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BlogArrowBusiness ManagementArrowCalifornia Investors: Why DSTs Are Better Than LLCs (Hint—Taxes!)
Business Management

California Investors: Why DSTs Are Better Than LLCs (Hint—Taxes!)

Scott Smith
Expertise: Landlording & Rental Properties, Business Management, Personal Finance, Real Estate News & Commentary, Real Estate Investing Basics
95 Articles Written

Disclaimer: This article does not constitute legal advice. We recommend you seek the counsel of an attorney familiar with your specific situation and market to ensure you make the best decisions within your real estate business.

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If you’re an investor learning about asset protection, it’s easy to get mixed up or receive poor advice. It’s even easier to fall into the logical trap of believing there’s a generic “best course” for all people.

After all, more than a few companies are all-too-happy to take your cash for a generic LLC, imply it’s all you need, “forget” to mention their products don’t include essentials like operating agreements or state filing fees, and toss you into the deep end of figuring out how to use the darn thing on your lonesome. Because once you’ve hit “pay” and received your docs, their work is done. They’re not your lawyers.

I am, however, a lawyer who’d like to take some time to clear up the confusion for my fellow investors here on BiggerPockets. The first thing you need to know is simple. Unlike a fly winter scarf, asset protection is not one-size-fits-all—at least if you’re doing it right.

One of the very first things to consider when developing your asset protection plan is where you live and hold property. If the word “California” appears in your answers, listen up!

This is the most essential information you need to know about the ideal structure for California residents: the Delaware Statutory Trust.

Why an LLC Might Not Be the Best Choice

Wait—aren’t you the guy who recommends Series LLCs for asset protection?

Yeah, that’s me. The Series LLC is an awesome structure for most investors. (Notice I said “most.”)

A critical point to understand about asset protection is that there is no silver bullet that works for everyone. An adequate asset protection plan is tailored to the individual, like a fine suit. The more your lawyer knows about you, the more tailored your asset protection plan can be.

When you work with a real asset protection attorney, we’re essentially doing the legal variant of crafting you an Armani-quality suit that’ll hold up so nicely you can be buried in it looking brand new. This is the strategy that defends your wealth, after all. It needs to stand the test of time.

For the California investor, though, we do know the starting point is different. Rather than isolating assets into LLCs or series within a Series LLC, we tend to recommend the California investor use a Delaware Statutory Trust (DST) instead.

couple on laptop, on holding gavel, online auction concept

In fact, understanding the Series LLC is a great starting point for understanding DSTs. Both use a parent-child structure and have infinite scalability, offering creative solutions for investors.

California investors have special concerns because of the state’s laws and tax regulations. While a Series LLC presents an ideal solution for investors in every other state, it would incur an $800 franchise tax at the very least.

The Delaware Statutory Trust is a great alternative, because it offers a similar level of protection to the Series LLC while also avoiding this tax burden. The state views DSTs as estate planning tools, which do not have to meet the same requirements as corporations or LLCs. Any investor who is doing business in California may be subject to state taxes.

Related: Estate Planning for Investors: Insight From a Real Estate Attorney

How a DST Can Benefit Investors Who Don’t Live in California

Let’s say you invest in California, but don’t reside there. Can you use a DST?

Yep.

That's right! You might have never set foot in California, but if you have property there—even with partners—you're still going to have to play by California's rules. Check with an attorney if you are in a partnership or have interest in an LLC operating in the state.

Business people shaking hands, finishing up meeting. Successful businessmen handshaking after good deal.

What is a DST Anyway?

At its most basic, the DST is the intellectual grandfather of the Series LLC. It uses a parent-child structure. I highly suggest you check out this previous Series LLC article for a more elaborate breakdown of this structure type and its asset protection implications. The same information is true of the DST (and I’ll be here when you get back!).

The DST is a type of trust that was among the first business structures created for asset protection purposes. Unlike a company, you have a trustee managing investments and a beneficiary (you), who receives the profits of properties held in the trust.

Like the Series LLC, it uses a parent company and many Series as asset-holding companies, sharing the liability limitation benefits. It’s an attractive alternative for Californians, because you receive the same benefits of Series LLCs (anonymity, streamlined business, tax flexibility) while escaping the requirements other companies must meet.

DSTs were designed to be low maintenance. No meetings or minutes are required, and compliance is fairly straightforward.

The DST’s structure separates your assets from you and one another. This concept is called compartmentalization and has two key purposes: making your assets harder to pursue at all and controlling the damage if one is successfully threatened and seized.

What happens to one Series need not affect the other Series or the assets within them. Of course, the above assumes a properly-formed DST, created with the aid of an experienced attorney.

Lawsuits are no joke, and you want the structure that’s best for you. If you’re in California, there’s no question that you should look into the DST, particularly if you plan to own multiple properties.

Disclaimer: This article does not constitute legal advice. We recommend you seek the counsel of an attorney familiar with your specific situation and market to ensure you make the best decisions within your real estate business.

Any additional questions I can answer for you about DSTs or LLCs? 

Ask me in the comment section below!

 

By Scott Smith
Scott Royal Smith is an asset protection attorney and long-time real estate investor. His law firm, Royal Legal Solutions, helps thousands of real est...
Read more
Scott Royal Smith is an asset protection attorney and long-time real estate investor. His law firm, Royal Legal Solutions, helps thousands of real estate investors and entrepreneurs in all 50 states protect more than $1.2 billion in assets. Since 2014, he has published over 1,000 posts and articles on BiggerPockets and has appeared on hundreds of podcasts.
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17 Replies
    Scott Slocum from Banning Ca.
    Replied over 1 year ago
    How does it work if you live in California but don’t invest in California? I had a conversation at a meetup yesterday with someone and they stated that California requires taxes and fees paid to them even if you don’t do business there. Is there truth to that?
    Scott Slocum from Banning Ca.
    Replied over 1 year ago
    Concerning LLC’s

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    Scott Smith Attorney from Austin, TX
    Replied over 1 year ago
    @Christopher Smith is spot on. Most of the time you will still be charged when you are investing out of state for the LLC if you continue to reside within CA because the state will consider you as “doing business” through the state.

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    Christopher Smith Investor from brentwood, california
    Replied over 1 year ago
    How are you conducting your business? California will tax all of your income if you are a resident (with potentially an offsetting credit for tax actually paid to other States). If you own a foreign LLC (an LLC formed in another state), it will in almost all cases need to pay the $800 minimum tax as it will be considered as conducting business in California if you’re personal involvement in the activity is anything other than purely passive, and that would be highly unlikely.

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    Obaid Ajmal
    Replied over 1 year ago
    Dear Mr Smith Greetings, Hope all is well and this mail finds you in the best of health. I read your article on DSTs vs LLC for California, I live and work in Virginia, Fairfax and would like to know if the same applies for me too. As an investor who wishes to have his own portfolio someday would you advice going for DST or LLC format. Your inputs and advice would be greatly appreciated. Thank you in advance. Best Regards Obaid
    Scott Smith Attorney from Austin, TX
    Replied over 1 year ago
    Hello Obaid, Most states will require fees and require certain corporate compliance standards from people who operate through an LLC, but California is unique in charging so much money. The DST is an available option people people who own property in all states. However, many investors will actually lean toward the Series LLC in most states, rather than the DST, because they function very similarly and the Series LLC does not cost as much to form generally. The reason the DST stands out for California investors is because it bypasses the annual $800 franchise fee investors pay PER LLC, every year. It adds ups fast. If you have more questions feel free to ask away! I work with these entities all the time.

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    Scott Smith Attorney from Austin, TX
    Replied over 1 year ago
    You can also refer to this article for more information on the Series LLC, as that might be a better fit for your current investing goals: https://www.biggerpockets.com/blog/the-traditional-llc-vs-the-series-llc-which-is-better-for-real-estate-investors/

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    Joe Homs Flipper from Mission Viejo, CA
    Replied over 1 year ago
    Mr Smith, I use these for privacy protection, but if the beneficiary is NOT my LLC then there is NO asset protection?
    Scott Smith Attorney from Austin, TX
    Replied over 1 year ago
    The Delaware Statutory Trust does act to separate the liability between the separate entities within it when you establish it correctly, so there is asset protection without the LLC in place. You may be referring to Land Trusts, which don’t offer any liability protection but are often used to introduce privacy by having an attorney sign the formation papers.

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    Lisa Horgan Rental Property Investor from Irvine, CA
    Replied over 1 year ago
    What if I live in California, but I do not own here, I am buying a 4-Plex in San Antonio, Texas, can I still make good use of a DST?
    Scott Smith Attorney from Austin, TX
    Replied over 1 year ago
    Yeah, the DST is really ideal for all Californian investors, whether they invest in the state or simply live in the state and invest elsewhere. California is very inclusive with their franchise tax and will take “their” cut even if you invest in other states using an LLC, so the DST is ideal for that use also.

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    Mitchell Rubinstein from Glendale, California
    Replied over 1 year ago
    Hi Scott, A little late to this thread but I'm about to close on my first SFR in MO. I am a new investor from California and am buying homes with a business partner who resides in Maryland. I've talked to a couple attorneys and none of them have mentioned a DST. Could this work as a business entity for my situation? We are planning to invest in multiple properties and have been looking for a way to avoid the $800 taxes per year for me being in California. Thanks in advance. Mitchell

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    Chester Lee from Richmond, California
    Replied over 1 year ago
    @Mitchell, One strategy I read on for CA residents, is to create a CA LLC, and pay the $800 annual fee. Just one LLC. The reason for this is becz you reside in CA. Then create a NV or WY LLC. NV and WY state legislators have crafted have excellent Charging Order protection language which limits lawsuits. The NV or WY LLC will be your holding company. Its sole purpose is to hold and own all the LLC you will form at the states where you own property. Lets say you own a property in MS. 2 properties in MI, and 2 properties in FL. This is what it looks like: CA LLC own the NV/WY LLC. NV/WY own the LLCs from MS, MI, FL. the NV/WY LLC will own 5 LLC (1 MS, 2 MI, 2 FL) In this manner, CA only gets $800 per year. It doesn't see the other LLCs and you don;t own the other LLC. The NV or WY LLC owns the other LLCs. Be sure to work with your attorney to ascertain Manager Managed vs Member managed when forming your LLCs. This is my understanding. I am not a lawyer nor do I possess any legal knowledge. I am not that well versed on asset protection and LLCs. Like many here, I am learning. If this information is wrong, some someone correct me. Chester
    Graeme Black Investor from Vacaville, California
    Replied about 1 year ago
    You will still have to register the NV and WY LLC's as foreign LLC's in California and pay the $800/year FTB tax. I am not an attorney. https://www.corporatesecuritieslawblog.com/2014/07/is-your-out-of-state-llc-doing-business-in-california/

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    Cheryl Collins from Tracy, CA
    Replied 8 months ago
    New investors with a new CA C-corp and wondering if a DST will work for our strategy. Our current plan is for the CA owned C-Corp to open a parent WY LLC and have that WY LLC parent all the other LLC ‘s in states we invest in (Flips/Buy and hold/Rentals etc). Under this strategy, I’m assuming that the WY LLC will need to be listed as foreign LLC and pay the $800 LLC tax...but correct me if I’m wrong.. the other LLC’s parented by the WY LLC would be not subject to the $800/each LLC tax..Correct?. Would the option of our C-Corp opening and DST to parent the individual state LLC’s work in our favor to avoid the $800 CA tax.? Also, I’m still looking for this answer and I may need to contact a CA Tax Atty, but since the CA C-Corp is the one opening the WY LLC, and we already pay the CA C-Corp tax, do we need to register the WY LLC as a foreign LLC and pay the $800,? Thanks in advance and we appreciate any advice or at least a point in the right direction. Being new, there is so much information to sift through. Brian

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    Basit Siddiqi Accountant from New York, NY
    Replied 8 months ago
    Taxes and Fees to set up entities should all be considered. I have seen invoices from Attorney's who set up $5,000+ to set up an DST. The $5,000 may be more than the sum of the taxes that would be paid if a DST was not formed.

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    Hardy Hodges
    Replied 8 months ago
    I am interested in the DST structure for asset protection but after consulting a CPA he seemed to think there was a camp that thought the "7 deadly sins" for DSTs, in the context of 1031 exchanges, might apply in general, even if no exchange (irs provided the rev procedure in the exchange context only, so seems like this leaves DST open to interpretation on tax compliance side). The area of particular concern to me is if I am able to do major renovations on a property in a DST. An attorney I consulted with claimed DSTs suited for passive real estate, which may tie in to one of the views on the irs rev proc. Another concern is I had to speak with 5 asset protection attorneys before finding one that ever heard of using a DST for asset protection. Makes me concerned there seems to be only one DST provider out there for asset protection. As one attorney put it, who had been doing asset protection for 40 yrs, there is either a flaw or major risk going with the DST, or its a genius idea and nobody else has caught on. Which is it?

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