Do You Need an LLC for Rental Property Investing?

Ashley:
This might be the single most frequently asked question by beginner real estate investors. Do I need an LLC today? We’re answering it once and for all. Hey everyone, I’m Ashley Kehr guest hosting the BiggerPockets Real Estate podcast. I hear this question all the time from rookie investors. Do I need an LLC when I buy my first property? And I think what people are really asking is how do I protect myself, my property, and the rest of my assets from legal liability? And this applies to both beginners and experienced investors. Things can always go wrong when you own a rental property. You need to take precautions so you’re shielded from the worst possible outcomes before they happen. So today I have Brian Bradley joining the show to explain the most effective strategies for asset protection. Brian is a lawyer, basin Oregon, who has been named one of the best attorneys in America and has worked with clients to protect more than 5 billion worth of assets.

Ashley:
We’re going to talk about what an LLC can and what it cannot do, who needs one and how to set one up. We’ll also get into even more advanced asset protection strategies like the many different types of trust. I know some of the legal strategy may not sound exciting, but understanding it can save you so much money in the long run. And Brian is great at explaining these concepts and why we need them. So let’s bring ’em on. Brian, welcome to the show. I’ve gotten the pleasure of interviewing you on the Real Estate Rookie podcast, but here today we are on the BiggerPockets podcast. So thank you so much for joining me today.

Brian:
Yeah, thanks. No pressure, right? The big show.

Ashley:
I hope we can live up to Dave Meyers standards. I know.

Brian:
So I always love talking to you and your audience and we got a lot of important updates in the law. Some will be some review and then there’s going to be a lot of fun like updates and so I’m looking forward to this one.

Ashley:
Yeah, so let’s start off with maybe you’re an investor that’s just getting started or maybe you have grown and scaled, but you really have no idea what asset protection means. Can you explain that for us?

Brian:
So asset protection is simply placing a legal barrier between your assets and your potential creditor. Like the person who’s suing you and wants your stuff before it’s needed. That’s it. It’s just a barrier. So think of a safe that we put our gold or our guns or valuables in anything of value you want to put behind that legal barrier and out of your personal name so that it’s not easily attached with a lien or reached.

Ashley:
Can you do an example for us? It may be tailored specifically to a real estate investor as to what are some of the common pitfalls that a real estate investor could actually be sued for?

Brian:
Yeah, so a lot of the pitfalls with real estate is an incident happening and then you not having anything in place and then saying, alright, I’m now getting sued, Brian, I don’t want to lose my property. What can you do for me now? There’s literally nothing or it’s going to be mold issues, deals falling apart. There’s a lot of ways in real estate that we can get sued and beyond a million dollar judgements.

Ashley:
I have heard people talk about that when you are creating and structuring an LLC that it’s setting you up to actually kind of a target for being sued. Can you kind of talk about what are the benefits of actually doing it? And if that’s actually true.

Brian:
So when it comes to asset protection, just people assume that by you’re leading to setting these up or setting up a trust that they’re somehow the ones that are creating the situation and the legal threat. But that’s not true. The peril already exists. The perils coming from the lawsuit, not from your legal planning like LLCs or limited partnerships or trust. If a lawsuit’s filed against you, that’s the actual threat, not the fact that you took steps ahead of time to protect yourself. And the courts are very clear on this. And an example here is the Cook Islands trust is the strongest trust in the world by far. Nobody even disputes that. And the US courts have been frustrated at every turn when they’re used, but not a single court has ever ruled that the creation of a trust in any way is illegal or immoral.

Brian:
It’s actually the opposite. We already have federal exemptions on some assets and then more and more states are starting to see that our legal system is a threat and creating their own protections. In fact, there’s a well-known asset protection case, Rikers v Rikers in 1998 and the court stated that the offshore Cook Island trust that was created was created for the legitimate purpose of protecting the family assets. There’s nothing wrong with that, that’s just smart planning. So what some people were getting in trouble for is when they try to move assets after they’ve already been sued or to hide assets to avoid paying taxes or hiding assets from your spouse for a divorce or having a poorly drafted trust where you maintain too much control or not knowing your state’s regulations and policies. But if the protection was pre-planned, meaning before any legal trouble and it’s set up properly, all you’re doing is exercising your legal right to structure your wealth defensively just like buying insurance before an accident. And so this is why cutting corners and online templates DIYing, your planning just doesn’t work. Yeah, it’s cheaper, but it’s just a false sense of security and a smoke screen and it’s really not cheaper if you lose. So we got to make sure we’re going to the right doctor for the right injury and that starts breaking down one of the bigger topics. It’s just like pros and cons of LLCs because it’s like a janky cookie cutter LL C’s just not going to work for you.

Ashley:
And there’s also a ton of rules and regulations you have to follow when you actually set up the LLC. First of all, you have to know how to actually set it up and then as time goes on every year, there’s certain requirements to actually keep your LLCA legal entity. Brian, I want to ask where a newer investor should start when it comes to thinking about asset. But first we have to take a quick break. Thanks for sticking with us. We’re back on the BiggerPockets podcast with Brian Bradley. So what would be the first step? If you are an investor and you’re thinking I need to get this LLC in place, what are some of the first things you should be doing?

Brian:
So if you’re just starting out and you’re thinking about investing in properties and you don’t know where to start, the tools are LLCs, limited partnerships and asset protection Trust. And just to break down these layers, I like to always think about winter. The first entry layer is your base layers, that thin shirt that’s going to sit on your skin. This isn’t LLC, this is when we’re just starting out investing like LLCs and insurances. And then as you grow, you’re going to get more assets, you get more units, you might be investing in multiple states, so we need more LLCs. That’s where a mid-layer comes in. Think of that sweatshirt or Carnegie. For you ladies, you’re going to have 500,000 probably of exposed net worth. This is a management company. You’ll hear some people talk about Wyoming LLCs. We use limited partnerships. And then as you get to run that $1 million mark, you have a higher level of protection that you need and that’s going to be your outer shell waterproof layer.

Brian:
That’s the asset protection trust. That’s your doomsday layer. But by layering, we’re going to be more flexible, right? We can adjust, make yourself more comfortable, and this is where LLCs come in, that foundational base layer. And there’s just a lot of misconceptions surrounding LLCs. A lot of people think that they’re just this magic pill create an LLC that personally guarantees protection no matter what. And that’s just not the case. But if we just want to break down a couple of key issues on where do we even set these LLCs up and we hear people getting confused like, oh, run off to Delaware, Wyoming, Texas and Nevada, what we’re really talking about our charging order protections and corporate veil piercing, like big legal fancy words that sound intimidating. What we have to remember is that LLCs offer a limited veil of protection that veils better than nothing, like having it all in your personal name, not good, but the veils fragile.

Brian:
It can be easily pierced just by not following the formalities of setting up an LLC and maintaining it. And so that’s kind of where this talk generally flows into next, like piercing the veil. A great example of this is let’s say you’re a California resident and you own California real estate and you go and create a Wyoming LLC and then you go and hold a key piece of California real estate in this Wyoming LLC and you’re paying California franchise tax on this out-of-state Wyoming, LLC. What you’ve done is just convert your Wyoming LLC to a California LLC because you’re doing business in the state of California. So if you have a liability issue in California, meaning a lawsuit, the judge is going to follow California law, not Wyoming law. You have no legal nexus or connection to Wyoming whatsoever. So this understanding then leads to a deeper questioning of why it’s crucial to differentiate between two very different areas of law and that is what’s the difference between business law and tort law, especially as it relates to real estate investments.

Ashley:
Well Brian, what if using that same example, but what if the person lives in California gets the Wyoming LLC, but they invest say in Florida, what is the actual recommendation? If you live in one state but invest in another state, where would you get your LLC in that scenario?

Brian:
Great question then If just for that source of Florida property, it would be a Florida LLC because that’s where the damage is going to come from, right? It’s not going to be from California. Most likely if that real estate we’re going to be using Florida law, someone gets hurt on that property. It really segues into what’s the difference between business law and tort law When we’re investing in real estate, we’re getting sued through tort law. That’s personal injuries and damage awards. That’s all state specific. And so it’s a very different area of law. And so that’s why common rule is wherever the real estate asset is held at, if it’s Florida, it’s a Florida LLC. If it’s Tennessee, it’s a Tennessee LLC. And then from there we can start cherry picking states for the management company, we can use an Arizona limited partnership or some people use a Wyoming LLC. And so that’s where it starts getting more nuanced at the second and third layer. But if you’re a California resident and you’re buying in Florida, Florida LLC,

Ashley:
That is one of the most asked questions of rookie investors. The first one is, when I buy my first property, should I put it in an LLC or should I put it in my personal name? And then the second one is, where should I get the LLC from? So what do you think about that first part though, as far as your first property?

Brian:
Yeah, the first property, don’t invest in your first property unless you can afford creating an LLC because you’re new to investing, just buying a property is going to increase your amount of risk. Create an LLC, put the property in an LLC. If you cannot afford an LLC, push pause, start off smart. Don’t risk it. That’s too risky. It’d be like taking my money down to Vegas and gambling and saying like I’m a good person. I don’t do things wrong. I’m going to follow the law anyways. It’s nothing about you being a good or bad person. It’s about a negligent event happening and then you getting sued and liable for damages and we need to cut the legs off of how much someone can get from you. And then the location, I think the confusion of it comes from everyone’s falling in love with the word anonymity. The thought that you can just create an anonymous Wyoming LLC, no matter what state that you’re in, you can just stick your assets in it and disappear and ghost a lawsuit.

Ashley:
I’m already picturing all the gurus that have the whiteboard drawing out their asset protection like no one will ever know my name.

Brian:
So create a Wyoming LLC in a land trust and you’re good to go. No one can ever bind you. That’s just completely false. So there’s so much case law on this, but like our prior topic, right? It is completely misunderstood. When your LLC is sued, you have a personal agent of service they’re required to have, especially for Wyoming and Delaware and Nevada LLCs there, their sole job is to serve you. Congratulations, you just got served. Now you got to get your butt to court. Also, the simple reality is that once a lawsuit’s filed, the legal discovery process in court begins. And what’s even worse is that if you want secrecy to even work, also known as lying under oath, let’s be clear about this. Lying under oath is a one-way ticket to jail. The bottom line is that privacy is good, I like privacy, I’m all for it, but privacy does not equal protection.

Brian:
Privacy helps stop harassment, but it does not make you lawsuit proof. Once a legal actions filed. Privacy does not prevent legal disclosures in court and courts have repeatedly ruled that while LLCs like Wyoming can offer a degree of privacy, legal disclosure requirements still apply. So the ideal strategy involves forming LLCs in the state that the asset is located in and then establishing a complete asset protection system that’s layered and then that leverages the strongest jurisdictions for actually the next two layers, the management company and most importantly the asset protection trust. And that’s where the magic happens when you add the next two layers, your sweatshirt and waterproof coat layer, like true protection does not come from LLCs. We can’t hide ourselves and ghost ourselves from lawsuits just because we create a Wyoming LLC. So LLCs merely serve as your starting point, like to get the assets out of your personal name. The real strength comes from the teeth which are the asset protection trust.

Ashley:
So to kind of summarize that, the advantage of privacy is maybe that if someone is looking to sue you, they can’t find out who you are to find everything else that you own. But the real gold is to actually have the asset protection because it shouldn’t matter if someone knows who you are because all of your assets are protected in this plan.

Brian:
Correct. I would much rather have the system be so strong that I can disclose all the assets in it and say, here’s everything my clients own. You’ll never see a penny from it.

Ashley:
Yeah. So Brian, real quick before we move on to trust. You had mentioned that you should be able to afford to create an LLC and to maintain an LLC, and I know it varies by state as to what those costs are, but maybe could you enlighten us as to where you can find those costs and maybe bulk park of what some of those costs are like including bookkeeping costs of an LLC, tax preparation, things like that.

Brian:
Generally I would say to maintain an LLC in any state ballpark, just like a hundred dollars renewal fee on average. And then you’re going to also in some states you’re going to have to deal with the franchise tax. I’ll go to the most extreme, which is California. That’s $800 per LLC.

Ashley:
Brian, I want to shift this conversation toward trust, but first we have to take a quick break. Okay, we’re back on the BiggerPockets Real Estate podcast talking asset protection with Brian Bradley. So you mentioned trust a lot throughout the episode, so let’s get into that. What is a trust that is meant for asset protection?

Brian:
They’re the heart and soul of an asset protection system, especially if you’re a high risk professional like you’re a real estate investor and especially if you start having multiple real estate investments and you’re investing in different states at that point, you’re going to be presumed high net worth if you have $1 million or more in equity. When we think about the world of trust, trust come in lots of different flavors and each type of trust has its own purpose and each state’s going to determine how it will interpret or recognize two very important terms for asset protection, which is irrevocability and self settle. So to list a few of the heavy hitter trust that you’re going to come across, we have the standard 1 0 1 trust that everybody’s familiar with a family revocable living trust your estate plan. This is for transferring assets, medical and financial directives, naming beneficiaries and avoiding probate Once you pass, all very important things.

Brian:
Part of adulting, we all need one, especially if you own anything, we got to get one. But we also need to realize that is not an asset protection trust, so we’re going to need both. They have no ability the estate plans to protect your assets from lawsuits whatsoever because they don’t have the teeth in them, which I’ll explain in a minute. Then you have land trusts for real estate that you hold your land in and you connect them to LLCs. But land trusts don’t have any protection in and of themselves. They’re only as strong as the LLC that they connect to. Land trusts are just a privacy mechanism, they’re not a protection mechanism, which is probably a shock to most of you when the LLC gets pierced, it falls apart. We then have other tax mitigation strategy trust that actually kind of mentioned one of them.

Brian:
And then we have trust like wealth generational skipping trust, New York spousal trust, Wyoming statutory trust, Delaware statutory trust, other trusts with different names, but for similar tax mitigation goals, most of these are for tax or inheritance purposes, so they don’t offer much protection for yourself when you’re actually getting sued. From there. We have higher levels of trust and one of the most important types of trust for asset protection is called an irrevocable asset protection trust. An asset protection trust is a unique type of self settled spendthrift trust. All this means is that it is designed for you by you and allowing you to be your own beneficiary. And a key feature is that they have very important spend thrift provisions in them. They are provisions that allow you to protect your assets from creditors like the person suing you while you are living. They’re the actual teeth behind asset protection trust. And for those teeth to work, the trust has to be not revocable, which means I can change it whenever I want, but irrevocable. So it’s a very different type of trust.

Ashley:
I have two follow-ups on that. The first is you mentioned the different trust. Are you going to a specific attorney to do the asset protection? Like if I’m saying, you know what, this sounds good, Brian, I don’t understand still the types of trust. I need to talk more with an attorney. What kind of attorney are you looking to use in this situation?

Brian:
If it comes down to I am concerned about lawsuits for my assets and getting sued and the legal liability, you have to go to an asset protection attorney. That’s what we do.

Ashley:
My second follow-up is the irrevocable trust. So the only experience I have with this is I have a friend who had this trust set up and they had it set up for like 15 years. It’s been now, and he was married and both people were the owners of the trust and they divorced and there was nothing that could be done with the trust. They were told that they just had to keep owning it together. Then the children are the beneficiaries. The children are now suing the trust and they want full disclosure of all the accounting, everything that has been going on. So this is a very complicated family matter obviously, but is that something with it irrevocable trust that you have to be careful of as to who you’re involving in the trust? And some of these, since it is irrevocable, some of these things could happen throughout your life.

Brian:
And that’s where the talk is heading towards is irrevocability means different things for different types of trust. So for asset protection it means something different than versus if I’m in New York and I create an irrevocable spousal trust or something like that, irrevocability. When it comes to asset protection trust is very different. So the problem with purely domestic US-based asset protection trust is that courts are constantly piercing them. So judges are just ignoring the choice of law clause and using their superpowers and piercing domestic trust on violations of those state public policies. And we see this in numerous cases when we create asset protection trust, they all need to be irrevocable and we want them to be irrevocable because we don’t want to judge in a lawsuit to say, all right, Ashley, we know you have this trust revoking and give the assets to Bob who’s suing you, otherwise we’re going to hold you in civil contempt of court.

Brian:
That’s the importance of having asset protection trust as irrevocable is the power to say, no, I’m not. The downfall if it’s a purely domestic case is there’s no teeth behind that because judges can just say, do it or I’m going to hold you in civil contempt of court because it’s your decision. If it’s an offshore trust, that’s completely different. If you use like the Cook Islands, it’s no longer in your for that situation. That’s where the offshore trustee can say no talk to the hand, here’s the big middle finger. We’re not doing it because it’s under duress and you can’t be held in civil contempt of court because it’s not you saying no, it’s the offshore trustee and the US has no control or authority over them. So it goes back to creating the peril. You didn’t create the peril, you set this up beforehand.

Brian:
It’s not your fault that the offshore trustee is doing their job protecting the asset. So that’s the difference of how irrevocability plays out for asset protection trust when it comes to domestic verse offshore, and as you can tell, it’s pretty clear that this is going to be a complex and nuanced topic with plenty of case law on this. And so you got to be really particular on the type of attorney that you go to because your standard estate planning attorney, they’re not going to know these nuances, especially state by state and what works for asset protection purposes. And so you’re probably listening this and hearing the limitations and you’re starting to feel pretty hopeless, but you shouldn’t, right? There’s light at the end of the tunnel and that solution is hybrid asset protection trust and how they play out.

Ashley:
I saw this post, someone had commented on a real estate rookie YouTube video, and I don’t remember exactly what the video was about, but I saw their comment pop up and it was like, okay, great. To get my first property, I need a bookkeeper, I need an attorney, I need a CPA. And it was like all these things. And so that person can add to the list an estate attorney and an asset protection attorney to that long list.

Brian:
And that’s the thing is a lot of people want to cut corners. And when you’re investing, you really got to start thinking about like, all right, everything’s peachy and fine when there’s no problems. What happens when I get punched in the face and I’m potentially going to get sued here? Did the corners that I cut and the team members that I didn’t involve in this, was that a good decision? So you need to have a good CP, you need to have a good wealth manager, you need to have an estate plan, and then if you’re owning assets, we have to protect them, but we can’t just protect them cheap and janky. We got to protect them properly, which means creating proper LLCs, which is going to cost a little bit, which means having proper management companies, which means creating the proper asset protection trust in the proper way in the state that you’re at that’s actually going to work if God forbid a big lawsuit were to come your way. The whole reason you’re creating this is for it to work under duress.

Ashley:
Well, Brian, thank you so much for coming on today to share your knowledge and experience. Can you let people know where they can find out more information about you?

Brian:
Yeah, absolutely. Just feel free to jump on my website, www.btblegal.com. I have a lot of free educational resources including video slide presentations and legal resource blogs and over 70 published articles on various ask to protection topics and break down a lot of the main states that we went over on that.

Ashley:
Well, Brian, I appreciate it. Thank you so much for joining us and it’s always great to have you on the BiggerPockets podcast. I’m Ashley, and thank you so much for joining me for this episode, and I’ll see you guys around.