Newbie Question - Buying, LLC, Trust, but in what order?

Question

Looking at buying my first single family rental. Do/should I set up a trust first, or buy the rental first, or set up an LLC then buy the rental, and then assign the trust as a member of the LLC?

I'm eager and exited to buy and secure the home so I'd love to do that first, but if I should really set up a living trust first and create an LLC before I buy the home, then I want to do the smart thing.

Thanks!

Mike

Chris Mason · Answer

Threads exactly like this one have been created hundreds (thousands?) of times before on this very forum.

TLDR: as a relatively new investor with minimal assets to protect to begin with, revocable living trust + umbrella insurance. That is the going consensus. Right around when you can't get residential loans anyways and have to go commercial is as good a time as any to LLC up, which "the system" already knows, hence it being the natural progression already built into the financing you can get (some commercial lenders REQUIRE an LLC).

For details, check out one of the previous threads.

Carl Fischer · Answer

Your not wrong. Circumstances, asset protection, tax bracket, state and local laws, etc all play a role in the answer.

Just buy it and see how it works. Make sure you like the business and and want to grow it before you spend a lot of money on the “infrastructure” —the answers will get clearer.

Katie L. · Answer

@Mike Huerta

You are right that a living trust is very common (and important!) step in California to avoid probate.  Most people from other states don't realize how easily a decedent's estate is subject to probate in California that if you own real property it almost becomes essential to have a living trust.  Probate in CA is a very costly and very time consuming process where fees are based on the gross size of the estate.  Courts move very slowly, and everything is public record, so it can be a while before your heirs receive your assets and they are viewable as public information.  Still further, if you do not have a proper estate plan, your assets may pass per state laws of intestacy meaning the state decides who receives your assets.  For a lot of other states, a Will will suffice, but that is generally not the case in California.

Estate planning becomes even more important if you have minor children to ensure that you have named guardians for them and have outlined how you wish for them to receive assets (such as at a certain age later in life rather than upon turning 18).

Most people in California that I know hold their LLC interest in their living trust.  In that case, it would seem that a trust should come before the LLC.  But, sometimes the timing doesn't work out and a good deal comes along first such that the LLC comes before the trust.  Each person is different.  Further, some people don't even hold property in an LLC and just hold it in their trust.

There is of course, as well, the possible difficulty with obtaining a loan for property in an LLC or a due on transfer clause if you transfer it to an LLC later.  An LLC also comes with it an $800 minimum tax to California and additional documentation and filings.

The answer is of course: it depends.  Everyone is different.  You should seek out an estate planning attorney in California to make sure you are getting advice specific to your situation and the state laws that you are subject to.

*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 are advised to seek professional advice.

Scott Smith · Answer

Hey @Mike Huerta

If you want to go forward with your strategy the best way to proceed is purchasing the property in your personal name, then transferring it into the trust and assigning the LLC as a beneficiary. This way your get the financing options in your personal name and the liability protection of the LLC, and you wont need to worry about the bank using the Due on Sale Clause on you. The main issue is that California will still want you to pay their $800 annual franchise fee, since you are operating in CA, so you will need to include that in your costs. The only way people have been able to effectively work around the franchise tax while holding onto good liability protection beyond insurance is the Delaware Statutory Trust.

@Randle Weaver I agree it is important to only invest into these entities when they make financial sense, but some of what you state is very risky. If there is a law suit in which there is a judgment against the property then they can take the property; however, if there is no liability protection in place then those filing the law suit can continue pursuing assets (personal and professional) until the judgment is satisfied. Some situations like this have wiped out entire investor portfolios. On top of that a single-member LLC still offers protection, as well as creating separation between investment and your other assets. So it's important to scale up protection with an investor's portfolio - which is something we both can agree on.

Scott Smith · Answer

Also, for some reference when approaching asset protection, this is how I try explain scaling up your protection with your portfolio. 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 - people with limited assets can start on a budget, while those with more to protect will want stranger protection in place to keep themselves protected. 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.

This is not legal advice, just my opinion as a real estate investor.

Randle Weaver · Answer

Banks do not usually lend to an LLC. If you are getting a loan you will need to keep it in your name. You could transfer it into an LLC, but the banks have a clause that if the title transfers while you have a loan they can call the loan due.

People sometimes want to go out and get everything done, when in reality you have time before each phase is truly necessary. If you are not near death, just have a will and save yourself the money right now. Invest that money into property.

People are also worried about being sued and losing the property. In reality, they cannot get your property, rather only the equity in the property. So, if you have a loan on the property jumping into an LLC may not be necessary right away either, plus the earlier fact that the banks won't like it. Also, with a single member LLC, ultimately you are still liable. Plus, your documents and accounting better be spot on or they can pierce the corporate veil and what was the point in an LLC.

Some say, get a trust, then get a LLC and put it in the trust and then get property and put it into the LLC. That method will cost minimally $2,000. Not worth it at first. That is nearly closing costs on a deal.

***Get yourself a property and figure out if you like being a landlord and make sure you are making money and happy. Then invest in a LLC. Once you are thinking about getting a second LLC to limit the damage any one LLC may have to your empire, then get a Trust.

Please remember this is my opinion based on my experience and others opinions may differ. Yes, I have a trust. Yes, I have 2 LLC's. Finally, yes I have rental properties.

Ned Carey · Answer

@Mike Huerta

Trust & estate law is very complex. I am not an attorney but I believe that is basically right. Estate planning is a legitimate use of a trust.

@Uneeq Khan I answered that above but maybe I was not clear.  There is a cost to moving a property into an LLC or otherwise changing the title. If you want a property to be in all LLC, why not put it in from the start?  Another way of looking at it is when do you want the liability protection of an LLC to start.

One reason to buy a property in your name is for better financing. Many people then move it into an LLC.. That brings up other issues like insurance and the risk of the bank calling the loan.

Uneeq Khan · Answer

@Ned Carey

When is it best to set up and transfer a property to an LLC? Before purchase? After purchase? After rehab? After refinance (if doing BRRRR)? After starting to rent?

Ned Carey · Answer

@Mike Huerta transferring a property has a cost, transfer and recordation costs is an obvious one. If you want a trust or an LLC generally that is set up before buying the property. However that many mean the title company who handles you transaction does it for you.

A bigger question is why you think you need a trust? Whether you get an LLC and/or a trust has many considerations.

Jo-Ann Lapin · Answer

You all have given amazing information . Thank you

Newbie Question - Buying, LLC, Trust, but in what order?

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