Which entity structure is the best way to go?

Question

Good morning everyone, I was up until 2 AM this morning reading various articles on the best type of entity structure for my real estate investing business.  From what I have gathered thus far, forming two LLC's to operate the business is the way to go.  For example, Investment Company A, LLC to hold all of my Capital Assets that is managed by a seperate Investment Properties B, LLC that would bill Investment Company A for its management services.  Additionally, Investment Properties B would lease the Capital Assets of Investment Company A in the name of Investment Properties B, thus therefore putting more of the risk with the Property Management LLC and less risk on the actual Capital Assets contained in the LLC created for holding all properties.

I am concerned with the costs and management of forming different LLCs for each property in California, as California does have the $800 minimum tax.  Also, would I have to create another LLC to hold Capital Assets located in Texas, or could those Capital Assets be thrown in the original California LLC and registered in Texas as a Foreign LLC?

Another thought, let's say I did go ahead and group all residential properties within LLC-A, and then formed individual Trusts for Commercial Properties, could each Property Trust then be owned and controlled by the LLC?  Anyone have any thoughts on this set-up for my business?

Thanks!!

Kurt Kreager · Answer

Good Morning, I have been going through the same exact process of deciding how to set up entities so I welcome the input of others who have done it.

What I am beginning to grasp is to put all the risk associated activities into one LLC, with the assets in another, ie a holding company with the "Risk LLC" leasing the assets from "Equity, LLC".  If the assets have a lot of equity, I hear it is a good idea to have even a third LLC, or your self personally or whoever has the equity, to place Deeds of Trust (or whatever deed your state uses) on the property to place a priority of lien in the case of a judgement.  Lawyers and others would look at the prospects of getting money differently on a property with a lot of equity vs. a property with mortgages and seconds ( to your self).  In example, $1 million dollar property with $500k mortgage to bank or other lender has $500k up for grabs in a lawsuit.  Same property with $500k mortgage (to same lender as previous example)) and $500k second deed to yourself, another investor who contributed $$ or an LLC owned outright by either one of you, would leave $0 money to grab in a lawsuit. As long as the Deeds were recorded before the lawsuit and or Judgement.

SO, isolate RISK, balance equity to $zero$,

I have been advised to make sure you fund the LLC properly in the beginning, NEVER co mingle personal expenses, and regularly sweep excess cash out ( ie. through an employment agreement or other DOCUMENTED business agreement like a lease back or whatever).

Also remember that you are liable personally for anything you personally do, LLC business or not. If you drop the ladder on your tenant, they'll come after you and all the LLC's and assets you own but if your LLC's employee or contractor drops the ladder, only the LLC's assets are at risk.

Also have been advised that LLC's are NOT a substitute for a great insurance policy and or umbrella policy!!

So far have separate LLC for our contracting business (high risk) and separate LLC for our flip business (some risk and occasional high equity). Next step is a Holding LLC for rental assets and an Equity LLC to hold paper on the equity the rentals have and the short term equity we have in the flips.

Will look forward to other advice / posts as I am still refining my strategy.

Jerry W. · Answer

I personally have very little faith in the multiple trust multiple LLC multiple lien liability scheme for limiting liability.  Entities that are set up to create notes for no bonafide business can be struck down as being fraudulent conveyances to defraud creditors.  A few simple interrogatories or a deposition will sort all of that our pretty quickly in many cases.  The cost of putting together that many different legal entities especially in California would be much more expensive than a couple million in an umbrella policy.  The tax planning for your structure is as important as the liability structure.  A review of your taxes would also possibly reveal the whole scheme unless you plan to commit tax fraud.  I would suggest keeping it simple at first and worry about making money and having good insurance as a first line.  After you are established and have accumulated some wealth get a good attorney to work some of these things out.

The multiple trusts, and layers of LLCs along with multiple mortgages are sort of a GURU sell point at the moment.  There are some businesses that have high liability that warrant the cost for fear of huge damages, but not many.  You might be buying a Cadillac when a bicycle would do.

I do not know enough about the new land trusts to give much advice, they have not hit my state yet.  I suppose I should start reading up on them.

Good Luck in your investing.

Roger King · Answer

Quinten - That's a lot of stuff to figure out, huh?  :)

Here's my 2 cents: Each property should be owned in an individual trust. Some states like FL, NV, and IL have Land Trust statutes, and can easily conform to state law. Others, like CA, don't have a specific statute, but trusts can certainly be used to own the property. The trustee needs to be someone you trust. There is varying opinion on whether the trustee can or should be an LLC. (I'm in favor of it, personally, but there are some state's laws to be careful of). The beneficiary would probably be the LLC that you're trying to figure out. And that LLC doesn't HAVE to be a CA LLC, just because you live in CA. My personal choice is either a Wyoming or New Mexico LLC, for differing reasons - mostly to do with privacy/cost/ease.

The REALLY big thing, though, is to start getting property if you haven't. You can read, learn and plan till the cows come home, but if all of it is theoretical,  and you're not actually doing the biz, then you're missing the point.  I don't know one real estate investor that hasn't lost money - myself included. So don't be afraid of losing money. Just get out there, learn the lessons YOU need to learn - sometimes the easy way, sometimes the hard way, by doing the biz.

But DO keep reading and growing - staying up until 2am trying to figure this stuff out is what every successful real estate investor does at various times.
	
	Keep moving forward!

Jerry W. · Answer

Sorry guys I am having problems doing the quote.  I really liked the part from @Kurt Kreager about keeping your corporate formalities up.

"I have been advised to make sure you fund the LLC properly in the  beginning, NEVER co mingle personal expenses, and regularly sweep excess  cash out ( ie. through an employment agreement or other DOCUMENTED  business agreement like a lease back or whatever).

Also remember that you are liable personally for anything you personally  do, LLC business or not. If you drop the ladder on your tenant, they'll  come after you and all the LLC's and assets you own but if your LLC's  employee or contractor drops the ladder, only the LLC's assets are at  risk.

Also have been advised that LLC's are NOT a substitute for a great insurance policy and or umbrella policy!!" by Kurt.

That is very important.  Courts will ignore any form of company you set up if you do not maintain proper corporate formalities.

Quinten Jones · Answer

@Roger King Thank you for your great advice.  In thinking about it, you are right, I should just go ahead and start somewhere.  I think that I am going to set-up a Trust for each property with Liability Insurance and have my Primary LLC own those Trusts.  Second, I will set-up another entity that will have a contract with my primary LLC to manage its Capital Assets, and it in itself would be covered by some form of Liability Insurance.  Again, thanks ever so much for your great advise.

Account Closed · Answer

I think a good insurance policy would be the way to go.

Joe Gore

Which entity structure is the best way to go?

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