LLC Formation Question

[Edward Segaar]

I just finished listening to today's podcast and was confused on the llc setup.  I live in PA but own in Florida.  I can not set up a Florida llc because it requires a Florida address to do so.  If I were to setup an llc through Wyoming or Nevada, or some other state, which state laws would apply, floridas or the state the llc was formed in?  Second question, how could I transfer my properties to my llc without triggering a due on sale clause?

[Jay Hurst]

Quote from @Ryan Coon:

Quote from @Jay Hurst:

Quote from @Ryan Coon:

Hi Edward,

These are great questions. First, as has been pointed out, you can set up an LLC in FL, even if you do not have an address there to provide. You can do this by hiring a Registered Agent and/or a virtual office service in Florida. You can typically get these for fairly cheap.

Second, while it is true that if you own Florida real estate in a WY or NV LLC, Florida law will still apply as it pertains to the real estate, there are still easy ways to take advantage of the strong asset protections provided by states like WY or NV. The simplest way is to set up a WY or NV "holding" LLC, that can serve as the holding/parent company for all other state specific LLCs like a FL LLC here. Thus, you can have a WY LLC own a FL LLC where the FL LLC owns the property.

You might be wondering why you would do this. Well, when it comes to asset protection for things like real estate, we can breakdown asset protection into two distinct categories, inside asset protection and outside asset protection. 

Inside asset protection is about preventing liabilities at occur inside an business entity like an LLC, from exposing or putting at risk other assets that are not in the LLC. Thus, for example, placing your FL property into an LLC can help prevent any lawsuits or creditors associated with that FL property from exposing your personal assets such as your home.

Outside asset protection on the other hand, works the opposite way by preventing liabilities coming from outside the LLC from exposing the asset inside the LLC. For example, this is what prevents your personal creditors (e.g. you get into a car accident and injure the other driver) from easily going after the assets inside the LLC.

A comprehensive asset protection plan will account for both inside and outside liabilities. Florida is especially illustrative of this concept because FL LLCs, especially single-member/owner LLCs, provide very little outside asset protection. FL, like many other states, provides little to no barrier to prevent your personal creditors from going directly after the assets inside your single-member FL LLC.

However, states like WY are famous for providing very strong and robust outside asset protections to LLCs set up there. Thus, by dual layering the LLCs where you own a WY holding LLC and the WY holding LLC owns the FL LLC you can effectively take advantage of WY asset protections while also satisfying FL law by having the LLC that directly owns property set up in FL. In this setup, personal creditors attempting to go after the assets in the FL LLC will first have to get through the WY LLC which can be a pretty tall order.

Third, as to due-on-sale issues, your options/ability to transfer the property into an LLC largely depends on whether the loan is backed by Freddie Mac or Fannie Mae. If the loan is backed by Freddie or Fannie then you can typically transfer the property directly into the LLC because both Freddie and Fannie have issued guidelines specifically allowing transfer to an LLC. The good news is that most residential real estate loans are backed by Freddie or Fannie. If you do not know if you're loan is so backed, you can check with Freddie and Fannie directly by following these links:

https://myhome.freddiemac.com/resources/loanlookup
https://yourhome.fanniemae.com/calculators-tools/loan-lookup

If your loan is not backed by Freddie or Fannie then this issue is not as clear cut. Some people use land trusts (in particular for residential properties of less than 5 units) to avoid due-on-sale issues. Some people will simply transfer the property anyway and then simply make sure they do not make late payments or otherwise default on the loan because most lenders won't spend the time and resources to audit the account and discover the change as long as borrowers are making on-time payments every month.

You can do all of this, but understand when/rates come down and you wan to refi to take advantage you will have to unwind this structure. Conventional loans require to close in personal name (and you are correct you can trasnfer back over, but that will trigger transfer taxes in FL) and even the vast majoirty of DSCR loan programs do not allow for layered LLC's.

I agree that long-term financing/refinancing goals can effect and inform decisions regarding the use of LLCs or other entities like Land Trusts (which are also a great option in FL) to provide protections to the real estate. Ultimately, any decisions will come with opportunity cost. I tend to recommend that if we're planning on refinancing soon, say within 6 months to a year, then perhaps holding off on moving the properties may be wise. However, if the potential refinance is years down the road, then I would be much more hesitant to delay getting some significant protections in place to limit liability exposure. 

Just pointing out that the how the liability protections can affect the financing options, so borrowers understand that side as well. It seems many, if not most, do not understand the ramifications as they do it themselves or their attorneys have no idea how it effects financing. so, that opportunity cost does indeed come at a cost when they want to ultilize the equity and find it hard to access or at least much more expensive then they thought.