Property Manager · Sacramento, CA · Member since 2015 · 161 posts · 24 votes
Hi BP, I'm looking into out of state investing, but am being told I need to have a California LLC to do that (I Live in Sacramento). However, I'm talking to a turnkey company in Ohio who says all I need is an Ohio LLC (much cheaper). My question is:
Where do I need to set up my LLC. Tax person says "By the very act of choosing this company while residing in California, you are exercising management which is defined as doing business within the state". Is he saying as long as I don't use a professional management company, I'm ok? But then what about collecting rent, isn't that business? I know someone who has moved 4 times without selling, so he has 4 houses in 4 different states. He has no LLC. I was thinking of getting just one house, near relatives, and manage through them...for now. If it goes ok, I can set up LLC and go bigger. What do you think? Thx.
If you're using it to hold property in Ohio, you'll either need an Ohio LLC or you'll need to register your foreign (out of state) LLC to do business in Ohio. I typically recommend to just register the LLC in Ohio instead since you're going to spend about the same in Ohio filing fees as it is. You'll also need a statutory agent with a physical presence in Ohio. If you don't have a point of contact in Ohio that's willing to serve this role for you, there are plenty of companies that offer this service for ~$100/year. Fail to register your non-Ohio company to do business in Ohio and you'll eventually run into a problem such as being able to freely transfer the title or gaining access to the courts for an eviction or other proceeding your company needs to initiate. The good news is that the filing fee is modest and the paperwork is minimal.
Regarding your second question, as I understand it California has been assessing their taxes on out of state LLCs when they're owned and operated by a California resident. The argument, supposedly, is that you're actively managing the company from California and thus doing business within the state and owe the state those taxes. If you don't willingly comply, the state finds out about the Ohio LLC through your state tax returns that contains documentation referencing your Ohio LLC.
If you're using the Ohio LLC to hold Ohio real estate and having local management handle the day to day operations I find it hard to believe that such a scenario qualifies as doing business in California and I think it's quite an overreach by the taxing authorities. That said, it's the taxing authorities opinion that counts and not mine and it does sound like they're willing and able to assess the California LLC taxes on LLCs in other states provided that you do live in CA. If you can find a California CPA or tax attorney that has clients that invest in real estate remotely, you may be able to get a more detailed answer on this.
If you're using it to hold property in Ohio, you'll either need an Ohio LLC or you'll need to register your foreign (out of state) LLC to do business in Ohio. I typically recommend to just register the LLC in Ohio instead since you're going to spend about the same in Ohio filing fees as it is. You'll also need a statutory agent with a physical presence in Ohio. If you don't have a point of contact in Ohio that's willing to serve this role for you, there are plenty of companies that offer this service for ~$100/year. Fail to register your non-Ohio company to do business in Ohio and you'll eventually run into a problem such as being able to freely transfer the title or gaining access to the courts for an eviction or other proceeding your company needs to initiate. The good news is that the filing fee is modest and the paperwork is minimal.
Regarding your second question, as I understand it California has been assessing their taxes on out of state LLCs when they're owned and operated by a California resident. The argument, supposedly, is that you're actively managing the company from California and thus doing business within the state and owe the state those taxes. If you don't willingly comply, the state finds out about the Ohio LLC through your state tax returns that contains documentation referencing your Ohio LLC.
If you're using the Ohio LLC to hold Ohio real estate and having local management handle the day to day operations I find it hard to believe that such a scenario qualifies as doing business in California and I think it's quite an overreach by the taxing authorities. That said, it's the taxing authorities opinion that counts and not mine and it does sound like they're willing and able to assess the California LLC taxes on LLCs in other states provided that you do live in CA. If you can find a California CPA or tax attorney that has clients that invest in real estate remotely, you may be able to get a more detailed answer on this.
Hi @Jeff Caravalho, awesome question and many investors don't think about this. I've referred a lot of investors to attorneys on this topic, and they all come back telling me exactly what @C. Timothy Murphy said. He nailed it.
@Timothy Murphy III and @Steve Olson thanks for you responses. California charges around $800/ yr for an LLC. I heard an LLC in Ohio is around $450 one time, then another $600 annually for tax prep and legal paperwork. Is this your understanding of the fees in Ohio for LLC setup? Just trying to get a comparison to California's cost.
So how does my friend get away with having 4 houses in 4 states without an LLC? Do you have to live in them for awhile?
If I want to buy 1 house out of state, is there any way I can do it with out an LLC. I'm thinking an LLC will eat into too much profit unless you have multiple properties to spread the cost & make it worth it. I'm not willing to go big right off the bat. I want to take baby steps with one & see how it goes for a year, but the cost of an LLC may make it not worth it. Kind of a catch-22. Thanks.
You need to read up on what a LLC provides: liability protection.
You don't need a LLC to buy a house, you can buy it under your name. But not having a LLC opens you up to liabilities if you get sued. A way to help is to get umbrella insurance.
Regarding the LLC out of state and living in CA. I just talked to a well known CPA and here is the answer...
If you're living in CA, you are considered to be doing business in CA, and thus even if you have an out of state LLC, you will need to do the appropriate filing for that in CA, which does include the $800. There doesn't really seem to be any way out of this. From my understanding, it's not whether or not you use a property management company or not. It's if you have business income that you need to file and pay taxes on from you rental.
@Jeff Caravalho Jeff - I live in CA and invest in VT, where I'm originally from. I've brought this up with my attorney here in CA before and his answer was "LLC's create a lot of unnecessary paperwork and expense, and just get a good umbrella policy". You'll see lot of pros and cons about this here on BP, so it's a personal choice. I hold everything under my personal name with a $2M umbrella policy (about $750 per year). I've been in the rental business for almost 15 years with no issues of anyone suing me.
Do keep in mind if you go the LLC route, most banks won't lend to an LLC, Those that do generally will charge higher rates and have shorter terms (commercial loans).
@Jeff Caravalho, at the root, you don't need a LLC to file taxes for a business income. For example, you can just be a sole proprietorship without any legal entity. You don't need a LLC to file business expense deductions.
For those of us out of country (Australia), planning on buying in multiple states, does it matter which state the LLC is created in? Are any particularly advantageous?
@Andrew Wong Interesting you say that because I am a sole proprietor. my thought is I don't need LLC to start out, with one house, much like a homeowner with second home they rent out. Once I feel comfortable with out of state investing (B neighborhood , near relatives), start LLC and purchase more property. What are your thoughts on how many properties warrants an LLC? I heard people say to start LLC with 1st house, one for each house. Others say put them all in LLC, or groups of them. Others use umbrella like @Tom S. I quess it depends on your investment style, net worth and your ability to sleep at night.
@Jeff Caravalho it depends on what you're comfortable with and what you can sleep with. If CA wasn't so expensive, I would probably put each of my properties under one LLC to keep them isolated from each other as much as I can. But given the reality of the situation, that's pretty rough on the income.
You should think less about "How many properties warrant a LLC? How many properties should I put under one LLC?" and more along the lines of "How much net worth would I need to warrant a LLC? How much net worth do I want to expose in one LLC?"
The $800 fee is some sort of annual tax that California charges. Ohio has no such annual tax. You will have to pay the $99 filing fee to file the articles of organization. The remaining costs will vary from attorney to attorney. The actual form to be filed is quite simple and most of my costs in establishing an LLC are incurred through consulting with the client to determine if the LLC is the way to go or not for them as opposed to the actual filing. The operating agreement, if you have one drafted, usually adds a couple hundred dollars to these costs.
For tax purposes, the LLC if solely owned by you is a disregard entity and its operations will appear on your personal tax returns. So there's no additional tax prep costs related to having an LLC as the taxes are handled the same way. If multiple partners jointly own the LLC then a partnership return needs to be prepared.
@Tom S. is spot on about the lending requirements. Traditional lenders won't let you title the property inside an LLC. Most investors that use LLCs are either cash buyers or creative financers and don't make use of bank funding for that reason. Some guys buy with traditional bank financing and then deed the property into the LLC to try and get around this. This violates due on sale clauses though so it's not without some risk. Your personal name will also appear in chain of title.
The umbrella policy is a good idea if you need extra protection beyond the insurance tied to each investment property. Factors such as owning a package of properties with equity or having a high personal net worth make it more enticing. Ideally, you have the property insurance, an umbrella policy, and an LLC all in place for asset protection purposes. I'd certainly wouldn't use any less than two out of the three. The structure Tom S. talks about work perfectly for someone that doesn't use the LLC.
It depends on what exactly you're trying to do, but it sounds like you'd be fine without the LLC to start out. A lot of out of town investors buy in their own names, typically with bank funding and hire local management to handle the operations.
@Andrew Wong, @Tom S., @Timothy Murphy III are there any disadvantages to an umbrella policy that I should know about? How much should I get? Any suggestions on Umbrella companies? Should the company be in the state I invest in, or is Cali ok? Thanks.
Not that I'm aware of. I haven't used them myself but as I understand it they work as secondary coverage behind your liability insurance on each property. As it's not the first line of defense, the insurance carrier's exposure is reduced and the premiums are usually pretty inexpensive. Talk with an insurance expert to get the details.