All Forum Posts by: Clint Coons

@Jerry W. Sorry, but I am confused by your comment. What do you mean by "whole fake facade"? I recommended creating one LLC that will be treated as a partnership for federal tax purposes. A partnership provides each partner, Anthony and his daughter, with a K-1 representing their share of partnership income and liabilities. This information is reported on their 1040 Schedule E, page 2. The partnership return will include each of the properties held by the partnership via the disregarded LLCs I suggested in my initial post. All of this would be fully discoverable by a lender through their 1040 filings. What exactly is "not honest" about putting properties into an LLC? I did not suggest hiding the fact that Anthony holds an ownership interest in an LLC that owns real estate, so your statement has me genuinely confused.

Generally, in my experience, underwriters will request copies of the partnership's Form 1065, along with the P&L statements and balance sheet, in certain situations. The partnership return will disclose all ownership interests held by the disregarded LLCs. Specifically, it will appear on the 1065 as if the partnership owns the property directly. Furthermore, if Anthony moves forward with creating a separate LLC for each property, as he initially suggested, he will need to file multiple 1065 returns each year since each LLC would be treated as its own separate partnership for federal tax purposes. I was offering a solution to avoid that scenario because filing multiple partnership tax returns can become costly, requiring extra CPA fees, and can also slow down the underwriting process. As I mentioned earlier, underwriters will likely request copies of each partnership return, which adds another layer of complexity and potential delays. By creating one LLC structured as a partnership, Anthony can consolidate the ownership of all properties under a single tax filing, saving both time and money while still being fully transparent.

Regarding the due-on-sale clause, that is a separate matter. Yes, if you move a property into an LLC and the mortgage is not yet owned by Freddie Mac or Fannie Mae (you can verify this information using their loan lookup tools online), there is a risk that the lender could accelerate the note. In my 27 years of practice and after easily recording over 15,000 deeds, I have only seen this happen a handful of times, and it's usually in specific situations, such as subject-to transactions or cross-collateralized loans. Your experience may differ, of course. For clients who are concerned about triggering the due-on-sale clause, I typically suggest using a land trust strategy as an alternative to transfer the property into the LLC. This approach can help mitigate the risk while still allowing the property to be effectively managed under an LLC structure.

Hopefully, this clears up any confusion. If there is something specific you’d like me to address further, let me know, and I’d be happy to elaborate!

@Ana Shapiro What you are describing is not an uncommon scenario. Based on your description of the exchange, I am assuming for purposes of this response that you were the owner of the downleg property, which is why you are taking title on the upleg property. To maintain the 1031 qualification, there cannot be a change in ownership from a tax perspective. This means the same taxpayer who relinquishes the property must also acquire the replacement property. Transferring your property into a disregarded LLC, wherein you are the sole owner, is permissible under IRS guidelines (See PLR 200131014: The IRS ruled that transferring hotel replacement property to a single-member LLC did not violate the holding requirement under 1031). However, you mentioned that your Indiana LLC is owned by a Delaware LLC, which is in turn owned by your living trust. This adds additional layers of complexity.

The key question is whether your Delaware LLC is treated as a disregarded entity for federal tax purposes. If your Delaware LLC is treated as a partnership for tax purposes or, alternatively, if it is disregarded but owned by your living trust while you reside in a non-community property state, it could technically be classified as a partnership. Partnerships introduce issues for 1031 exchanges because they do not meet the "same taxpayer" rule. In this situation, you may need to consider restructuring how the LLC is titled within your living trust to ensure it qualifies as a disregarded LLC. This could involve retitling the LLC or even modifying the ownership structure to simplify compliance with 1031 exchange requirements.

One last, but critical, point: when transferring real estate into your Indiana LLC, do not use a quitclaim deed. Instead, use a warranty deed. A quitclaim deed can create future title issues because it does not provide the same guarantees as a warranty deed. Additionally, from an asset protection standpoint, using a quitclaim deed could make it easier for creditors to trace ownership back to you. If a creditor were to investigate ownership of the Delaware LLC and discovered the use of a quitclaim deed, it would be an obvious indication that you are ultimately the owner because a purchaser would never accept a quitclaim deed from a seller. For these reasons, using a warranty deed is a much safer and more reliable option for transferring title.

Yes if you file for the FONCE exemption.  Keep in mind you must file for this each year.  

@Anthony Pitruzzello  This is definitely doable and can be structured in a way that works for both of you. Your daughter will acquire the property in her individual name, using funds from you for the down payment. As @Chris Watkins mentioned, it’s important to ensure that the funds are properly allocated to her to avoid any issues. For example, you may want to transfer the funds into her account now so they are seasoned for at least two months before the purchase (Chris can provide more specific guidance on this step). Once the property purchase is complete, you should consider placing it in a land trust. I recommend using a land trust to help avoid the lender potentially accelerating the note if they discover the transfer. This provides an extra layer of protection and flexibility for your future plans.

After the land trust is in place, have your daughter transfer her interest in the trust to an LLC that the two of you collectively own. Your post suggests that you might be considering making multiple investments together, so it may be worthwhile to set up a holding LLC with both of you as its members. I personally recommend setting up the holding LLC in Wyoming due to the enhanced privacy and asset protection benefits. Once the holding LLC is established, you can create single-member LLCs under it to hold each individual investment.

The reason I bring this up is that if you set up a separate LLC for each of your investments without a holding LLC, each individual LLC will be treated as a partnership for federal tax purposes, which would require the filing of separate partnership tax returns for each one. However, if you use the holding company approach, the holding LLC will be treated as the partnership entity (since it is owned by the two of you), while the single-member LLCs under it can be disregarded for tax purposes. This means the single-member LLCs won't require separate tax filings.

Additionally, it’s critical to seriously consider consulting with a professional for setting up your overall structure. There are many factors and legal nuances to consider when partnering with someone, even if it’s a family member. Proper structuring can ensure that both of you are protected and can avoid complications down the line. For example, you may need to address issues like profit-sharing agreements, decision-making processes, and contingencies for future changes in ownership or management, divorce, death or lawsuits. These are all important details that should be carefully thought through to ensure everything is set up smoothly and in alignment with your goals.

@Heath D Wallace If you want to place your property into a Tennessee (TN) LLC, it's crucial to apply for the FONCE exemption. Without this exemption, your LLC will be subject to an annual franchise tax (this is different from the CA franchise tax). The FONCE exemption allows LLCs to avoid paying the tax if they meet specific criteria. Specifically, you need to make the election, and the LLC's members must be individuals or family members.

As an alternative consider holding title in a land trust and then assigning the beneficial interest to your Texas (TX) LLC. This avoids the TN filing and the FONCE issue. However as @Joe Homs

mentioned, it's also important to think about the risk of placing multiple properties under one LLC. If both properties are under the same LLC, a lawsuit involving one property could jeopardize the other. This creates a higher level of risk that you may want to avoid, especially if protecting your real estate investments is a top priority.

I understand that since you reside in California, you may be hesitant to pay the additional $800 annual California extortion fee for a second LLC. However, while this fee might seem burdensome in the short term, it could be a worthwhile investment when you consider the long-term protection it provides for your assets. By separating your properties into different LLCs, you can significantly reduce your exposure to liability.

Excellent post!!

David,

You are correct. The LLC, to the extent you have taxable income, will create a double taxation problem for you in Canada because, as you indicated, the CRA does not recognize the pass-through election you would make in the US for the entity. In the US, LLCs are often treated as pass-through entities for tax purposes, allowing profits and losses to flow directly to the owners and avoiding corporate-level taxation. However, the CRA treats LLCs as corporations, meaning you could face double taxation—once in the US and again in Canada at the personal level when the income is distributed.

Typically, this issue is addressed by establishing a holding LP or LLP and then using single-member disregarded LLCs that are wholly owned by the holding LP. The holding LP acts as a blocker entity and consolidates all of the income, which is then reported individually to the partners via a K-1. This structure prevents double taxation by ensuring the income is recognized as partnership income, which aligns with how the CRA treats LPs and LLPs.

However, there is a caveat with this strategy. In our experience working with cross-border clients, we've encountered a handful of situations where local tax preparers in Canada have pushed back against this setup. These preparers argue that the CRA might "look through" the LP and disregard the tax election for the LLC, potentially creating the same double-taxation issue. While I understand their caution, I disagree with their analysis. I believe they are being overly conservative and have not provided a tax opinion to back their concerns. Without clear guidance from the CRA or definitive legal precedent, this remains a gray area, but it's worth noting that we have not seen CRA challenge this structure in practice.

If this potential issue makes you uncomfortable, there's an alternative structure to consider. You could set up separate LPs for each property, with a common general partner entity structured as an LLC holding a 0.05% partnership interest in each LP. This LLC, in turn, would be used solely for asset protection purposes and would not generate any significant income from its minimal ownership interest. The advantage of this approach is that it minimizes the risk of CRA scrutiny while still providing a layer of liability protection. However, it may involve more administrative complexity and costs due to the need for multiple LPs and coordinated filings.

@Dennis Li

Dennis, your question is very common among real estate investors, and it's an important one. Insurance is crucial, and you should always ensure your property is properly insured, whether it's held in an LLC or your personal name. Having insurance provides peace of mind, but it's equally important to carefully review your policy to understand what is excluded from coverage. Here is a detailed list of common exclusions in landlord policies that can pose significant risks to property owners:

Toxic Mold & Environmental Contamination – Most policies exclude claims related to mold, asbestos, fentanyl, viruses, bacteria, lead paint, or other environmental hazards. For example, a client was sued for mold contamination that resulted from a tenant improperly installing their own washing machine, leading to water damage and mold growth. 

Dog Bites from a Tenant’s Dog – Many landlord policies exclude liability for injuries caused by a tenant’s dog, especially if it is considered a restricted breed. In one case, a client’s Rottweiler, which was chained in the backyard, bit a neighbor who was trying to save her small dog after it attacked the Rottweiler. 

Criminal Acts or Intentional Misconduct – Insurance does not cover claims of negligence if the alleged act was intentional, such as wrongful eviction, harassment, or assault. For instance, one client is currently dealing with a claim where a plumber sent to repair a toilet was accused by the tenant of sexual harassment. 

Fair Housing & Discrimination Lawsuits – Claims involving discrimination, wrongful eviction, or violations of the Fair Housing Act often require separate coverage. Without this additional protection, landlords could face significant legal costs and damages in the event of a lawsuit.

Tenant Injuries Due to Poor Maintenance – If a tenant is injured because of known maintenance issues, such as broken stairs or faulty wiring, and negligence is proven, insurance may not cover the claim. One client is currently being sued for failing to remediate standing water in a crawlspace. The client was aware of the issue and attempted to fix it but did not fully resolve the problem, which resulted in an environmental hazard and tenant complaints.

Bed Bug & Pest Infestation Lawsuits – Most landlord insurance policies exclude coverage for pest infestation lawsuits, such as bed bugs, roaches, or rodents. For example, a client faced a lawsuit after attempting to remediate a bed bug infestation, but the tenant refused to allow the exterminator into the apartment.  

Contractor or Worker Injuries – If you hire an unlicensed worker, such as a handyman or plumber, and they get injured on your property, you may be liable unless you have workers’ compensation or a separate policy in place. One client hired a contractor whose license had lapsed. During a roofing job, the contractor’s brother-in-law fell off the roof and tragically died.  

Personal Injury & Defamation Claims – Standard landlord policies usually do not cover claims for libel, slander, or invasion of privacy. For example, if a tenant sues for illegal surveillance or damage to their reputation, you may be left entirely exposed to financial liability.

Many of these exclusions carry the potential for significant damages. I often view using an LLC as a preventative measure. While the likelihood of being sued may feel small, the consequences of a lawsuit can be severe. In my 17 years of real estate investing, I have not been sued once, despite experiencing major property damage—such as two homes burning to the ground due to faulty wiring and a tree collapsing onto a master bedroom while a tenant was sleeping. Thankfully, no one was injured, but had I not been so fortunate, I would have faced serious financial risk without the protection of an LLC.

Based on my experience working with many clients who have been involved in lawsuits, I can confidently say that LLCs work. They offer a layer of protection that can shield you from personal liability. Another critical point to consider is that even if a claim is covered under your insurance policy, having an asset protection plan in place can discourage attorneys from seeking the sun, moon and stars as damages. 

Lastly, take a close look at your umbrella policy and ensure it does not rely on your landlord policy for coverage. In some cases, if the underlying policy does not cover the claim, the umbrella coverage may not apply either. 

@John Clark

An LLC does not necessarily need to be actively conducting business in its registered state for liability protection to apply, but it must be properly maintained, compliant with state laws, and treated as a separate legal entity. This means adhering to formalities like keeping detailed records, avoiding perceived co-mingling of personal and business assets, signing documents in a representative capacity, and, of course, refraining from fraudulent activities. For example, if you set up a Wyoming LLC to hold real estate in Oregon and properly respect these boundaries, the LLC should shield you from a lawsuit brought by a tenant, such as a claim stemming from an injury on the property. However, failure to adhere to these principles could potentially lead to the piercing of the entity veil, exposing you to personal liability.

One critical issue to consider is whether or not your LLC is registered in the state where the property is located. If your LLC is not registered in the state where the property is held, it may lose the ability to bring an action, such as a lawsuit. For instance, this happened with a client who set up a Nevada LLC to own a rental property in Illinois. When he attempted to evict a tenant, his case was dismissed because the LLC was not registered in Illinois, and thus the court ruled he lacked standing to bring the action. For this reason, it is generally best to have the LLC registered or qualified as a foreign entity in the state where the property is located to avoid complications like this. In some cases, we may use land trusts to hold the property and then place the trust's beneficial interest in an out-of-state LLC to provide additional asset protection. However, this structure is usually recommended for clients who employ a professional property manager (PM), as the trust arrangement can create additional administrative complexities.

Regarding whether to use one LLC per property or place multiple properties under a single LLC, the answer largely depends on your risk tolerance and investment strategy. I used to recommend placing no more than five properties in one LLC, with a maximum equity limit of $300,000. This approach focused on limiting potential equity loss if the LLC were to face a lawsuit or liability claim. However, as I built my own portfolio, I realized that my primary reason for investing was cash flow protection rather than equity protection. This shifted my perspective, and I began recommending one LLC per property to minimize cash flow interruptions. The idea is that if one property faces a lawsuit or liability issue, only the cash flow from that single property is at risk, leaving the rest of your portfolio intact.

As your portfolio grows, you might find it more practical to group several properties under one LLC, depending on your financial stability and risk preferences. For example, an investor with 60 single-family homes, each generating $5,000 in annual cash flow, could reasonably group three or four properties per LLC. If one LLC were to face a liability issue, the potential loss would be limited to $15,000 to $20,000 per year in income—an acceptable hit for an investor earning $300,000 annually. On the other hand, for an investor with just four properties, losing income from all of their properties due to a single lawsuit would be devastating. It ultimately comes down to your willingness to take on risk and the trade-off between investment costs and the potential savings if a lawsuit arises and your insurance policy doesn't cover the claim (e.g., discrimination, harassment, dog bites, toxic mold, etc.).

When it comes to structuring your investments, there is no one-size-fits-all solution. Some strategies may involve using separate LLCs, potentially with a holding LLC to provide anonymity and simplify management. Others may incorporate land trusts for title transfer purposes or to address specific tax considerations. The most effective plan is usually one that is tailored to your individual circumstances, so it's crucial to work with someone who understands both structuring and real estate investing.

@Melissa Stanley

Your scenario is fairly common — "I've got the funds, you've got the experience, let's make lots of money." We frequently meet investors who have capital and are eager to partner with someone who brings time, expertise, or specific industry knowledge to the table. While many of these partnerships can be fruitful, some turn out to be less successful, with unfortunate outcomes that could have been prevented with proper planning and safeguards.

For instance, we recently encountered a case involving an investor, or "money partner," who contributed $650,000 to a real estate deal facilitated by another investor, the "developer." The arrangement initially seemed straightforward: they set up an LLC for the property, moved the property into the entity, and planned to share the proceeds. However, things took a turn for the worse when the developer transferred the property out of the LLC without informing the money partner, leaving the investor blindsided. Situations like this underscore the importance of structuring deals properly to mitigate risks and protect all parties involved.

One way the money partner could have safeguarded their investment would have been by structuring it as a participating loan. This would have allowed the investor to secure their interest against the asset while also benefiting from any equity appreciation upon the eventual sale (assuming the plan is to flip). This approach provides both security and potential upside in a deal. Alternatively, a tenant-in-common (TIC) structure is often preferred by investors in similar situations. A TIC arrangement not only protects the investor's ability to execute a 1031 exchange on their share of the sale proceeds but also ensures that their entity remains on the property's title. Being on the title is a critical layer of protection, as it prevents a partner from unilaterally making decisions about the property's ownership, such as transferring it without consent like the example I provided.

Ultimately, we always advise investors who are considering a partnership with a third party to conduct thorough due diligence on their prospective partner.  Additionally, structuring your investment in a way that provides legal and financial safeguards is essential to avoiding the types of horror stories we’ve seen all too often over the years. Taking the time to set up the right agreements and protections upfront can make all the difference in ensuring a successful and mutually beneficial partnership.