The problem: How to maintain a property in California?
Countless people invest in real estate every day. Some dream of becoming the next real estate mogul, while others simply want to supplement their salary with additional income. Whatever your motivations, owning investment property can yield great rewards, but also great problems. That is why it is important to maintain the title of your property in the most beneficial way. The Internet is saturated with publications and articles promoting the most effective techniques for managing your property. It can often be a daunting task to sift through the vast amount of information in an attempt to discern which advice is trustworthy and which advice can get you in trouble. Our goal here is to provide a clear and concise summary of the safest and most important strategies for holding investment property in California. We hope the result is a valuable starting point to consider the best ways to protect you as the owner / lessor from liability and also ensure the best treatment of your assets.
The risks of owning a real estate property
As noted above, while property can be a valuable investment, there are significant risks as well. One of the biggest risks is lawsuits. From common slips and falls to environmental pollution, homeowners and homeowners are easily exposed to legal lawsuits. Landlords have also been successfully sued for victims of crimes, such as robberies, rapes, and even murders, that occur on their property on the theory that the landlord provided inadequate security.
Options for owning real estate
Given the risk of litigation, it is essential that you do not own investment real estate in your name. (The only real property you should have in your name is your primary residence.) Fortunately, there are a number of ways that a person can own property that is not in their name. These include as a corporation, limited partnership, limited liability company (“LLC”), trust, and many others. While there are many options, when it comes to real estate investments, LLCs are the entity of choice for most investors, attorneys, and accountants.
For many reasons, few investors have investment real estate in C corporations. A corporation protects shareholders from personal liability, but double taxation of dividends and the inability to take “paper losses” from depreciation flow to the owners. make a C corporation unsuitable for real estate investments.
In the past, partnerships and limited partnerships were the entities of choice for real estate investors. Limited partners were protected from personal liability and at the same time could incur tax losses (subject to IRS rules; you will need an accountant or attorney to resolve the issues of risk limitations, etc.) on the property. However, the biggest disadvantage of limited partnerships was that someone had to be the general partner and expose themselves to unlimited personal liability.
Many small real estate investors also hold properties in a trust. While a living trust is important in protecting the owner’s privacy and provides valuable estate planning treatment, the living trust does not provide anything in the area of liability protection. However, while a trust does not provide liability protection, it should not be overlooked as it can easily be paired with an LLC.
1. Benefits of an LLC
LLCs seem to be the best of all worlds for holding real estate investments. Unlike limited partnerships, LLCs do not require a general partner who is exposed to liability. Instead, all LLC owners, called members, have full limited liability protection. LLCs are also superior to C corporations because LLCs avoid double taxation of corporations, but maintain full limited liability for all members. Also, LLCs are quite cheap and easy to form.
A. One LLC or multiple LLCs?
For multiple property owners, the question arises whether to keep all properties under one LLC or create a new LLC for each additional property. For various reasons, it is generally advisable to have an LLC for each property.
First, having a separate LLC that owns each separate property avoids “spill” liability from one property to another. Suppose you have two properties worth $ 500,000 and they are in the same LLC. If a tenant is injured on property 1 and wins a judgment of $ 750,000, they can bond both properties for the entire $ 750,000 even if property 2 has nothing to do with the plaintiff’s injury.
On the other hand, if each property had its own LLC, then the creditor could only place a lien on the property where the plaintiff was injured (assuming he cannot pierce the corporate veil).
Additionally, many banks and lenders require separate LLCs for each property. They want the property they are lending against to be “remote from bankruptcy.” This means that the lender does not want a separate property problem to jeopardize his security interest in the property he is lending.
2. Benefits of a trust
As stated above, an LLC can be used at the same time as a trust to provide the best protection and patrimonial treatment for your property. There are many types of trusts, but the revocable living trust is probably the most common and useful for maintaining title to real estate. The main benefit of having a property in a trust is that the property prevents probate after your death. As many know, probate is a court-supervised process for transferring assets to beneficiaries listed in the will. The advantages of avoiding succession are numerous. The distribution of property held in a living trust can be much faster than probate, the assets in a living trust can be more easily accessible to the beneficiaries of the trust, and the cost of distributing the assets in a living trust it is often less than going through a succession. . [Note: One should also be aware of other ways to avoid probate. For instance, property held in joint tenancy with a right of survivorship automatically avoids probate whether or not the property is in the living trust. Consult an estate planning attorney for more advice regarding probate matters.]
3. Use both an LLC and a trust
Because an LLC and a trust provide significant benefits to a real property owner, a smart investor should consider using both an LLC and a trust to adequately protect himself and his property. Utilizing a trust and LLC creates the best combination of liability protection and favorable estate planning. To accomplish this, the owner must maintain investment property in a single-member LLC, with the living trust as the sole member of the LLC. Here, the trust is the owner of the business and has all the interests of the LLC. This form of ownership gives you an added layer of LLC protection, as well as the added estate planning benefits of a trust.
A. Costs
For the most part, the costs of forming and maintaining an LLC and a trust are fairly minimal. For an average LLC, the costs are simply nominal filing fees and a fee of $ 800 per year for the state of CA. While simple incorporations can be done on your own, it is highly recommended that you seek the advice of an experienced attorney so that no mistakes are made. The same can be said for the formation of a trust. A little money now is worth the price of avoiding big problems down the road.
B. The CA LLC Fee
While the costs of forming an LLC are generally small, there are additional fees that may be imposed on LLCs in California depending on gross earnings. California Revenue and Tax Code Section 17942 (a) includes an additional fee for LLCs if total gross income (i.e. rent) exceeds $ 250,000. “Total gross income” refers to gross income (not earnings). Under this Section of the Tax Code, the amount of the fee is determined as follows:
1. $ 0 for LLC with total gross income less than $ 250,000;
2. $ 900 for LLC with total gross income of at least $ 250,000 but less than $ 500,000;
3. $ 2,500 for LLC with total gross income of at least $ 500,000 but less than $ 1,000,000;
4. $ 6,000 for LLCs with total gross income of at least $ 1,000,000 but less than $ 5,000,000; Y
5. $ 11,790 for LLCs with total gross income of $ 5,000,000 or more.
Although the fee is relatively small, it should be noted that the fee is assessed based on gross income, not earnings. This means that the fee must be paid regardless of whether your property is profitable or not. For a property with high income but narrow profit margins, the fee would reflect a higher portion of the property’s profitability than on a property that is highly profitable. For example, a business that owns an office building with rental income totaling $ 1 million, but a mortgage of $ 995,000, would actually operate at a loss after the $ 6,000 fee was imposed. Furthermore, the fee would be particularly burdensome for those companies that anticipate incurring losses in their early stages of development.
4. Limited partnership: a possible strategy if gross income exceeds $ 250,000
For the vast majority of investors, the CA LLC fee should not deter you from forming an LLC. However, if the impact is very damaging, there are several potential solutions that can be explored. A competent attorney or accountant can work with you to avoid this fee. One method may be to form a limited partnership. The partnership must be established with an LLC as the general partner (assuming responsibility) and the property owner (s) as the limited partner (s). By forming a limited partnership with an LLC acting as the general partner, the lessor will likely be able to avoid the higher fee imposed on an LLC while protecting his personal liability. While this may be a possible solution, it is strongly recommended that you consult with an attorney or accountant about the best course of action.
While there are risks associated with real estate, with smart decision making and careful preparation, real estate can be a worthwhile investment. However, the first step is to make sure that you have adequately protected yourself and your property. We hope this article will help property owners begin to discover the various ways that investment property can be owned, as well as the protections and benefits that such property provides.
