Ive been trying to research the pros and cons of each. It is really confusing.
I spoke with my lawyer, and he suggests putting my rental property into a trust.
My goal is to buy and hold very long term (sell when it makes sense to my situation)
Which would benefit me more? Im concerned about protection and tax advantages.
I'm biased but I'd listen to my lawyer :) All three if set up and managed properly should provide protection of personal assets. You'd have to follow-up with your attorney on why he thinks a trust is best, it may have something to do with being more difficult to "pierce the veil" if an issue arises, but I don't know MA corporation or trust law. It may also just be a less demanding form of protection on your end as far as record keeping requirements, etc. Again, you'd have to ask him.
Do you have someone who handles your taxes to double-check the tax advantages of a trust over an llc or s-corp? Is your lawyer well versed in tax issues? Personally I prefer deferring tax advice to tax professionals and focusing my time on the liability side.
I think you're already on the right track by hiring professionals to do this stuff for you while trying to keep abreast of it yourself. You should follow up with them on why they think x is better than y. They should have an answer for you, and if you don't like it you can always go somewhere else.
Nobody on this site is going to be able to give you better advice than your lawyer that knows your actual financial situation and goals. If you want a second opinion, consult a second lawyer.
If you search the forums, you'll find a million posts asking this identical question - it will always boil down to "it depends."
The vast majority of the time, you're not going to want an S-Corp. If you have a relatively small number of properties, an LLC is probably fine. Once you get a lot, pay a lawyer to figure out the trust vs LLC thing. Many people will also tell you a good umbrella liability policy is plenty of asset protection, and mucking around with complicated asset protection schemes isn't really worth the time, money, and effort.
@Michael Gefvert thank you for your response. My lawyer has about 20 clients who have rental properties, and he said its different for everyone. I know he has my best interest at heart, he basically said if I plan to open up an LLC it could get expensive, with a $500 filing fee every year.
I would assume im going to be moving properties around over time, refinancing, etc. I know any entity will create friction with the banks. But Id like to sleep well at night.
@Aaron H. Thank you for your response, I think I should have clarified a little better. Im just trying to get a better understanding of how each one operates, what can and cant be done with each. For example, can I hold more than one property in an LLC?
Yes, you can hold as many properties as you want in an LLC. But, if LLC #1 holds two properties, then a lawsuit against LLC #1 could reach both those properties (but not your personal assets, usually). If you had each property in a separate LLC, then a lawsuit against LLC #1 could only reach one property.
But, it may not be practical or cost-effective to hold, say, 50 single family homes in 50 separate LLC's. So there's always a tradeoff between complexity and protection.
If your main goal is to sleep better, get an umbrella insurance policy. That will protect you financially irrespective of the corporate structure you use to hold the properties.
Thank you @Jack Bobeck
@Brian Ellis I'm not a lawyer, nor CPA, not this is legal advice - your due diligence is still required.
AFAIK, a trust is not providing liability protection - is just a layer of anonymity that is often employed with a legal entity (an LLC) as it is complementary to it. So, unless MA has a special treatment for trusts, I would not employ trusts for the rentals (not alone for sure, but together with an LLC).
You don't want to hold real estate in S-corp and C-corp - Owning Rentals in an S Corporation Might Be a Costly Mistake.
That leaves you with the LLC - and even here there are many things to be discussed (when to do it, how to do it, proper transfer to preserve title insurance chain, DOS, financing, management, distribution of properties per entity, insurance etc.).
The LLC is a legal concept, of no particular taxation benefit (you can have it as a disregarded entity for taxation, or taxed as a S-corp or C-corp). You can structure your asset protection strategy such way that you might be able to get some tax benefit depending on what you do in your real estate investing, like if you self manage, or do flips, but just for holding, no tax advantage.
Here is a diagram I put together from my learnings on the same path you are walking now
A trust with an LLC as beneficiary is generally the way to go. But of course it depends, e.g. whether you want to refinance the property at some point (difficult with LLC as beneficiary b/c of Freddie Mac and Fannie Mae rules) and what is the main purpose of your endeavor (anonymity or asset protection or both?). Your attorney is on the right track. The only thing that bothers me is the statement of 500.- filing fees. That is excessive and in the absolute majority of states not operative (didn't check MA for this post).
@Alexander Y. Peter I plan to refinance as soon as its renovated, I would expect a trust to give me the same problems with the bank, as would an LLC?
Also, the annual filing fee in MA for a LLC is $520
@Brian Ellis Is the annual/franchise fee $520, or the filling fee $520 ? one is paid every year (and it looks to me is closer to $20), the other is paid at the beginning when you form the LLC, one time, and is $520. Big difference if so.
@Costin I. it is a $520 annual filing fee with the secretary of states office
@Brian: Depending on the setup of the trust (is the trustee an individual or an LLC?) and the bank you're dealing with, you will be able to refinance with the residential department of the bank (better rates). The LLC will get refinancing only with the commercial department.
As to the filing fee: If you just hold title in real estate, you dont have to establish an LLC in MA with excessive filing fees. Nobody forces you to have an MA LLC for that if you dont do business there resp. you dont have to register as foreign (= out-of-state) LLC. Furthermore, I just the website of the Department of State in MA: There is way too much info about the LLC posted online. Compare that with other states!
In other words: An MA LLC doesnt give you much privacy at all...
For using a trust you would make the trust pay for everything that happens in the property.....taxes would come out of the trust too. So you would not have to use as an income. Bad side to that is the trust keeps all the money from the property. IF you take any out.....taxes.
Get a CPA to talk to you about this....
Also moving things out and in and changing things in a trust will involve a lawyer that is $$$$$$.
So, I would say ask the lawyer you have how much to change the mortgage inside the trust? How much to add another property to the trust? How much to take money out of trust?
Ask a million questions and figure out if that is best. I personally would say it is best for me.
@Costin I. - excellent post. I did all the DD on entity types (but not trusts) with my attorney when I first started 16 years ago. My s-corp is for actively earned income only (mgt fees, consulting, wholesaling, etc) and owns NOTHING.
I base my decision of whether to LLC or not on property type and whether debt will be involved or not. Little houses with debt? No way. Especially if you hope to refi again someday. I act above board and carry good insurance only on houses. If the insurance co will offer me $300 to $500k in liability protection for peanuts, maybe the worry of a lawsuit is actually false evidence appearing real (FEAR).
I hold commercial assets inside LLCs (multi-member). I keep each below $1M to avoid having to do Sch L&M on the 1065, which are a pain as a self-filer. The most I would hold in 1 LLC is $2M if I could help it. Obviously I can't break up 1 commercial asset worth more than that. I would hold 1 per LLC at that point.
Just my $.02 after consulting with a competent legal pro a while ago.
Thanks @Steve Vaughan , coming from you it's a big compliment.
I recommend people to look at LLC and asset protection as another form of insurance complementing regular insurance - insurance against litigation. It's not a guarantee that you'll not be sued, but it makes the target on your back smaller, more difficult to find (if complementing with trusts), unappealing and expensive to sue, and contained and difficult to collect in case you lose.
Another perspective would be to apply the "Asspro rule of 2%" (© Costin 2018) - the cost of setting up and maintaining your asset protection should be less than 2% of equity you are trying to protect. Let's say, it costs you 1.5K to get your structures in place (holding LLC or Series-LLC, with or without land trusts, with or without separate operations LLC) and 0.5K per year (for maintaining the LLC properly, bookkeeping, lawyer and CPA, etc.) for a total of 2K. You should have 100K or more in equity to protect before it makes sense to spend that money - compare that with how much you spend in annual insurance for the same property/equity (on the same FEAR principles, just in case your property might burn down).
Again, this is a simplified rule of thumb, as there is a lot more to the LLC question - when to do it, how to do it, current mortgage, proper transfer to preserve title insurance chain, DOS, future financing, management, distribution of properties per entity, insurance, partners, etc. - stuff barely touched in current thread.
There is no one-size-fits-all - the risk threshold is a subjective measure particular to each individual. And there is no absolute answer and unique tool/strategy in anything real estate. You need to learn how and when to use all the tools available to you (financing, insurance, management, etc.) and to understand how they fit together in your toolbox, as none will give you everything.
But @Brian Ellis is in the right place (BP) to learn and get answers.
"Ignorance is bliss. Knowledge is power, but also a burden. The cure to both - the 4 ions: education, action, progress(ion), not perfection".
@Michele: I dont understand the first part of your post: "For using a trust you would make the trust pay for everything that happens in the property.....taxes would come out of the trust too. So you would not have to use as an income. Bad side to that is the trust keeps all the money from the property. IF you take any out.....taxes."
Do you mean that the trust is an entity that can accumulate income, is taxed as separate entity and any "distribution" is taxed again at the beneficiary level?
I can see why you might be concerned that your lawyer isn't experienced in this area. However, only an attorney familiar with your personal situation can give you the best advice. Ideally, that lawyer should know a thing or two about asset protection.
Is the attorney suggesting an Anonymous Land Trust (AKA Title Holding Trust)? If so, he's on the right track. This is actually a way to *avoid* friction with the bank. For more on that, see this previous BP article.
S-Corp Vs. LLC: Making that call will depend on personal factors like your income, tax situation, partnership/membership issues, and much more than anyone can ethically go into detail with you on this forum. An S-Corp would be less appropriate for lower-income, newer investors or those who could easily form a single-member LLC. It's a highly personal decision that will require, well, personal information.
I hope some of that was helpful regardless! Let me know if you have additional questions.