Yikes—entity fees potentially killing my cash flow, help!

17 Replies

Yep—another newbie here, wondering what I'm missing ... I have only recently learned that owning my properties free and clear puts me in a more vulnerable position for liability and know now that I need legal asset protection. As I'm beginning to educate myself in this area, I'm frustrated in discovering the costs that are involved. 

From setup, to maintenance, to tax return filing fees—the costs incurred are threatening to put a huge dent in my cashflow. Yet, when doing property evaluations and analysis, I've yet to see these fees being called out in the various formulas I've been shown (including the BP calculators). Is having an entity a necessary element of investing—or only in certain situations such as owning free and clear properties?

I understand that entity set up in NV or WY is more cost effective than in CA where I live, but the costs involved still appear to be significant. I would love to hear how other investors are managing this, and if there are any inside secrets you can share. Thanks in advance!

@Elaine Hester yes, it is expensive to set up and operate an LLC in Californi

And even if you form an LLC out of state you will still likely be required to register your LLC in CA and pay the annual $800 tax.

That being said, whether an LLC (or some other entity) is necessary for your situation is something only a qualified asset protection attorney can tell you.

But in general, yes, a free-and-clear asset is a tasty target.

Good luck.

I can't assess your individual situation, but I own a number of CA rental properties and a few out of state. I don't utilize legal entities of any kind and at least for me there is no reason to utilize them. 

My regular day job is very low risk (i.e., I'm not manufacturing dynamite in my garage), so my overall liability risks are low. As such, standard landlord insurance on each rental property with an overall umbrella policy is far more than adequate coverage.

In my opinion, people have gone absolutely overboard in setting up legal entities like LLCs, and I think they have done this primarily out of fear, ignorance and vanity. I save probably 10k a year (and a whole lot of paperwork headaches) by NOT using legal entities, and all with NO meaningful level of additional risk.

We have an LLC but we do not rely on it for liability protection and none of our RE assets are in the LLC. The LLC is mostly just an $800/year name for our use that makes it superficially appear that there can be some separation of liability but it is unlikely to hold up to any scrutiny.

We use an umbrella insurance coverage for our liability protection. Our coverage amount is high enough that it is unlikely that we will ever exceed the coverage. An umbrella coverage is almost dummy proof. you do not need to worry about things like commingling of personal assets and LLC/corporate/trust assets. Of course the coverage is not free but it does provide peace of mind. Also to increase from a couple million to a 10 million coverage is not super expensive; i.e. the coverage costs are not linear.

The insurance carrier that most of our RE assets are insured with would not provide us an umbrella coverage (deemed us too risky) so we had to go with another carrier (a carrier that did have a couple of our properties insured with so not a completely new carrier, just not our preferred carrier).

I suspect that the reason you do not see these in any of the calculators is that it is not linear per property.  After you set much of this up for the first property the costs for subsequent properties is fairly minimal.

Good luck

@Elaine Hester

Asset Protection is very important. There are several methods/strategies for asset protection. Some are expensive and are considered bullet proof but likely cost $$$$. There are also some other strategies that might not be as bullet proof but cost $.

You should definitely consult an attorney to see what the best strategy is based on your wealth profile, risk exposure, risk tolerance and budget.

You may want to double think about creating an LLC in NV and WY if your property is not located there. It may further add to the cost.
Creating an LLC in NV and WY will require you to register with the SOS in NV or WY. You will also be required to register as a foreign entity in the state that you do business further adding to the cost. In addition you would need to pay for a registered agent in NV and WY.

Have you looked into an umbrella insurance policy?

A. If you have few (1-3) properties with little equity and/or are financially strapped…insurance and proper management. Concentrate first on getting deals and growth.  Read and implement Every Landlord's Property Protection Guide ( https://www.amazon.com/Every-Landlords-Property-Pr...). More than 3 and/or lots of equity, get an LLC.

B. When setting up entities there are multiple decisions for each property that have to be considered:

1. Liability protection 2. Ease of management 3. Tax Angles.

The number of properties per LLC should be based on a number of different factors: equity, number of units, cash flow, location of real estate, and tenants. They are often rated on a scale from Poor to Excellent. The investor has to decide what level of each and mix is optimal for their situation.

For example, you might own 4 properties with a sum total of 50k in equity but one of the properties generates $900 per month positive cash flow. In this situation I would structure it so the cash cow property is held separate from the other 3 rentals despite the low overall equity. In other words each person/situation is a case by case scenario.

C. Insurance doesn't cover in all instances, like mold or fraud (very easy to misrepresent something when discussing your properties).

Originally posted by @Christopher Smith :

I can't assess your individual situation, but I own a number of CA rental properties and a few out of state. I don't utilize legal entities of any kind and at least for me there is no reason to utilize them. 

My regular day job is very low risk (i.e., I'm not manufacturing dynamite in my garage), so my overall liability risks are low. As such, standard landlord insurance on each rental property with an overall umbrella policy is far more than adequate coverage.

In my opinion, people have gone absolutely overboard in setting up legal entities like LLCs, and I think they have done this primarily out of fear, ignorance and vanity. I save probably 10k a year (and a whole lot of paperwork headaches) by NOT using legal entities, and all with NO meaningful level of additional risk.

I agree that for many people an umbrella policy is sufficient to cover them against liability related to investment properties, but LLC's do provide a level of coverage that a lot of people are often glad they have when something goes wrong. This is something an attorney can tell an individual after looking at their local laws and particular circumstance.

I currently do not use an LLC and rely on my umbrella insurance. However, one thing to consider going forward is to meet with your CPA and do some tax planning. As part of the new tax plan effective this year, pass through entities (i.e., LLC's) receive a 20% deduction on their taxable income simply for being a pass through entity. This can mean huge tax savings depending on the level of rental income you have. If the additional savings outweighs the cost of operating an LLC, why wouldn't you do it? Just food for thought.

Originally posted by @Igor Messano :
Originally posted by @Christopher Smith:

I can't assess your individual situation, but I own a number of CA rental properties and a few out of state. I don't utilize legal entities of any kind and at least for me there is no reason to utilize them. 

My regular day job is very low risk (i.e., I'm not manufacturing dynamite in my garage), so my overall liability risks are low. As such, standard landlord insurance on each rental property with an overall umbrella policy is far more than adequate coverage.

In my opinion, people have gone absolutely overboard in setting up legal entities like LLCs, and I think they have done this primarily out of fear, ignorance and vanity. I save probably 10k a year (and a whole lot of paperwork headaches) by NOT using legal entities, and all with NO meaningful level of additional risk.

However, one thing to consider going forward is to meet with your CPA and do some tax planning. As part of the new tax plan effective this year, pass through entities (i.e., LLC's) receive a 20% deduction on their taxable income simply for being a pass through entity. This can mean huge tax savings depending on the level of rental income you have. If the additional savings outweighs the cost of operating an LLC, why wouldn't you do it? Just food for thought.

You don't need a legal entity to benefit from the new law change you reference, owning in your own name will be sufficient (i.e., owning in your own name is in end effect a pass through). Now whether passive rental real estate activities will qualify for the new provision is still unclear.

Originally posted by @Christopher Smith :
Originally posted by @Igor Messano:
Originally posted by @Christopher Smith:

I can't assess your individual situation, but I own a number of CA rental properties and a few out of state. I don't utilize legal entities of any kind and at least for me there is no reason to utilize them. 

My regular day job is very low risk (i.e., I'm not manufacturing dynamite in my garage), so my overall liability risks are low. As such, standard landlord insurance on each rental property with an overall umbrella policy is far more than adequate coverage.

In my opinion, people have gone absolutely overboard in setting up legal entities like LLCs, and I think they have done this primarily out of fear, ignorance and vanity. I save probably 10k a year (and a whole lot of paperwork headaches) by NOT using legal entities, and all with NO meaningful level of additional risk.

However, one thing to consider going forward is to meet with your CPA and do some tax planning. As part of the new tax plan effective this year, pass through entities (i.e., LLC's) receive a 20% deduction on their taxable income simply for being a pass through entity. This can mean huge tax savings depending on the level of rental income you have. If the additional savings outweighs the cost of operating an LLC, why wouldn't you do it? Just food for thought.

You don't need a legal entity to benefit from the new law change you reference, owning in your own name will be sufficient (i.e., owning in your own name is in end effect a pass through). Now whether passive rental real estate activities will qualify for the new provision is still unclear.

I'll be interested to find out for sure after I speak to my accountant but I am almost 100% positive this is not correct. The new regulation specifically calls out the need of use of a pass through entity for the 20% AGI savings so I don't see how not using one would get you the benefit. You are right that the end result of a pass through is regular personal income, but the regulation isn't a tax credit on regular income, it's on the LLC income prior to hitting your personal AGI. I will know for sure soon when I meet with the CPA.

Originally posted by @Igor Messano :
Originally posted by @Christopher Smith:
Originally posted by @Igor Messano:
Originally posted by @Christopher Smith:

I can't assess your individual situation, but I own a number of CA rental properties and a few out of state. I don't utilize legal entities of any kind and at least for me there is no reason to utilize them. 

My regular day job is very low risk (i.e., I'm not manufacturing dynamite in my garage), so my overall liability risks are low. As such, standard landlord insurance on each rental property with an overall umbrella policy is far more than adequate coverage.

In my opinion, people have gone absolutely overboard in setting up legal entities like LLCs, and I think they have done this primarily out of fear, ignorance and vanity. I save probably 10k a year (and a whole lot of paperwork headaches) by NOT using legal entities, and all with NO meaningful level of additional risk.

However, one thing to consider going forward is to meet with your CPA and do some tax planning. As part of the new tax plan effective this year, pass through entities (i.e., LLC's) receive a 20% deduction on their taxable income simply for being a pass through entity. This can mean huge tax savings depending on the level of rental income you have. If the additional savings outweighs the cost of operating an LLC, why wouldn't you do it? Just food for thought.

You don't need a legal entity to benefit from the new law change you reference, owning in your own name will be sufficient (i.e., owning in your own name is in end effect a pass through). Now whether passive rental real estate activities will qualify for the new provision is still unclear.

I'll be interested to find out for sure after I speak to my accountant but I am almost 100% positive this is not correct. The new regulation specifically calls out the need of use of a pass through entity for the 20% AGI savings so I don't see how not using one would get you the benefit. You are right that the end result of a pass through is regular personal income, but the regulation isn't a tax credit on regular income, it's on the LLC income prior to hitting your personal AGI. I will know for sure soon when I meet with the CPA.

First, no new regulations have been issued yet, so it would be a little difficult for them to call for anything insofar as they do not yet exist.

Second, to my knowledge no where in the language of Section 199A of the recently passed Act do the words "pass through" appear.

Third, its not a credit its a deduction.

I've excerpted the relevant portion of the Section from the Act so you can see for yourself: 

"SEC. 199A.QUALIFIED BUSINESS INCOME.

.—In the case of a taxpayer other than a corporation, there shall be allowed as a deduction for any taxable year an amount equal to the sum of—"

An individual, at least the last time I checked, qualifies as "other than a corporation"


It's definitely not required, and I've stayed away from them for that exact reason- kills cash flow. And further with that, as I've found out they don't always offer 100% asset protection anyway. I ended up going the umbrella policy route for liability protection. Here's details-

https://www.biggerpockets.com/renewsblog/2013/08/1...

There's a ton of information in the comments as well.

The primary mistake you are making is leaving dead equity in a rental property. This is a major financial mistake.  In reality all the money is earning is what you save in interest on a mortgage.

You can kill two birds with one stone by pulling out the equity. You would then not feel you need LLC protection and you could reinvest the money in a income fund and double your potential return. You may even find you could sell your properties and earn the same or higher returns.

Dead equity doesn't work for you, it works against you .

Originally posted by @Igor Messano :

 I will know for sure soon when I meet with the CPA.

No, you won't. :)  Your CPA will not know for sure, either. Nobody does at this stage, as the law is half-baked and will be modified and clarified in the coming months. We are all making educated guesses in our (noble) attempts to interpret the new law. 

We (meaning the tax pros) all agree that a formal entity is NOT a requirement for the 20% deduction. As of today, that is.

@Christopher Smith

Just asked my colleague who is a tax expert and he shares your same opinion that it does not sound like a pass through “registered” entity is needed as a sole proprietorship is sufficient. The concern seems to hover around the actual nature of the business as certain service industries do not qualify. I did also find a time article that describes the same in a more detailed manner for whoever is interested. Christopher, I am guessing 2019 tax season will be a great time for you.

http://newsfeed.time.com/2012/10/10/philadelphians-wear-more-sweatpants-than-anybody-says-study/

Thank you all for your comments and willingness to share your opinions, this is very helpful.

I had a meeting with Anderson Tax and Legal Advisors on Wednesday, which prompted me to reach out for community advise. I actually asked them about using an umbrella policy on two occasions during our call and the advisor essentially rolled over my questions as if I hadn't asked. I supposed that was not surprising considering that is apparently not one of their products.

We actually have a 3-day Tax and Asset Protection "class" through Anderson that we paid for through an educational program we enrolled in that I'm sure is designed to sell the need for their products alone. So, although we may learn something, I don't expect that it may be the best advise for every individual attending.

I will look into the umbrella policy and also try to find an asset protection attorney to speak with. --If anyone has any recommendations, please PM me.

Thanks again!

@Elaine Hester my experience with them are pretty bad. I am glad I got out and will never go back again

@Elaine Hester have you looked into a Delaware Statutory Trust?  Message me and I can send you a primer on it.  If structured correctly, benefits include cutting the $800 a year franchise cost, anonymity, and compartmentalization.  Also, you can scale it to fit your needs.

Best of Luck!

@Liz C. , thank you for your candid response regarding Anderson ... would you mind sharing a bit about what happened in your experience with them?

@Scott Smith , I had not heard of the Delaware Statutory Trust before. Thank you for offering to share more info, I will PM you.

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