IMPORTANT UPDATE 2023-11-17: It turns out that anonymity that you get by building an LLC corporate structure is extremely brittle. I have recently learned that I should not consider any LLC structure as fulfilling anyone’s long-term anonymity goals.

Anonymity is very easy to destroy by accident. Any strategy that can not protect you from a single moron is no strategy.

I will be reworking this article to take into account this new data. In the meantime, keep this notice in mind.

Summary

I find myself repeatedly writing similar emails, answering questions about setting up a corporate structure for real estate investing. So I thought to write up our experiences from the quest for the correct corporate structure, and answer the most frequently asked questions.

I am grateful to the re-investors group for all the discussions and advice over the years. You know who you are.

Disclosure

In the text below I link to some paid services and to some online stores for various paid material. I get nothing in return for driving traffic to them. I link to them because I find them valuable and want to share that value with you. Not that I think my links will ever be a significant source of traffic anyways. We use, or have in the past used some of these services. You don’t need to use them. There are many companies that offer comparable services. Feel free to find and use the ones that suit you best.

Introduction

So, you want to create a company that will operate your real estate portfolio?

Here is a list of useful things to know, in Q&A form. This list is not complete. Feel free to suggest topics that I haven’t touched, and I’ll try to backfill with what we dig up.

This list may not answer all the questions that you may have, and it may not answer them expertly enough. That makes sense, as I’m not a legal professional, but rather someone who tries to build pragmatic rules of thumb to run a family real estate business.

The main goal here is to point your attention to topics of interest, so that when talking to an actual professional you know what questions to ask.

I would appreciate it if you would point out unclear or incorrect points by commenting on the document, so that they could be fixed.

Can you recommend some resources to learn about all of this?

Videos

Select videos from YouTube are a nice resource to start learning. Here is a playlist with informative real-estate videos you may want to watch. This is my personal playlist. It contains videos that I found relevant and it grows over time as I add more things. YMMV.

Books (regular, e- and audio-)

A while ago I discovered audiobooks as a way to make good use of my commute time. My entire audio library is at www.audible.com. All of these books are available in their paper editions too. I just find it convenient to listen to audiobooks when unable to set aside quiet reading time.

This is a list of some books that have influenced the way I think about real estate. It’s going to take me a while to fill out this list, since there are probably a few dozen books that are worthwhile reads. Once you read enough of them, the increment of new information you get from each new book starts going down.

Rich Dad’s Guide to Investing.

I am not a fan of Robert Kyosaki’s investment strategies, but his books are probably the most interesting from the perspective of adopting the right mindset to become an investor if you aren’t one already. That’s why this book is the first in the list. It beats less around the bush, compared to the more famous “Rich Dad Poor Dad''. To save you some money in case you get “hooked” as people seem to tend to get with Kyosaki’s books, his books tend to be repetitive, rehashing the same material and stories. So if you read one you likely read most of the others too.

Real estate investor’s deskbook.

This is the reference manual for real estate investing. It’s mightily expensive, but is worth every dollar you spend on it, and then some. It contains explanations and worked out examples for pretty much every aspect of real estate under the Sun. It is a very boring read. I’d say it’s like an encyclopedia of chess openings, but for real estate. But it is very useful if you know what you are looking for. You can find older editions cheaper on eBay. Older editions are quite useful on their own, except they will likely not include information about the credit crunch of 2008 and the ensuing regulation. Mine is from 1996.

Best Real Estate Investing Advice Ever (audiobook, two parts)

A grounds-up intro to real estate.

Best Ever Apartment Syndication Book (audiobook)

This is an A-to-Z guide for a would-be syndicator. Everything you need to get from zero to successful apartment syndication is contained there.

Real Estate Investing Gone Bad (audiobook)

For the cautious person, this is a run-down of 21 scenarios in which real estate investors got themselves in a pickle. It is a good book to understand what you are up against.

Rich Dad Advisors: Tax-Free Wealth, 2nd Edition: How to Build Massive Wealth by Permanently Lowering Your Taxes.

This is a fairly comprehensive book of tax strategies for optimizing one’s tax obligations. That said, if your only income is on a W2, it’s probably not going to help you much. Real estate is an attractive asset class among other things because of its favorable tax treatment. This book will explain some of the approaches that you can use to minimize your tax bill.

The Hands-Off Investor (audiobook)

This book is for anyone interested in investing in real estate only passively. How to figure out where to place your money in real estate if you are not interested in managing it day to day.

What structure do I need?

It depends on what your goals are. It is all about risk and reward.

Some operators decide to run properties in their own name, and do not create any corporate structure to support it. Recommendations I have heard is that if you want to do so, then also take out an umbrella policy that will serve as a liability protection. This is not an ironclad strategy, however. See the section below.

Other operators decide to set up a corporate structure.

LLCs are vehicles of choice for real estate in particular for several reasons. These are:

1. Limited liability in case of a judgment against the business entity.

2. Charging order protections in case of a judgment against you personally (this has to be set up correctly to make use of it)

3. Anonymity (though this has to be done correctly to work well) Also see the update below.

4. Simplicity (LLCs are pass-through taxed, so it is easy to start, and if you change your mind you can change the election and get taxed differently - limitations apply, so be sure to inform yourself what they are)

See this video to start learning about the basics of LLC use. The main idea is to use LLCs wisely to limit the value of assets you have on the line. It is sort of an insurance policy, based on limiting your liability in certain adverse scenarios. It is also like an insurance policy in that it will cost you money and expertise to maintain it. The proverbial lunch is not free.

One well-known point is that you should either incorporate your LLC in the state where your property is located, or incorporate in a different state but register the company as a foreign entity in the state where your property is located.

But, incorporating is not straightforward. Different corporate structures will offer different levels of protection, depending on various scenarios. The linked video gives an outline of several scenarios of interest.

Why would you want LLCs for real estate?

There are several reasons you may want to create an LLC to run your real estate business:

• You want to limit your liability in case of disputes with tenants that end up with a judgment against your entity.

• You want to limit someone who gets a judgment against you personally to reach into your interest tied into an LLC. This device is called a charging order protection. The charging order protection limits the manner in which someone who is your personal creditor can liquidate your share of an LLC. States differ in the strength of charging order protection offered. Wyoming, among other states, has apparently a particularly strong legislation in this respect, making it a good choice for your incorporation.

• Note though, the charging order protections are not intended to protect you: they are intended to protect your partners from ending up in a partnership with someone (e.g. your creditor) they don’t want to partner with. Which, in turn, means that if you are the only member of an LLC, you don’t get to enjoy this benefit. There simply isn’t anyone else to protect.

• You want some shielding from frivolous lawsuits. This becomes more and more useful as your real estate business grows, since you become a more attractive target as you become a deep pocket defendant and are more exposed to lawsuit risk.

• You want to form a partnership of some sort and need to make an upfront agreement between the partners. LLCs are quite flexible in how the partnership can be structured. You can set up an LLC as a partnership, where distribution percentages are not proportional to the ownership share. It is also easy to structure it such that the liability of each partner is limited. Contrast that with general partnerships, for example, where all partners may be liable in full for everything any partner does.

• If you want to do any commercial real estate deals: residential 5 or more units, warehouses, malls, storage, industrial space etc, having an LLC is the default assumption of any parties you will be interacting with. For example, lenders will simply assume you are an officer of some LLC. Appearing as a sole proprietor will confuse people and you will have a fun time working through the misunderstandings.

• You may have to make multiple LLCs if you are considering sponsoring a syndication. Lenders often require single-purpose entities for large acquisitions financed by non-recourse agency debt, so you may end up having to make at least as many entities as you will have projects, plus any additional entities to manage the properties and manage the investor relationships.

Why would you not want LLCs for real estate purposes?

You may not want to have an LLC if:

• You have a fairly small portfolio and an LLC does not buy you much but instead complicates your life.

• You don’t like paying all the little fees associated with operating an LLC.

• You do not believe you are disciplined enough to keep records required for operating LLCs properly.

• Loan options for LLCs are limited. You can not get an agency conventional residential loan in the name of an LLC, for example.

• It can be hard for LLC members to pull out of an LLC if they change their mind about being a member of a partnership LLC. It is possible to sell a business interest, but the demand for it isn’t exactly bustling, so it’s tricky and better not to be in a position where you must do this.

• LLCs are a very recent creation on the legal timescales in question. They have existed since the 1970s in the US. Contrast that with the centuries old history of corporations. This, in turn, means that the laws that govern the operation of LLCs have not been tested in court enough to base firm legal advice on. So much advice around LLCs, even when given by experts, are based on opinion only, not on case law. Which means you may be in for a ride if any such opinion is challenged and doesn’t hold up in court.

• It can be a challenge to open bank accounts for LLCs that don’t have natural persons as owners. Not every bank will do it. Federal regulation also states that when opening such bank accounts, any entity with more than 20% ownership stake must have a representative be present in person to open a bank account. Which means you may be in for a red-eye flight across the country if it so happens that your operations are far from where you live.

• It can be extremely challenging to get certain types of loans and/or open a bank account, especially if you have a deeply nested corporate structure.

• To wit, you may need to reveal your entire corporate structure from the LLC, through the chain of ownership all the way to your person.

• You may find out that if any of the entities in the ownership chain is a trust, that you can’t open a bank account, or can’t get a loan.

• This is not a final verdict - there are lenders and banks who will want to work with you.

• But you want to know early which ones they are rather than get to know a few weeks into the process that they can’t/won’t serve you.

What are my alternatives to having LLCs?

Some people take out a landlord’s insurance and an umbrella insurance to cover them against claims, then run the business in their own name. This approach has limitations, see the question below.

Other people may want to create an S- or C- corporation. Note, however, that an S- or C- corporation is not a particularly good vehicle for holding title to real estate. See the section below for details.

Why not take out umbrella insurance instead of incorporating in an LLC?

There is nothing specifically wrong with taking out an umbrella insurance and running the business as a sole proprietor, instead of incorporating. Some people do this.

However, there are two main issues with insurance:

1. Your claim may be denied. In this case, you may have started with one problem (a judgment against you), but now you have two (need to also fight with insurance).

2. Every insurance has a maximum insured amount. But, in theory, liability could exceed that maximum amount. For example, if you get a judgment to pay someone’s medical bills, you know that the amounts to pay in the US can be staggering.

Why wouldn’t I use a corporation (S-corp or C-corp) to hold title to a property?

There are a couple of reasons why S-corps and C-corps are not a good solution to holding real estate.

• Moving property in and out of corporations is a taxable event. In contrast to LLCs, where it is not.

• The income you receive from corporations is subject to double taxation: corporations first pay income taxes at the corporate tax rate (e.g. 21%); the share of the income distributed to you as a member of a corporation is then taxed again, at your marginal tax rate. If you are a high income individual, that tax rate can be 35% or more.

This does not mean that corporations do not have a place in a real estate corporate structure. A good thing about corporations is that they are taxed on their net income, which means they pay taxes on what remains after the corporation pays all expenses. Contrast that to how your personal income is taxed, where you pay taxes on your gross income. Furthermore, corporate tax rates are typically lower than those of high income individuals.

This suggests the following use of corporations: if you can set up the corporate operation such that its income is mostly reinvested rather than distributed, you effectively pay a tax at a lower rate than your marginal tax rate (21% vs say 35%), and you pay those taxes on the income that remains after expenses. You can tap into the income by having the corporation buy equipment you need for work. For example, if you need a car or some such, but to do this correctly you want to talk to a tax professional. You could have a corporation that manages a property owned by the LLC, and the LLC can rent out the equipment from the corporation.

So, if I make an LLC, I’m safe against judgements, right?

Not quite. You only know in advance what is the likely maximum amount you stand to lose.

That is, if someone gets a judgment against your LLC, they can at most recover as much money as there is in the assets that the LLC owns. For example, if your LLC owns a $100k building, but someone has a $1M judgment against it, they will likely be able to get to only $100k, and will need to kiss the remaining $900k goodbye.

They typically can not get to your personal assets or your other assets, but this isn’t universally true. Under some conditions the court may allow it. I am not an expert on the specifics, but IIUC this is in cases of criminal conduct, or improper LLC operation. Also, laws across the US states differ about this, and if you want to know more details, you really want to talk to a lawyer.

Conversely if someone gets a judgment against you, under some conditions they may not be able to force you to liquidate your share of the LLC to satisfy the judgment. See the question above for details.

How to create an LLC?

If you are sure you want an LLC, there are various options for LLC creation.

You can do everything yourself. I do not recommend doing this yourself, however, since the names and data of the founders will end up in the public records. As a company owner, you should prefer to stay anonymous if possible. But if you are intent on DIY, you must know exactly what paperwork to file and where. At the moment it is beyond the scope of this document to point you where to dig this information up.

You can do everything yourself, using a service such as www.rocketlawyer.com to get the required templates, which you then tailor to suit your particular case. The form output is (I suppose) reviewed by their legal counsel, but note that they will probably not take into account your specific situation and may miss something that becomes important to you in retrospect. Like anonymity, for example.

There are services like www.corporatedirect.com, which will create initial paperwork and file things for you. This costs somewhere around $1000 per entity, though cost varies per target state.

There are services like www.andersonadvisors.com, which charge from $1500 per entity, to $10000+ for a plan whereby they will create an arbitrary number of entities on your behalf, and advise of the best corporate strategy that matches your business ideas.

There are corporate attorneys who can make an artisanal organic operating agreement and file paperwork just for you. This costs a few thousand dollars. To give you a ballpark to work with, in the past we have had the entities created for us for around $2500 per entity.

Do I need a bank account for each LLC that I form?

Yes.

You need at least one bank account for each LLC that you form. So, with three LLCs, you will need to create at least three separate bank accounts, at least one in the name of each of the respective LLCs. These accounts must be owned by the respective LLCs.

For a number of reasons.

1. It makes bookkeeping much easier.
   That said, you probably want to hire someone to handle your bookkeeping. DIY is possible, but is likely not worth your time if your purpose is to run a business.

2. It protects your corporate veil.
   To get the protections that the law affords to LLCs, your LLC needs to be operated as a proper independent business. You may not commingle funds, or otherwise run the company just as an alias for you. A component in making sure this is done is keeping separate bank accounts. It is not the only requirement, this video by an actual lawyer goes into more detail.

How do I move money to and from the LLC?

You can move money by transferring from your bank account to your LLC’s bank account. This is called “contribution” or “funding” your company. When you do this, your equity stake in your company is increased by the contribution amount.

You can move money from your LLC’s bank account to your bank account. This is called “distribution”. When you do this, your equity stake in your company is decreased by the distribution amount.

To protect the integrity of your company you must keep an accurate record of contributions and distributions, and you must not use company’s funds for your personal purposes. Never use the company’s bank account for your personal shopping. For example, never buy a car for yourself with company money.

Your operating agreement may also restrict how you may contribute or distribute funds to or from a company. For example, some companies may mandate that each member contributes equal amounts. So if Member 1 contributes $1,000, Members 2 and 3 (assuming 3-member LLC) must also contribute $1,000 each.

It is possible to use company money to make tax advantaged purchases. To make proper tax advantaged purchases using company funds talk to your tax advisor.

How much will it cost per year to run the LLCs?

As a rule of thumb, running a basic LLC will cost $1000 to $2000 per year per LLC.

Here are some fees that you may be up against. This list is not intended to be exhaustive; add a comment to let me know if I omitted something.

• Yearly registration fees: ~$50/year, varies by state

• Read details for California here.

• Foreign entity registration fees: per each entity per each state other than home state that the entity does business in, ~$50/year, varies by state

• Registered agent fees: per each entity, per each state, roughly $100/year per each entity-state combination. You are required by law to have a registered agent in each state you do business in.
  I’m not 100% certain that you absolutely need foreign entity registrations though, better check yourself.

• California franchise tax: any CA franchise taxes you owe if you “do business in CA,'' which is a notion with a fantastically broad definition. It will cost you a minimum of $800/year per each such entity that is known to California. This fee is waived for the first taxable year, but I suppose it is waived only if you’d need to the minimum only. Can be significantly reduced if you structure your entities properly.

• This needs to be paid via ftb.ca.gov [Form FTB 3522]

• Mind your head here: a CA registration for your company is required to be able to open a bank account for the company in California. This is what our bank told us. However, this article seems to say that California corporate code does not consider this a requirement. What? [CA Corp Code § 17001 (through 2012 Leg Sess), specifically 17001(ep)(2); but I don’t know what is the latest form of this law]

• Anonymity quirk: A CA registration gives the state the ability to subpoena your company’s home state and request member information. This may destroy the anonymity protections you were hoping for when opening a company in, say, Wyoming.

• Legal protections: Not having a registration in a state may mean inability to use the state’s court system to fend for yourself.

• Taxes: Any “regular” taxes due. (good luck)

• Mail forwarding fees: registered agents charge extra if you want them to receive general mailings for you in addition to legal docs; (~$15/month)

• Bank account fees: payable monthly, you may need to pay the bank to maintain your accounts if you keep the balance low; but other caveats apply here, like you must keep “enough” on the account so your entity is “adequately capitalized”.

• Accounting fees: if you have a CPA do your accounting and prepare your taxes. You could totally do it yourself; but how much is your time worth to you?

• File statement of Information:

• CPA told me that I may have to pay $25. But when I filled the form online, it didn’t ask for any payment

• https://www.sos.ca.gov/business-programs/bizfile

What is this thing about California and LLCs?

In short, California’s Franchise Tax Board (FTB) wants every LLC that “does business in California” to pay a franchise tax of at least $800/year. The “does business in California” is very broadly defined. California authorities will argue (according to some sources) that your LLC is “doing business in California” if its members or officers are domiciled in California, for example, even if the LLC really has no other ties to California whatsoever.

Opinions differ on how justified the state of California is to require your LLC to pay them. It should be possible to create a corporate structure that doesn’t require you to fork over these fees, and to keep California at bay. If you wonder whether that’s OK, note that you do not have a duty to pay any more than the minimum required amount of taxes. Here is one example of structuring and some rationale. The short of it is that investors sometimes choose to form a holding company in WY, for the charging order protections and privacy that Wyoming corporate law affords. Then create a company owned by this holding, and you have yourself a company that is not tied to California. You can hang more companies off of this WY entity if you need to.

Now, does this work? The answer is that I don’t know for certain. When I asked and read about it, it turns out that this structure is very commonly used, based on the opinions of some fine legal minds, but has not been tested in court. Folks with a lot of experience have told me: “we have done it like this for 35 years and never had any issues.” It’s not proof that it works, though.

The main point is, while California may write the requirements, California’s ability to pull out enough information from other state registries to enforce its regulations is under question. That is, if your entities are structured well, California won’t be able to get enough information to build an argument that they are entitled to some of your money. But, if you are at the point where you intend to test these waters, you’d better hire a professional.

Here are some sources that cite actual corporate code as references:

• When to Register a Foreign Business in California - San Diego Corporate Law

• Victory for Out-of-State Members in LLCs “Doing Business” in California

Remember, you do not have a duty to maximize your tax obligations. Not now, not ever. So it makes sense to find every way to ensure that you pay your share, but no more than that.

I want to create an LLC in Texas, but live in California. How does California know that my Texas LLC is tied to me?

It is through your tax return. If your LLC makes its way to your tax return through a K-1 form, and you then report that as partnership income, California will know about your LLC. They will then send you a letter saying that they want you to pay them the franchise tax, which is a minimum of $800/year per entity. See the question above for more discussion. On the flip side, however, if California doesn’t get a K-1, they won’t know that a company exists. Just sayin’.

What is in an LLC name?

Some business advisors suggest that you should pick a corporation/LLC name that does not easily associate you with it. So instead of naming it “Your Name LLC”, name it “Something Unrelated LLC”.

The idea is that this could protect you against frivolous, rent-seeking lawsuits. It won’t do any good in, say, criminal proceedings.

Will lenders invoke a due-on-sale clause when transferring a property from personal ownership into an LLC?

We were told this could happen. We were told it happens extremely rarely. And it happened to us recently. You can read more about that escapade in What we learned moving our properties into an LLC.

Random interesting facts to know which didn’t fit well anywhere else

• “Foreign entities” below means: companies that are created in a different state. For example, a Wyoming LLC would be considered a “foreign entity” in California.

• Banks may refuse to open bank accounts to foreign entities. This is one reason why you may want to have at least one company per state where you operate your RE properties in.

• Lenders may refuse to lend to foreign entities. This is one more reason you want to have a local business entity.

• It may be better to be taxed in two states than just one. Roughly this is because being taxed in two states is subject to “apportioning rules”, whereby your total tax base is divided over two states. Each state then taxes you using their regulation, and some states have 0% tax for example. This can have an effect of lowering your tax burden compared to the situation where you are taxed in one (high tax) state only.

• You are required to appear in person to open a bank account. You and any other entities owning more than a 20% share of the business. Federal regulation, apparently. If you find yourself on a red eye flight to Cincinnati in the middle of a snow-storm, this may be the reason why.