All Forum Posts by: Ryan Coon

This is an odd situation you you've found yourself in, especially where the new title company won't alloy closing with an exclusion where the old title company did. It does sound like you're on the right track though by consulting with an attorney to get this across the finish line. Most likely you're options will be:

(1) Get a release/recission from the fireworks company. This is likely the cheapest approach assuming that (a) you can locate the company or it successor, and (b) they are willing to simply release rescind the lease and/or release there rights thereunder. A local attorney experienced in these types of title issues should have resource to help locate the old fireworks company where you have not had success.

(2) If you can't locate the fireworks company or get them to agree to a rescission/release, then you may be forced to file a quiet title action of with the county. A quiet title action allows you to take the issue before the court and have a judge issue a ruling to "quiet" the title by removing judicially removing the encumbrance/cloud on title being created by the lease. Typically you will have to show the court that you have made reasonable efforts to inform the other party (e.g. the leaseholder), up to publishing notice in a local newspaper (though the specific rules will depend on the state/county where the property is located).

Again, this is all assuming you cannot get the title company to allow you to close by simply excluding the lease from and encumbrances created by it from the policy. Occasionally, an opinion letter from an attorney could be enough to get the title company to capitulate and allow the closing.

Note: This information is for educational and informational purposes only and does not constitute legal, tax, or financial advice. No attorney-client, fiduciary, or professional relationship is established through this communication.

Frankly, I would love to see a few examples as well as I have not personally done a deep dive into the caselaw on this issue. That said, I have worked with hundreds of clients in the last few years who are involved in both long-term investing and flipping/wholesaling and I often recommend that people involved in both worlds simply avoid the issue entirely by keeping their flipping and wholesaling activities isolated from their long-term hold activity. You can do this by performing your flips and wholesales in a Corporation such an S-corp or C-corp. Because the corporation is a separate taxable entity from yourself, its the corporation that would get tagged as a dealer, freeing you to engage in investment activity outside of the corporate structure and remain classified as a real estate investor personally. I have yet to see this method fail and you get the added bonus of corporate taxation for your flips and wholesales which is generally ideal anyway.

Note: This information is for educational and informational purposes only and does not constitute legal, tax, or financial advice. No attorney-client, fiduciary, or professional relationship is established through this communication.

@Dylan Brown brings up an important issue of determining your balance between simplicity vs complexity in your structuring. I agree that for larger real estate portfolios, bank accounts in each LLC/Cell/Series can become quite cumbersome for many investors. In this case comprehensive and meticulous bookkeeping, in particular through something like QuickBooks, can go a long ways to mostly maintain the legal separation between entities while cutting down on the administrative burden of managing many bank accounts. With great bookkeeping and no major separation issues with the individual LLCs, such as comingling assets, then the lack of a bank account is unlikely to undermine the asset protections provided by the separation.

I do think it's worth clarifying that, if carefully planned, the use of a C-corp as a management company need not incur much, if any, corporate taxation or dividends taxation, thereby avoiding both ends of the double-taxation problem of C-corps. 

Example: If your C-corp collects management fees, lets say $10k worth, but you have $10k worth of expense reimbursements including medical expenses, then the C-corp can reimburse you for these expenses, thereby zeroing out the C-corp. By doing this you negate any Corporate taxes (no profits to tax) and any dividends taxes (no money to distribute as dividends). Thus, rather than adding taxation you are mitigating ordinary income taxes on the $10k that you would have paid had these funds simply hit your tax return as rental income. This does require some reverse-engineering to fund C-corp with as much as possible to take reimbursements without overfunding it. Now overfunding is not the end of the world, because you could take a salary from the C-corp for a reasonable amount, and the salary will be a deduction to the C-corp (mitigating corporate taxes), but will be taxable as a salary.

This strategy is certainly not for everyone, but I have worked with many investors who have saved substantial amounts on taxes with this strategy with some careful planning. Thus, it's certainly worth consideration if you have a taste for creative tax planning.

There are certainly pros and cons to each approach, however, personally I would avoid pulling funds from my pension due to the taxation and/or early withdraw penalties. If we want to rule this out then some other options may be:

1) Paying for what repairs are necessary from personal funds. This assumes you have enough to make all repairs and renovations necessary to have the home up to code, safe, and marketable.

2) Depending on the amount of equity in the home after purchase, you could consider a second loan on the property to pull out enough equity to pay for the needed repairs.

3) If you have a personal home with significant equity you could consider a HELOC to fund the repairs.

4) You could look for an alternative funding source such as a Private Money Lender (PML) to obtain the needed funds the repairs.

I'm sure there are other options that are not coming to mind right now but these are a few common funding mechanisms that I often see other investors use which may be a good place to start depending on your circumstances.

Note: This information is for educational and informational purposes only and does not constitute legal, tax, or financial advice. No attorney-client, fiduciary, or professional relationship is established through this communication.

Certainly. My approach would generally be something like the following:

Parent company set up in Wyoming for charging order protections and possibly anonymity in your ownership (if using a third-party registered agent and filler for the LLC). WY is known for having really strong asset protections, in particular charging order protections, to prevent personal liabilities from exposing assets inside the LLC. Parent LLC disregarded tax status (or partnership if owned with a spouse)

Real Estate Holding LLC (e.g. series LLC) owned by the WY Parent LLC. Here I would either have separate LLCs for each property or a series LLC with separate Cells for each property (this largely depends on the state where the properties are located and how much asset protection is provided to individual cells in the state in question). Separate LLCs or Cells for each property prevents liabilities on one property from exposing the others. The Real Estate Holding LLC(s) would be disregarded with the WY Parent LLC as the sole member.

Then I would have a Management Company, taxed as a C-corp and owned directly (not via the Parent LLC). The idea behind the C-corp is to use it as a tax mitigation tool. There are a number of tax free reimbursement that you can get from a C-corp including business expense reimbursements and, very powerfully, medical expense reimbursements. This means that if you can get money into the C-corp, the C-corp can turnaround and reimburse you, tax free, for all of your out-of-pocket medical expenses (e.g. deductibles, co-pays, insurance premiums, etc.).

So the question then is how do you get money into the C-corp? This is where the management fee comes in. The Real Estate Holding LLCs can execute a property management agreement with the Management Company allowing the Management Company to manage the rentals and take a management fee for these services, say 10% of the rental income or whatever the standard is in your area. You do want to be careful not to over-fund the C-corp though because best case scenario usually involves you zeroing out the C-corp so as not incur corporate or other taxes trying to get money from the C-corp. The balance is in getting just enough money into the C-corp to optimize tax-free reimbursement from the C-corp and no more. Thus, you can effectively get somewhere in the ballpark of 10% of your rental income to you tax-free through these reimbursements, rather than paying ordinary income tax rates on this income. This does require some careful planning but can save you substantial amounts on your taxes.

Now you can have the Management Company owned by the Parent LLC, however doing so will likely negate any anonymity (if that is a goal) and doesn't create quite as much separation between the rental properties and the management activities.

If by "contact the agent" you mean the sellers agent, then you are going to run into conflict of interest issues with the agent. You can bet that the agents agreement with you to lowball the seller (the agent's client) is a conflict of interest for the agent and a breach of the agent's fiduciary duties to the seller. Thus, any real estate agent who values their license and does not want to be held personally liable for losses in sales price on the property will run the other way if you contact them with such an offer. And to be frank, they would be right to do so.

Note: This information is for educational and informational purposes only and does not constitute legal, tax, or financial advice. No attorney-client, fiduciary, or professional relationship is established through this communication.

First, you note, it is wise to follow the same vetting procedures that you do or would for a standard tenant. 

Second, as for the contract, generally you want to make it clear that the subtenant has all of the same obligations, responsibilities, and restrictions as the direct tenant. The last thing you want is for the subtenant to think that they do not have the same obligations for things like upkeep of the property, reporting of maintenance issues, payment of rents, refrain from illegal activity, and so on. 

Third, it often also wise to make sure you have a signed writing with the direct tenant reaffirming that their subletting the property to a subtenant does not release them from their obligations including the payment of rents, maintenance of the property, etc. This can help ensure that if there is an issue with the subtenant, you can go after the direct tenant as well as the subtenant. This signed writing can either be a separate contract with the tenant, or it can be integrated into the lease with the subtenant. Either way, the direct tenant should sign.

Note: This information is for educational and informational purposes only and does not constitute legal, tax, or financial advice. No attorney-client, fiduciary, or professional relationship is established through this communication.

You are correct in your synopsis of the management company taking the management fee then redistributing back to the holding LLC. It should be noted that while a management company taking a fee in some circumstances may offer some advantages, here where the management company is disregarded, you may actually be adding to your tax liability. This is because the management activity would likely be classified as active income thereby adding self-employment/FICA taxes (~15.3%) to what would otherwise simply only be hit with ordinary income taxes. Thus, while the management company is disregarded, taking a management fee may not be ideal for taxation.

As for separate bank accounts in your cells, having separate bank accounts in each cell can help support the argument that these cells are separate and distinct from one another. This is important from an asset protection perspective (assuming that your state provides asset protection and separation between cells) because it can help limit your exposure to a single lawsuit by only allowing the creditor of one property to go after the assets of that cell. Now, if your bookkeeping is really good such you can easily identify the income/expenses of each cell then you may be able to get away with having a bank account in just the series LLC without having bank accounts for each cell.

Hi Raven,

First, while you can collect rents in the management LLC, in particular if you have a management agreement between the management LLC and the property holding LLC, this income would not general belong to the management LLC. Just like when using a third-party property manager, the rents belong to the LLC that owns the properties being rented. This wheels the management LLC could deduct a management fee from the rents, the reminder of the rents would ultimately belong to and be reportable to the property holding LLC. Failure to make this distinction will likely nullify any real legal separation or distinction between the two entities and may even negate any asset protection benefits provided by the LLCs.

Second, as long as the management and holding LLCs are disregarded for tax purposes (e.g. by being single member LLCs with no corporate tax election) then the holding and management companies can simply transfer the funds to the parent company. This should be classified as a "member draw" or "member distribution". These transfers are non-taxable again as long as the LLCs are disregarded. 

It's also important to note that if all of the LLCs are disregarded then there are no taxes or tax returns for the LLCs. Income and taxes would simply flow down to the owners personal tax return. Again, this all rests on how each of these LLCs are taxed and my response assumes disregarded taxation on all LLCs.

Hi John,

From a legal perspective it would probably be a good idea to cross a few t's and dot a few i's as you prepare to convert a portion of your current home into a rental. First, you may want to sit down with a family law attorney in your area to confirm that you're thinking through the division of assets issue correctly. Especially in a community property state like WA, it's often not as simple as who's name is on the asset. It would be unfortunate to put the work into this property and then subsequently lose it to the divorce.

Second, you will want to do your homework on zoning and other possible restrictions on you renting a portion of the property, including any possible HOA restrictions. I've seen too many investors acquire or reno a property for a purpose that is not actually allowed by local zoning or other rules or by HOA restrictions so it would be a good idea to make sure your ducks are all in a row here before getting to far into the planning process.

Note: This information is for educational and informational purposes only and does not constitute legal, tax, or financial advice. No attorney-client, fiduciary, or professional relationship is established through this communication.