​Living in CA, investing out of state. Where to form LLC?

33 Replies

I think I have a simple enough situation that I won't require advice from a asset protection lawyer, I'm hoping some of you are in a similar situation and can pass on what you have done.

My wife and I live in California. We are under contract for our first investment deal, a multifamily in South Dakota. We have assets outside of this property that we would like to protect, so my plan is to form an LLC for this property and then get umbrella insurance on top of that. The property is over four units, so we're looking at a commercial loan regardless. The lender has no issue with an LLC holding the property.

I know California is going to consider us "doing business in California" and therefore subject to the $800 minimum franchise tax in California. It seems my options are to either form a South Dakota LLC and register it as a foreign company or form a California LLC and register it as foreign company in South Dakota.

My questions:

  • The LLC operating agreement can be simple, my wife and I will be the only members. Can someone share a sample simple operating agreement for this "married couple holding a single property" LLC?
  • What are the pros and cons of forming the LLC in CA vs where the property is? The typical advice for RE investors is to form in the state where the property is because it avoids the overhead of having to register a foreign corporation where you are doing business. But since we are CA residents, we have that overhead regardless.
  • California is a community property state, South Dakota is not. If we form a South Dakota LLC, can we still treat it as a disregarded entity because we live in California?

Thanks in advance!

Kelly.

I live in LA and invest only out of state. I form a new LLC for all of my properties and form the LLC in the state of Wyoming and Nevada.

I assume you picked  Wyoming and Nevada as those are generally considered friendly places for forming an company, right?

But, don't you end up having to pay filing fees in WY or NV, plus register a foreign corporation in the state the property is in, and then also register in California? That's three places to do annual filings. Also, in many states, you have to have a registered agent with a local address in that state too. 

@Kelly Byrd California will consider an LLC formed in another state whose only asset is property in that other state as doing business in California, just because the owners live in California? That doesn't sound right to me. No business is being transacted in California, other than you receiving income there. By that logic, any business anywhere in the world that sends a check to someone in California is "doing business" there. Not sure that would pass constitutional muster.

Have you double-checked this with a CA corporate lawyer?  Seems like something they would answer for you in five minutes and not charge you for.

"California will consider an LLC formed in another state whose only asset is property in that other state as doing business in California, just because the owners live in California?"

@Jonathan Twombly : Yes, I am sure, my own research dug this up, my RE-focused CPA confirmed this. A few years ago, The California Franchise Tax Board decided on an expanded definition of "doing business in California". If I talk to my property manager about my property, or a banker, or whatever, I am doing business in California.

@kelly how substantial is your networth aside from these to be acquired assets? it might nit be worth it forming. there are more asset protection vehicles than llc. first stop is of course insurance and second trust. Unless Antoine Martel 's NV and WY LLCs are 100% owned by the CA LLC (and not himself), them he has to domesticate those in CA and pay three 800s to FTB. If he doesn't, then LLCs formed in foreign states is useless as it there is no corporate veil tp protect and anyone could directly access personal assets. "No legal advice on statements above, pure experience and common knowledge about corporate and state law".

Yep ... what Manolo said in his first two sentances ... first question to be answered is the pros and cons of opening a LLC at all vs an umbrella insurance policy on assets held in your name. After you get past that question, then on to which state to open the LLC in ... however, in most cases, the analysis doesn't lead most past the first question ... if you are buying a 100 unit apartment building, by all means, open up a LLC ... for a few scattered lower value SFRs, then I personally think there are better ways than a LLC. Asking an asset protection lawyer if you need for them to set you up a legal entity is kinda like asking a barber if you need a haircut :)

I don't know how to answer the "how substantial is your net worth aside from these to be acquired assets?" in a public forum. It's enough that I'm concerned about it.  We have investments outside of real estate. We have our home. The property I'm acquiring is a 12-unit apartment building.

Agree about barbers and haircuts, that's why I'm asking here first. Re umbrella, I'm doing that regardless. 

@Kelly Byrd I had a similar situation last year. I mistakenly opened an LLC in California for rental properties in Texas. I immediately closed the CA LLC and didn't have to pay the $800 franchise tax since I dissolved within a year, hired a local Texas attorney to open a series LLC there (I have multiple SFRs). His fee was not that expensive, he filed and within a few weeks had my LLC.

There was no issue creating an LLC in Texas since my attorney used his office address as the "local LLC" address. My advice would be consult with an attorney in the state where you are buying the property to set up and file the LLC docs, then you are set.

Paying California income tax on the Texas rental income is another story, however...

Originally posted by @Bret Faszholz :

@Kelly Byrd I had a similar situation last year. I mistakenly opened an LLC in California for rental properties in Texas. I immediately closed the CA LLC and didn't have to pay the $800 franchise tax since I dissolved within a year, hired a local Texas attorney to open a series LLC there (I have multiple SFRs). His fee was not that expensive, he filed and within a few weeks had my LLC.

There was no issue creating an LLC in Texas since my attorney used his office address as the "local LLC" address. My advice would be consult with an attorney in the state where you are buying the property to set up and file the LLC docs, then you are set.

Paying California income tax on the Texas rental income is another story, however...

If you earn income and pay taxes in CA, then you are doing business in CA, and you still owe the $800 CA franchise tax fee, regardless of where the LLC is incorporated ... the OP is right on that one ... I would not expect a TX attorney to necessarily be well versed in CA law to be familiar with this issue and think you need to consult with a CA attorney and/or CPA about such matters, at which time you may want to dissolve your TX LLC.

Originally posted by @Kelly Byrd :

Ok, so CA investors with properties out-of-state, did you form your LLC in that state or CA, why did you choose one over the other?

To answer your question, I invested in properties in Phoenix and put them into an AZ LLC because it was easier and less costly to do it that way. I put them into a LLC in the first place because they were my Roth IRA funds and thus had to be "arms length" rather than in my personal name ... for all others, both in and out of CA, I bought in my personal name and took out a reasonably sized umbrella policy. Unless your net worth is in the 8 figures, and/or you are doing some seriously risky business with a very high liability and probability of getting sued (which I would not place well run buy and hold real estate in decent neighborhoods), then you would be best served IMO to do the same because the juice just isn't worth the squeeze. If these "special conditions" are the case, then consider opening a LLC in the state in which the properties are located, but then plan on paying the $800 CA franchise fee (which it sounds like you are), along with extra bookkeeping fees, tax preparation fees, etc. and commercial financing probably under less desirable terms than on a conventional mortgage in your name or buying them all cash and holding them free and clear.

Thanks @David Faulkner for directly answering, I really appreciate it. So I'm not in the eight figures...yet ;-)  

But I'm doing a commercial loan anyway for this 12-unit property, so the loan isn't the issue. I intend on the umbrella insurance anyway, the quotes seem cheap for the amount of coverage. But, I just got an email from my home/auto insurance agent that they won't add a 12-unit to a personal umbrella policy.  Hmm, I guess I need to talk to a commercial insurance broker.

@Kelly Byrd There was a theory playing around in my mind before when I considered expansion in NV because of a potential project. If the NV LLC is owned 100% by CA LLC, then NV is domestic on its own and the CA only owns them wholly, it might offer a big grey area as to protection, since NV corporate veil is very rarely pierced. In theory, you don't need to domesticate NV LLC, and of all the CA business lawyers I asked couldn't give me a straight answer. If I were in your position, I would make them in CA and foreign register them to any state. If you do the other way around, you will have to register NV to CA then TX to CA then WY to CA, in the end you will be maintaining 3 states FTB + 3 home state fees, while if you do CA to TX, WY, NV, you will maintain 1 CA FTB then 3 home state fees. Either way, there is no escape, it's a matter of fee avoidance than that of corp veil protection. As far as operating agreement is concerned, I would have a lawyer draft it if your assets is "substantial" vs that of off-the-shelf, the 1500 will easily pay off. If we are only talking of 200k networth, it wont be even worth to form an LLC. I'd even go for a real Corp than LLC, it has more laws and more protection, not big difference in maintenance.

95% out-of-state landlords who I know they form LLC in the state the property located. They told me the reason is that the cost of CA LLC needs to be paid annually $800. This is hurting cash flow on the rental.

I don't see it really matters the LLC is formed in which state. I have seen TX LLC manages properties in bay area. However, your case is a 12-units commercial residential property. I think you definitely need to form LLC to protect your other assets. Attorney can help you to do it correctly, including your question about how to hold the LLC.

My lender told me that easier way is to get the loan under your name and immediately transfer the title to LLC... Some lender might hesitate if the LLC is brand new with no record. Also, don't forget to ask the loan broker about any limitation of refinancing under LLC.

I own 2 SFR rentals in CA and one in TX..... in my research and consultation I found no benefit to forming an LLC for any of them in either state. My properties are in our family trust and we have an umbrella policy......

Kind of a side topic but...... so I can see the benefit of an LLC when you start to get big MF complexes etc, but what is the true benefit when you are under say 10 SFR properties? As long as you place the ownership in a trust and have a decent umbrella, what's the benefit of an LLC?

Updated almost 4 years ago

Forgot to mention that in my research that when it comes to most small investor situation, most decent lawyers will easily dismantle your "protection" as an LLC anyway..... ANY co-mingle of your private $$ and your LLC $$ at its all over....

It seems like you are stepping over dollars to pick up pennies. If you are purchasing a 12-unit multifamily then why be concerned about an $800 LLC filing fee or hiring a CA attorney to make sure this is done right? The best bang for your buck is to get good legal advice, as in any business transaction. Do-it-yourself and anecdotal advice are not likely to serve you well in this case.

I own out-of-state properties that are not in LLCs but they are not material to my overall investment portfolio - it sounds like your case is different. I would strongly recommend working with a CA business/real-estate attorney and using an LLC and umbrella insurance. The best argument against an LLC is that if you think you need one to protect yourself, you should question whatever it is you are doing that could lead to being sued. And as others have said, good lawyers get around an LLC easily if you are not acting properly as the landlord/owner.

My strategy has been to focus on getting good tenants - that resolves 95% of all other issues with owning real estate (assuming your purchase diligence is good).

You can find lots of operating agreement examples online, and I bought one from Nolo.com for a business I set up. But again, why doesn't it make sense to spend $1,500 with an attorney to protect an investment worth many hundred times that amount?

Originally posted by @Kelly Byrd :

Thanks @David Faulkner for directly answering, I really appreciate it. So I'm not in the eight figures...yet ;-)  

But I'm doing a commercial loan anyway for this 12-unit property, so the loan isn't the issue. I intend on the umbrella insurance anyway, the quotes seem cheap for the amount of coverage. But, I just got an email from my home/auto insurance agent that they won't add a 12-unit to a personal umbrella policy.  Hmm, I guess I need to talk to a commercial insurance broker.

 Hey kelly

I am in the same predicament. I live in CA and have rentals in MO and IN. I was initially hoping to open 2 llcs one in each state...May I ask what you ended up doing?

Originally posted by @Bo Kim :
Hey kelly

I am in the same predicament. I live in CA and have rentals in MO and IN. I was initially hoping to open 2 llcs one in each state...May I ask what you ended up doing?

Sure! I formed an LLC in South Dakota, where the property is.

I am not a legal expert, but I looked up the California LLC code.

Owning an LLC for out of state property looks like it is clearly a foreign LLC. Simply owning or being a member of an LLC is not considered doing business in the state.

Entering into contracts that must be accepted out of state, maintaining property, maintaining a bank account for a foreign LLC company are all clearly excluded in the code.

See the items below (sorry copy and paste seems to have colored text in a weird way I can't fix):

https://leginfo.legislature.ca.gov/faces/codes_dis...

Noted at: 17708.03.

"...activities of a foreign limited liability company that do not constitute transacting intrastate business in this state include all of the following:

(1) Maintaining or defending any action or suit or any administrative or arbitration proceeding, or effecting the settlement of those, or the settlement of claims or disputes.

(2) Carrying on any activity concerning its internal affairs, including holding meetings of its members or managers.

(3) Maintaining accounts in financial institutions.

(4) Maintaining offices or agencies for the transfer, exchange, and registration of the limited liability company’s own securities or maintaining trustees or depositories with respect to those securities.

(5) Selling through independent contractors.

(6) Soliciting or procuring orders, whether by mail or electronic means or through employees or agents or otherwise, if the orders require acceptance outside this state before they become contracts.

(7) Creating or acquiring indebtedness, evidences of indebtedness, mortgages, liens, or security interests in real or personal property.

(8) Securing or collecting debts or enforcing mortgages or other security interests in property securing the debts and holding, protecting, or maintaining property so acquired.

(9) Conducting an isolated transaction that is completed within 180 days and is not in the course of a number of repeated transactions of a like nature.

(10) Transacting business in interstate commerce.

It also states in the section following the above excluded items:

(c) Without excluding other activities that may not be considered to be transacting intrastate business in this state within the meaning of this article, a foreign limited liability company shall not be considered to be transacting intrastate business in this state merely because its subsidiary transacts intrastate business in this state, or merely because of its status as any one or more of the following:

(1) A shareholder of a domestic corporation.

(2) A shareholder of a foreign corporation transacting intrastate business.

(3) A limited partner of a foreign limited partnership transacting intrastate business.

(4) A limited partner of a domestic limited partnership.

(5) A member or manager of a foreign limited liability company transacting intrastate business.

(6) A member or manager of a domestic limited liability company.

(d) A person shall not be deemed to be transacting intrastate business in this state within the meaning of this article merely because of its status as a member or manager of a domestic limited liability company or a foreign limited liability company registered to transact intrastate business in this state.

(e) This section does not apply in determining the contacts or activities that may subject a foreign limited liability company to service of process, taxation, or regulation under the law of this state other than this article.

(Added by Stats. 2012, Ch. 419, Sec. 20. (SB 323) Effective January 1, 2013. Operative January 1, 2014, by Sec. 32 of Ch. 419.)