LLCs, holding companies overkill?

Question

I want to start buying investment properties. I want to set up a legal system correctly from the beginning to protect me from potential lawsuits. I want anonymity. I have been looking at different companies that provide physical address, mail forwarding, attorney and tax id, and nominee directors. These companies range from 4K-12k for their packages. Does anyone have any advice for someone like me starting out. I can’t imagine starting -12k right from the beginning before I even start bidding for properties. Oh yea and yearlies for the agent and mail forwarding ~1k.

Thanks.

Scott Smith · Answer

When meeting with clients the first order is to discuss (A) their personal assets, (B) break down their current investments portfolio and other business ventures before discussing any (C) future goals. Each of these variables will dramatically change the advice for the individual asking this question. I often break it down into the "five pillars" of protecting your assets.

1st pillar is avoiding unnecessary and risky activities (don't drink and drive, insurance generally won’t cover your poor decisions) and take good care of your investments - these simple steps will help you prevent lawsuits before they even occur.

2nd pillar is a good insurance policy as that cover the majority of your exposure. However, insurance is limited because it only protects you from one type of liability: accidents/negligence. Insurance doesn’t protect you from any part of the sale or acquisition of a property (e.x. Somebody wanting to sue for you backing out of a bad deal or accusing you of selling them a property with defects like unknown termite damage). Insurance also doesn’t protect you from misunderstandings, especially those made in writing and email. What happens in these misunderstandings is that something goes wrong either in the sale or after, and then they sue you for some statement you made that they “misunderstood”. That lawsuit is a claim for fraud, and that’s what fraud typically is...a misunderstanding and someone being “injured” and wanting to hold the other responsible for it. Insurance never protects you from these kinds of claims and they happen all the time.

3rd pillar applies after you have good insurance You need to protect yourself from what insurance doesn’t cover by compartmentalizing your assets. Compartmentalization means that if something happens to one property they can’t touch you or the other properties. You should use either LLC’s (the old and expensive way) or a Series LLC (the new and more cost/time effective way). No matter where you live or where you own assets, I personally recommend the Series LLC to be a great tool for the individual investor who is planning to expand their operation, as it allows for you to scale infinitely for FREE- check out this article to learn more.

4th pillar is somewhat similar - you want to separate your operations from your assets. One company owns everything and does nothing (this is your SLLC a/k/a “asset holding company”) and a completely separate company handles all of your operations (this is a traditional LLC a/k/a “operating company”) For the operating company which serves as your face to the world and through which you do all your business, you establish a Traditional LLC to carry out the operations of your investments. The operating company takes on all of the liability that would otherwise blow back on you including: paying property management, paying contractors, collecting rent, marketing, etc.

5th pillar is owning everything anonymously. If people don’t know what you own, then they are less likely to sue. People don’t sue people that qualify for food stamps. This anonymity can be accomplished for free by using Trusts to own your companies as well as the assets. Trusts create this anonymity by removing your name from public record. Even if they can see you used to own a property, when properly transferred it will look like it was sold to investors. If they somehow guess you are the owner still, it doesn’t matter because you are not the owner. The trust and the LLC are the owner of the asset/real estate, so even in the scenario that they guess, they guess wrong.

The key is scaling your protection with your assets. Paying 12k for asset protection on your first rental would kill just about any investor. You want to start with what you can afford and scale it up with your business. This is the main reason I recommend people talk with an experienced attorney. An attorney should be able to map out your exposure and give you some different strategies and explain their pros/cons and give you a recommendation. From that point you need to decide how you want to proceed. Some clients I work with want far more protection than others, so it really comes down to what you are comfortable with.

This isn't legal advice, just my opinion as a real estate investor.

Jerry W. · Answer

@Kris Abejuela, lets compare your corporate protection to buying a toilet for your bathroom.  When you buy your first rental you need a toilet in it.  It needs to be functional, it needs to look properly, you need to know and understand how it works so you can fix it if needed.  You might pay $50 to $120 for that toilet.  Now after you own 4 or 5 rentals you might need to buy taller toilets or handicap accessible toilets that are $200 or $300 each.  They will be very good toilets.  Now you may need to put a beday (no idea how to spell it)  into a rental that may cost you a few thousand dollars.  That will be high end and only needed if you have top of the line clients.  Eventually you may want to buy a $30K toilet that you can flush bowling balls down the toilet.  It would be crazy to do that in the beginning and in fact you will probably never need it.  Some of the anonymity schemes and trusts and multiple LLCs are going to require a lot of paperwork and money.  If you don't keep great records they will be useless.  If something truly bad happens they will likely be able to find you with a few depositions or interrogatories anyway.  Usually an LLC going through a managing company is great protection.  if you need more then you can add another layer of LLc for a managing company and owning company are separated.  If you run them right they should be fine.  If you are hands on in any way you will never really be anonymous.  There is a reason NONE of the big players on this site use anonymity in investing.  If you truly did something bad they will get to you, period.  Barring that you should be OK.

Cody L. · Answer

I setup new LLCs all the time.  I have ~30 of them.  Costs me $300, paid to secretary of state in Texas.  What's $12k??

Katie L. · Answer

@Kris Abejuela

There are several considerations that can go into the analysis of whether you need an LLC or whether a large insurance policy will suffice. Will depend on several factors like the type of property, type of tenants, your risk tolerance, other assets you own, your estate planning, laws where the property is located, etc.

Any lawsuits would be limited to the assets of the LLC and not your personal assets (assuming you run the LLC appropriately and the corporate veil is not pierced). But, an LLC will not limit you from liability in total. You can still lose your investment in the LLC. If you're going the umbrella insurance route, make sure it will cover you for several things including just the routine slip and fall (like mold or earthquake). You'll also want to ensure you have a good property manager to look after the upkeep of the property if you are not there to notice anything deteriorating or which may need attention.

Creating an LLC in California would cost you a minimum tax of $800 every year. You would have ongoing filing requirements with the State and would need to keep business records and documentation.  California, however, does NOT recognize series LLCs so each LLC you create would subject you to this $800 minimum.  Even if you created a non-CA LLC, if you are managing it from CA, you cannot escape the tax.

I have had clients before pay a company to serve as agent of service of process and also use them for business address and that helps to keep your anonymity but it is hard to remain entirely anonymous.  I think the most you can really do is make it more difficult to find your information or to reach you.  The cost of such a service is usually fairly reasonable through a company.

You also want to look at whether a pass-through entity helps your bottom line and your taxes. There is a new 20% pass through deduction you may qualify for that could help you, but not everyone qualifies. You should still be able to get this even if the properties are not in an LLC, if you qualify.

These are all things you will want to discuss with your attorney and CPA. If you need references for either of them in San Diego, let me know.

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

Jerry W. · Answer

@Kris Abejuela, when you mention the magic word California it opens a huge can of worms.  While I am not  a fan of anonymity, @Scott Smith has often talked about a thing called a Delaware Trust.  I know practically nothing about them, but it is my understanding they do get some protection from liability like an LLC, but they do not trigger the $800 franchise fee California charges for every LLC  or Corporation you own.  I would presume that it has pass through tax status or he would not be promoting them.  He would be the one to give you more information about them.  The $800 franchise tax may make an option like a Delaware trust more affordable.

Derek Guivehchi · Answer

@Kris Abejuela Overkill ... find a local attorney to help you set up an effective structure that will match your investment goals and address your liability concerns. Also check the attorney recommendations with your accountant to make sure the structure is not going to create any unfavorable taxation.

Ned Carey · Answer

@Kris Abejuela Yes it is overkill for most people. It is also probably not as effective a strategy as you think. I know my Private investigator could find you. I bet I could to.

How much do you have to protect?  How large do you expect to grow? How risky are the properties you intend to buy? You can do a lot of what you talk about here for a LOT less than $4k, and certainly less than $12k.

When you say a "Holding Company" are you talking about a parent company holding other LLCs? Multiple entities will increase your costs and headaches. I know I have lots of entities.

It is more important that you run your company correctly and follow the laws than it is to have a complex entity structure.

It is your first post here - there are lots of posts here about the pros and cons of LLC and various structures like Nevada or Wyoming companies.  Do a search and keep readinig

Scott Smith · Answer

It really comes down to what you are comfortable with. Sounds like you have a pretty reasonable grasp of your liability and know what direction you want to proceed. The benefit of the forums is that people can point out things you may not expect/anticipate. The main thing meeting with an attorney would provide you at this point is a more clear understanding of what you have that might be at risk, and potentially catch a "specific" liability that general advice on a forum or CPA might not catch. Some people don't think it's worth the consultation cost, others do. Is the chance they catch something other people have missed worth the cost of the consultation to you?

This isn't legal advice, just my opinion as a real estate investor.

Kris Abejuela · Answer

Thank you all for your input, everything said hits hard to me and makes me think deeper. I am getting closer to deciding that I’m probably going to open up a LLC in Cali as a holding company then branch from there to other LLCs. Heard many good points about all aspects, but logically I think this one makes the most sense. I am giving up anonymity because i believe that if someone really wants to get you, they will get you. Also I don’t think I have enough assets yet to deal with the headaches(paperworks) of creating the Wyoming LLC and nominee directors with yearly fees on top of each phase.

I do see that when I start to become more successful and bigger I may adapt the other more sophisticated models. I spoke with my CPA who basically advised me on the Cali LLC and the out of state one. CPA advice good enough? Or should I still seek advice from an attorney? At this point I feel like I understand the risks/benefits?

Kris Abejuela · Answer

thanks all for your advice! Very helpful! I love this community! 😆

LLCs, holding companies overkill?

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