As real estate investors, we must safeguard our rental properties and personal assets from potential risks and liabilities.
One effective strategy is establishing a limited liability company (LLC) structure.
In this comprehensive blog post, Semi-Retired MD explains the intricacies of LLC formation for rental properties, exploring the best practices and benefits of this approach.
It explores various considerations, such as asset protection, anonymity, and estate planning benefits, that come with housing your properties in an LLC.
Additionally, practical advice and step-by-step instructions to help you set up your LLC structure are provided.
Summary: Many real estate investors use limited liability companies (LLCs) to house their investment properties. This post covers the reasons you should consider putting your property in an LLC. We also give an overview of the LLC structure that we use. As well as provide a guide with step-by-step instructions for setting up your LLC structure.
[Disclaimer: We are not accountants, lawyers or financial advisors, so please consult your own team of professionals about the topics covered in this article.]
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A limited liability company (LLC) is a legal entity that can operate a business. Real estate investors use LLCs to house their properties. They offer additional legal protection with the added benefit of flow-through taxation (more about this later).
When we first started investing in real estate, Kenji and I set up several LLCs to hold our rental properties. Over the years, we have continued to spend the time, money and effort to form additional LLCs. We believe the benefits of housing our properties within LLCs far outweigh the costs to create and maintain the structures. While many look at LLC structures as an expense, we look at it as an investment.
The goal of this article is to cover the benefits of LLCs. As well as to offer a real-life example of how we set up our LLC structure.
But before we get into the details, a disclaimer. We are not lawyers, and the information contained in this post should not be considered legal advice. We gathered the information contained in this post over the course of the last several years through our own reading and research. Ultimately, we used it to form the basis for setting up our own LLC structure. We have consulted several attorneys regarding our LLC structure and documents. And we always advise that you discuss your individual situation with an attorney. As well as use one to set up your LLCs to ensure that they are done correctly.
Points to Consider
Also, note there are some states where putting your properties into LLCs may incur an additional cost. In Florida, for example, there is a documentary stamp tax of $0.70 per $100 for transferring your property to an LLC. This means putting a $100,000 property in an LLC will cost you $700. Which may or may not be worth it to you. Add to that Florida’s broad homestead exemption. Which protects your personal property from creditors, and LLC coverage could become less attractive. This is all to say your personal situation may be different from ours depending on where you purchase rental properties.
As a reference to use in this post, here’s a diagram of how our LLCs are set up.
As you can see, each property is owned by an LLC in the same state as the property. Notice in this example, we chose something generic like flower names rather than using your own name. Because you don’t want anybody to be able to identify you from the name of the LLC. All of the property LLCs are then owned by an umbrella LLC in Wyoming.
And with that, let’s address why we put our properties in LLCs using this structure.
The main reason we choose to house our properties in LLCs is for asset protection.
If you own a rental property in your personal name, what happens if you are sued by a renter and lose in court?
The potential outcome is that your renter can seize your property. As well as the money in your personal bank account, your personal property and possibly garnish future earnings. Now, there are certainly variations depending on your state of residence (and this is why you need a lawyer!). However, speaking in broad swaths, losing a lawsuit when a property is in your name can result in personal financial devastation.
Benefits of an LLC Owning Your Property
Now, let’s look at that same situation when the property is owned by an LLC. Meaning it’s owned by a company, not you.
In that case, when the renter wins the case, they can maybe seize the property and what’s in the property’s bank account. However, they shouldn’t have access to your personal bank account or other personal assets. That is, assuming you’ve treated the LLC as a separate business.
And what happens if that property-owning LLC is owned by another umbrella LLC located in a state like Wyoming? Now the renter has to hire a lawyer in both states to take the property LLC and umbrella LLC to court. And if they win, they may only get a charging order.
Getting a charging order means that the renter doesn’t get to take your property. They only get the right to receive an interest in the owner’s distributions. The great thing is, you get to decide when to make distributions. So maybe you decide instead of making distributions to recycle money back into the business to grow it? Or maybe you just want to pay yourself a salary so there is no profit at all?
This is a serious deterrent to any lawyer who is deciding whether or not to take on a renter’s case. If they see multiple layers involving Wyoming and their charging order protection, this makes taking the case pretty unattractive. Even if they do win, there’s no guarantee of a payout.
The second motivator for putting our properties into LLCs is anonymity.
As doctors, we are well aware of the personal financial risk of being sued. We are also aware that we might be perceived as “profitable” to sue. Since the public perception is that doctors are rich. Heard of the “doctor dollar” anyone? Along that vein, Kenji and I are pretty motivated to not have our renters know that their building is owned by a couple of doctors.
LLCs can help maintain your anonymity as the property is no longer in your personal name. If you do it right, all public information about the property should be in the name of your LLC. And, if you choose to copy our LLC structure, the “sole member” (aka owner) of the property LLC is an umbrella LLC, which is owned by a trust. One of the benefits of choosing Wyoming for your umbrella LLC is that they won’t release the names of the umbrella LLC owners. Wyoming lists an “organizer”. If you do it right, you can have a third party step in as the organizer and leave your name off of their public website.
Is There a Perfect Solution?
With this structure, is your name still on anything? The answer is yes.
If you used a residential loan, your name remains on the loan documents after you transfer ownership of the property to the LLC. In addition, since you’re likely managing your umbrella LLC, your name appears on most of the documents signed by that LLC in your capacity as a manager. Unless you hire an outside person to do that for you.
As with everything, the anonymity isn’t perfect. There’s always a chance that you can get sued. Just like there is always a chance that a particularly smart lawyer may be able to find a way around your LLC protections. In U.S. court, nothing is 100% protective. The idea here is to shield yourself the best you can using business entities.
One last personal note about anonymity. I know there are some doubters out there saying, any lawyer can figure out who owns the LLC. While this may be true, anonymity isn’t just about lawyers. A story about one of our properties made the news…and not in a good way. Fortunately, our structure kept us out of the limelight. That one incident alone made our asset protection completely worth the investment!
Estate Structure Benefit
Although not a huge benefit like asset protection or maintaining your anonymity, the estate structuring benefit is worth mentioning. This was a pleasant surprise to us that saved us a lot of time when we were working on our trust. If you choose to structure your LLC companies with an umbrella LLC as owner of all the property-owning LLCs as we did, it is fairly easy to transfer your holdings into a trust.
When we set up our trust, our estate-planning lawyer simply drafted a single document that transferred ownership of the umbrella LLC to the trust. The umbrella LLC owns all of the LLCs below it. Therefore, we did not have to complete additional paperwork for each property LLC and their respective properties. If you didn’t have the properties in LLCs, you would have to change everything from property taxes, utilities, bank accounts, etc. from your personal name to your trust.
There are other benefits to placing your properties into LLCs besides asset protection and anonymity. Which include tax benefits and benefits for tax-reduced estate planning. For example, you could gift a portion of your LLC to your children over the years. So over time they are able to inherit the company and it’s holdings tax-free. These topics are beyond the scope of this post. However, if you would like to learn more, consider referring to the examples found in Start Your Own Corporation and Tax-Free Wealth to get an idea of how to harvest these benefits and then, talk to your tax accountant, attorney and/or estate planner.
Our LLC Structure
As you can see from the image above, we formed an umbrella LLC, located in Wyoming. We made the umbrella owner of our property LLCs.
Why is it located in Wyoming when we don’t own any properties in Wyoming?
Throughout the course of our reading, we found that there were specific benefits to establishing an LLC in Wyoming and Nevada. These included not having state income or corporate taxes As well as greater protections and increased privacy afforded by the LLCs formed in those states. One of the greater protections offered by Nevada and Wyoming is the fact that a creditor can only pursue a charging order (see explanation above) when suing you. As a result, your LLC assets are protected from seizure even if you lose a lawsuit. The anonymity protection described above provides a higher level of privacy. Both States allow you to list a third party on their public websites.
Why Did We Choose Wyoming over Nevada?
First, it’s much cheaper to form and renew an LLC in Wyoming ($100 to form and $50 to annually to renew). In Nevada, it costs $425 to form and $350 to renew. Note that these prices may change over time. Check the most recent fees by going to the Secretary of State website for each State.
Second, it’s reportedly much harder to open a bank account in Nevada compared to Wyoming because of the anonymity described above. With that said, you can often find a bank in your State of residence to open up a bank account for your WY or NV LLC.
Another reason we chose Wyoming was that in Start Your Own Corporation, Garrett Sutton had a note about a relatively recent change in Nevada’s law that allowed law enforcement agencies engaged in a criminal investigation to request the owner’s information from their Nevada registered agent. While we never intend to be part of a criminal investigation, this could be an indication that Nevada is slowly weakening its LLC protections over time.
Finally, we just love the landscape of Wyoming and like visiting there (emotional pull) so we would have chosen the state if all else had been equal anyway.
About Those Property-Owning LLCs
Our property owning LLCs are based in the states where their property is located. This means we have now established LLCs in three states. Requiring a lot of time and effort (and resulting in consulting multiple lawyers in different states). Why did we go through all this extra effort?
In our minds, perhaps the most important reason is that when your property-holding LLC is located in one State and your umbrella LLC is in another state, anyone who wants to sue must secure two lawyers, one in each state. That takes a lot of effort and cost on the part of any renter who wants to sue you. In the words of Garrett Sutton, “the more road blocks the better.“
Additionally, we found that Sutton’s book advised that if we registered all of our LLCs in Wyoming only, for example, we would have had to get them “qualified” to do business in whichever state the property was actually located, which apparently can be fairly expensive (and seems like a ton of work given the number of properties we have).
In Start Your Own Corporation Garrett Sutton also suggests that having the property-owning LLCs set up in the state where they are located gives you better protection if you are personally sued (i.e. in the case of a car accident – where your properties are not involved) since the person suing you has to go through the WY LLC with all its protections to get to your properties.
And, finally, for the simple answer to the question: because all of the lawyers we spoke to suggested it. Have to trust the experts!
Now, Why Do We Have So Many LLCs?
Again, this comes down to what our professionals told us. You can limit liability by separating each property into its own LLC rather than combining multiple properties under a single LLC. Imagine a situation where a renter is injured in one of our buildings and successfully sues our property-owning LLC. In comparison, if we had all of our properties housed in that one LLC, the renter could potentially gain access to all of the properties.
Setting Up Your LLCs
Now, as you can imagine, there is a lot of work behind setting up these multiple LLC structures and treating them as separate business entities.
To help you with yours, Kenji has put together an extremely detailed LLC Guide of all of the steps you must take to successfully set up an LLC in WY (enter your name and email below for a free download). We recommend you start setting up your LLC structure soon after purchasing your first property. If you are buying a commercial property with financing, you’ll want to buy the property in the LLC name. So you’ll want to have this all set up before you buy the property.
Since the download is in PDF format, we’ve included the links for quick access to the companies we’ve used to set up our LLCs:
For setting up an anonymous physical and mailing address, we use Traveling Mailbox.
For Registered Agent service, we use Incorp Services Inc.
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Are you prepared to elevate your estate planning and ensure a smooth transition of your rental property holdings with the right LLC structure?