forming my first entity

4 Replies

Ive been doing RE investing for about 3 years now and I have 4 SFR in 2 states. I plan on buying more this year. It is my goal this year to start to operate more professionally so I can continue to scale my business. Up to now I have been keeping my books in excel and all my properties are in my name with conforming financing. This has worked well, but I have two goals. 1) make sure Im operating in a way that protects me from liability 2) be as hands-off as possible

I have parsed through threads here on BP, read asset protection books, and talked to my accountant and various lawyers. It seems there is still no clear path for me. In my mind a great outcome would be a situation where I have an entity/entities holding and managing the properties. The day-to-day operations would be handled by local property managers, and monthly books kept by an hourly book keeper. That way I can focus on sourcing and acquiring new deals (and my day job). I can do some annual formalities for the entities and my accountant can file taxes from the books kept by the book keeper.

Unfortunately I haven't been unable to find anyone in my personal network who has been able to advise me to my satisfaction. I was able to get a referral to a RE attorney in Kentucky but their help was limited as they typically work with local investors on larger commercial deals.

I live in California and work at a tech company. I have taken on RE investing as a hobby and a way to invest windfall earnings. I have learned a lot being involved in the nitty gritty of buying foreclosures from out of state and getting them rented out. I own two houses in California (5 hours away from my home) and two in Indianapolis also. I am aware there are potentially better markets but I have worked hard to establish networks in both of these places. Unfortunately my network hasn't yielded much help in the way of entities or asset protection. Part of that might be because I don't know how to ask the right questions and Im shy asking around at my day job for that kind of referral.

Currently my best guess looks like holding title to the properties in individual revocable trusts and the beneficiary of the trusts can be an LLC. This seems to be the best compromise for cost/protection/complexity. I am aware of the LLC tax in CA. Its possible I would only hold the California properties in a trust and skip the LLC (but cant I change the beneficiary without any public filing?). The LLC would be formed in a state where taxes make sense and probably charging orders are the only creditor remedy, even though there is a chance other state's law could apply. I would conduct company business only while I am not in California. I travel often.

Am I on the right track? Can anyone offer suggested reading or a real life example of something similar to my situation? I feel like my situation is not complex or unique.

This is tricky. Let me start by saying I am neither an attorney nor an accountant. So my advice is solely based on my personal experience. 

Most real estate laws and entities are based on "Home Rule" meaning local law takes priority. For example, in Illinois you can file a Delaware or Nevada LLC, but if you do business in Illinois you must file as a foreign entity registered to do business. Basically you are now bound by the laws and taxes of Illinois regardless.

So where you have your properties, reach out and speak to an attorney there. Because the laws vary greatly from state to state. 

Again just advice based on my personal experiences.

@Brian G.

I created an entity when I first started investing to establish a formal business and to help my mindset.  The only partner I have is my wife in the entity.  The only benefits I have seen is the entity does add some credibility to you when you are accumulating debt with banks.  

If you need help forming an entity in California I can help.  It is really easy.  You don't need an attorney to form the entity but you would probably want on to create the operating agreement if you had partners.


Frank

Thanks @Frank Romine but Im trying to avoid forming a LLC in CA. In my mind I would only put the out of state properties in the LLC and hold the CA properties in a trust. I could conduct my business for this LLC while out of CA. Additionally having the LLC as the beneficiary of several trusts could prevent me from having to register it as doing business in each state where I hold property as long as the LLC doesn't participate in the management of those properties--if I understand correctly.

Keep the ideas coming, Im happy to invest time learning about this or listen to advice that this is all too much work for nothing.

@Brian G. one of the main reasons people here on BP use for setting up an LLC is asset protection. At some point the LLC was created (likely by an attorney) and it has become very popular. Unfortunately people greatly overthink their situation and more times than not an LLC simply increases your annual expenses through filing fees, setup fees, attorney and accounting fees, etc... and offers you no other benefits and offers you no more asset protection than a general liability insurance policy.

Take into consideration your three SFRs. Let's say each is valued at $300K. I have no idea what your market is like so it's a start. Total asset value is $900K. Assuming you don't own them all outright, you have mortgages on them. Let's be conservative and say you have 40% equity in each property. Your total equity is $360K. This is your exposure in the event you are sued and they go after all of your assets. I realize you may have cash and other assets but I'm keeping things simple. You can add your personal assets to the $360K if you'd like a better picture. 

So total exposure is $360K. Even if you triple your holdings in the future and get to 9 properties of roughly the same value, you are still just over $1M in equity/exposure. Now compare the cost of a $1M liability policy with the cost of setting up and maintaining an LLC and decide which is right for you.

You can form a relationship with a local bank that does commercial lending or you can work with a larger commercial lender but at the end of the day it's going to be your reputation, your experience, your personal financial strength and the financials of the property that you are acquiring that the bank wants to know about. Being a sole proprietor or an LLC or an S-Corp will not matter. Even as an LLC or an S-Corp, you are going to have to personally sign for every mortgage you get.

Just some things to think about.