumbersome than other states when it comes to taxes and filings. Even if you create a non-CA LLC, if you are managing the business from California, you will likely be deemed to be "doing business" in California and therefore likely subject to CA taxes. California charges a minimum tax of $800 a year per LLC, and more if you have gross receipts in excess of $250k. So, if you create an LLC in another state, you will likely need to register it as a foreign LLC in California. Though, this process will be the same for the other state (if you created a CA LLC you may need to register it as a foreign LLC in the state in which you are doing business/holding property). This means that you will probably need to pay registration and filing fees in at least 2 states if you don't buy CA property as a CA resident.

Be sure to tell your accountant that you may now need to file non-resident income tax returns in each state where you own property as well. CA taxes residents on worldwide income but may provide a credit for taxes paid to other states.

Most likely the state where the property is located is where lawsuits would be brought if they are something for personal injury like a trip and fall or something of that nature because the “cause of action” arose in that state. So even if you pick a state with stronger protections like WY or NV, the cause of action arose in the state where the tenant fell, so likely that the court where the accident happened would have jurisdiction. Of course, with all things, the answers to all these matters will depend on the circumstances.

California tends to have more laws on the books and requirements and restrictions that it can be a good idea to form a CA LLC for out of state property so that you as a CA resident are covered, and to try to have your contracts fall under the purview of CA courts. It also is helpful to have a California LLC in case you ever sell that property and move into another state so that you do not need to form a new LLC altogether with new operating agreement, just re-register in the new state as a new foreign LLC. Also, the state of formation is likely where internal disputes would be brought among LLC members, so if you and a partner and/or spouse live in CA, you probably want to arbitrate in CA if the two of you had a disagreement. It may also make it easier for your estate planning attorney to line up ownership with your estate plan, assuming a CA-estate plan if a CA resident. But, that is not always the right answer and you should speak with someone familiar with your personal situation to get advice specific to you.

*This post is informational only and is not to be relied upon. Readers are advised to seek professional advice. This post does not create an attorney-client or CPA-client relationship.

[Mahender Bist]

Thank you so much for your insightful response @Chris Seveney, @Nathan Gesner, @Alecia Loveless, @Corby Goade, and @Stuart Udis. Nathan's response covering various angles gave me a good blueprint. Additional details on the Umbrella policy and how to manage contractor work and ensure being an additionally insured party to the GC policy were great.

I intend to create one CA LLC (without moving properties to another LLC after renovation for renting), get a good umbrella coverage policy, and ensure renovation and rental guidelines (GC insurance, Fair Housing Act, etc.). Thanks again, everyone!

[Nicholas L.]

@Mahender Bist

i know this wasn't your question... but i have to ask.  you state that you're based in CA and are about to start buying properties in AL.  do you know the market in Alabama?  do you have a team there?  do you have experience in renovation?  will you go there in person to supervise and check in on your projects?

all of that is way more important than an LLC.

[Marcus Auerbach]

Quote from @Corby Goade:

The best advice I can give is talk with your attorney. BP is probably the worst place on the planet to get legal advice. You'll get people spewing gospel that have never done a deal. 

There's no right or wrong way to do this, just varying levels of risk and reward and YOU need to understand what they are for whatever strategy you choose. 

@Nathan Gesner said it best, IMHO- the need for an LLC is totally exaggerated on BP. I'm not saying you shouldn't have one, but it shouldn't stop you from taking action either. If you know and follow the law, especially when it comes to PM, there is very little to worry about. When you start "picking" tenants or doing favors or acts of kindness for tenants is really when you can get yourself in legal trouble.

Best of luck!

Asking an attorney if you have enough legal protection is like asking an insurance sales guy if you have enough insurance. The answer is always no.

LLCs are overhyped, especially for people starting out with buy and hold and are not even running a real "business" (yet). Get good insurance, plus an umbrella policy. I'll skip the details, you'll find thousands of posts on BP on why.

You probably want an LLC for your flips in the State where you flip. Read a few books about flipping, they spell out the details.

[Ashish Acharya]

@Mahender Bist For properties in Alabama, forming an Alabama LLC is simpler and provides property-specific legal protection without requiring foreign LLC registration in the state. While Wyoming LLCs offer anonymity and tax benefits, you'd still need to register it in Alabama and California, adding costs and complexity.

If you are not flipping properties, there is no need for Rehab LLC.

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