Forming An LLC to protect Rental Properties

To follow up the original STARTright post with a quick synopsis here, the original question asked was of course:

“suppose I have four properties and I rent them out and I missed the bus and didn’t form an LLC and can be liable for anything that happens in them, do I form an LLC and group them all in the same LLC together?  Do I form enough LLCs to put each one in its own separate LLC?  And, how does an LLC “get” credit when its brand new?”

There are two questions in that paragraph. 

1. How many LLCs do I need to form for my rental portfolio,
2. How do I start getting the financing for new properties out of my name by getting the LLC qualified?

1. There are multiple ways that real estate can be vunerable.  How do I protect my real estate?

I get asked about the virtues of “putting a piece of real estate in an LLC” all the time.  Lets consider what the issues might be.  First lets look at the rental.  

The standard rental seems to look about like this beauty, and there is little wonder why landlords feel the need to protect themselves.  The question to understand here, is that if the house is the source of an injury that creates a legal cause of action, who is on the hook?  In a word, the owner of the property.  This is why people form an LLC and put their piece of property in the LLC.

The LLC was the first entity to offer the corporate veil protection without the corporate tax.  For more information about this, read the original post about forming an LLC for rental properties.

Ok, so now to the original question, what if you have two or three of the beauties that we see above? Do I need an LLC for each property?  Well, the sad reality is that there is no definitive answer. There are three options and each have their pros and cons.  The answers are as follows:

1. Put all the eggs in one basket: 

• Pro:  The pro of forming one LLC and deeding all rentals back to that LLC is that it is cheap, fast, and better than day dreaming about the massive scheme.  Get something in place.  
• Cons: The reality is that if one of the properties creates a law suit, you are protected personally, but all other properties in the LLC are exposed as loot to satisfy the claim.

2. Putting eggs in seperate baskets.

• Pro: This is always an exercise in strategic grouping.  If your investment portfolio gets larger than say two or three properties, it may be a good idea to create two or three LLCs, and divide assets between them.  Put quick-flip properties in a different LLC than rentals, and determine which rentals can safely be grouped, and which rentals may need to be isolated in a single LLC.
• Cons: Yes, a completely seperate LLC for each property ensures isolation, but as the portfolio grows, it becomes a management and tax headache.   If you are in california, you start paying the annual $800 FTB tax for each LLC.

3. The Third option is the Series LLC. To read more on this, read the original post.  forming an LLC for rental properties.

Blogged with the Flock Browser

Blogged with the Flock Browser

Checking Out Flock

I am checking out flock for the first time.  It is pretty cool.  Lets see what happens with images.

Forming a California LLC Does Not Have To Take Forever

One of STARTright’s first LLCs that it helped business owners form back in August of 2008 was the California LLC.  When we developed our service using the California LLC we realized how many of the other services out there were not being honest.  We wanted setting up a California LLC, and later LLCs in other states to be affordable and teach the owner something as they formed their LLC.   With LLCs available in six states, and many more scheduled to become available in February, we feel we have met the users need for an affordable “forming an LLC” solution at a low cost.  STARTright costs $129 for an annual membership.  For those who either prefer to pay by the month, or just need a one time setup solution to form one LLC, STARTright’s monthly membership at $9.99 fits the bill.   

Today I want to write a quick note about California filings as the California LLC is one of the few LLC’s we offer a submission service for.  The business model for STARTright was to make forming an LLC yourself so easy that you would not need to pay extra costs except for the State LLC filing fees.  

If you are going to form a California LLC, here are some things about the submission process that you should understand. California has some interesting rules for the California LLC formation process. When forming a California LLC, you need to create the Articles of Organization for a California LLC. That is the easy part. California LLCs have the most basic and easy to fill out Articles of Organization in use. Next, you have to submit the Articles to the California Secretary of State who will stamp the files as received one they determine the LLC name is distinguishable from other LLC names in use by California LLCs.   Once the Articles are stamped as received, the California LLC is alive and well and can be used to do business from.

Now the tricky part is this. The California submission process allows for two ways of submitting the California LLC Articles of Organization. The first method is by mail. Though it may not take this long to actually have the Articles of Organization for the California LLC stamped as filed, the Office of the Secretary of State claims that they will not ensure any faster filing than that of 30 to 45 days.  This depends upon the volume of all filings received, not just California LLC filings.  That is a very long time to wait to start doing business in a California LLC.

The second option is to hand deliver the California LLC Articles of Organization. This is done by actually walking the California Articles of Organization in the front door of the Secretary of State office in Sacramento California. They want you to do this because they charge up to $15 for entrance. It is like a cover charge just to get your California LLC Articles of Organization in the door. This is by far the fasted method to get your California LLC formed. The California Secretary of State claims that they will do a standard processing for a walk-in during a 5 to 10 business day window. Unlike a California LLC that mails in the Articles, expedited filing is available to all California LLCs that walk the Articles through the door. With expedited filing, you can get the California LLC Articles stamped in either 24 hours ($250) or 4 hours ($400). This is not a cheap option, but it can be done fast.

The following is an email that we received from a user who went with the submissions service.  Their experience has been typical of many, but we cannot make any promises that turn around times will always be this fast.

I used your website to form a California LLC. I paid the $49 for the membership. I then decided to use the STARTright Submission Service to have my California LLC Articles of Organization delivered to the California Secretary of State. They told me it would take between 10 and 15 business days and I had to pay $100 for the submission service.  I also had to pay a $70 fee that would be taken to the secretary of state as the filing fee. Thus I paid: $49 membership fee to STARTrightllc.com, $100 STARTright submission service fee, and $70 state fee for filing. All this adds up to about $119.  Not bad, but I was not excited to wait half a month to get my business started.  I have seen other services that do a lot less in a lot longer time.  [Competitor's name removed] will do a California LLC for around $500 and I still would have had to pay the $70 state filing fee. They promise it to be done in 15 days.  Yikes!   Anyway, the STARTright service somehow got my California LLC Articles of Organization finished in less than 24 hours and had sent me an email with scanned in copies of all the documents.  This was a very good experience.

We hope the STARTright submission service can wow the socks off more of you.  Keep in mind that we do not get any of the $100.  We continue to pay a service in Sacramento to ensure fast and quality care of our customers’ California LLC filing documents.

Why form an LLC? An LLC introduction.

STARTright is the web’s easiest and most efficient way to form an LLC.  Some of our new members have asked me to write an LLC introduction or an overview of why someone would want to form an LLC.  I spent about an hour on the phone with one of our member’s the other day (she is from Arizona, and I only practice and am barred in Arizona, so I cannot advise at length to people outside of Arizona).   I realized that some basic LLC fundamentals concerning how one forms an LLC, how an LLC is taxed, the liability protections of an LLC and general use of an LLC in one’s business where not well understood.  So in order, lets talk about the why’s and how’s of forming an LLC.

 

Why form an LLC?

Forming an LLC is the right decision for almost any small business owner or partnership.  Most business owner’s are worried about three issues when starting their business.  Those issues are 1) start up costs, 2) lowering tax liability, and 3) liability protection.  I will discuss how forming an LLC is the best solution for each of these.

 

1. Forming an llc minimizes start up costs.

There is no question that hanging your sign and opening your doors for business will have the lowest start up costs.  This may not be the most prudent approach, however.  It also may not end up saving that much over forming an LLC.  When you start a business without forming a legal structure from which to operate that business, you still need to get a business license in order to open a business account at a bank.  In most counties, a business license can run upwards of $100.  If you form an LLC, you can usually get the Articles of Organization filed with the state for under $100 (states vary, but the vast majority do not charge over $100).   Almost any financial institution will open an account for your LLC based upon a filed copy of the Articles of Organization.   With that said, the savings you gain by not forming an LLC which is recognized and given state LLC law protections may be minimal and probably not worth it.

 

If the question is whether to form an LLC or another entity, the choice to form an LLC to save on startup costs is even clearer.  For a single business owner, the only other legal entity available is a state corporation.  Both the LLC and corporations offer legal protections which we will address shortly.  Fees to form an LLC as opposed to the fees to form a corporation are cheaper in most state.   LLCs are generally less complex and require fewer formalities.  This enables business owners to properly manage much of the LLC themselves cutting down on legal bills.  Many business owners that have corporations may choose to manage their corporation themselves, but few do it right.  Corporations have strict formality and structural rules.  As we will discuss later, the protections for those corporations are dependent upon those formalities being executed properly.   

 

2. LLCs have the most tax flexibility.

Many people complain about the complexity of the federal tax code, but it was designed to deal with the fact that no two businesses are completely alike.  For some businesses the ease and convenience of flow through taxation (that of a sole proprietorship) where the business is listed as an extension of the business owner’s person assets fits.  For others, the “self-employment tax” minimization of an S-Corporation fits, and for others, the large benefit write-offs of a C-corporation fits.  Before business owners could form and operate from an LLC, federal tax choices did not line up well with state structure and liability choices.   A business owner seeking corporate veil protections could not also get sole-proprietor type tax flexibility and vice versa.   By forming an LLC, you can keep the structure and formalities of your business simple and minimal, the protections at the highest levels allowed in any state, and choose the tax structure that works for you.

 

3. Forming an LLC gives you premier legal protections.

An LLC carries the greatest level of protections from legal liability available today.   Most people do not realize that the liability pendulum can swing from two directions.  The LLC offers both 1) corporate veil protections as well as 2) statutory business asset protection (the charging order).   

The LLC’s corporate veil protection is superior for one main reason.  The corporate veil is only as good as a judge says it is, and whether or not a judge will acknowledge or pierce the corporate veil depends upon the state law requirements for maintaining the businesses’ veil protection.  Corporations have lists of formalities and structural requirements such as shareholders, directors and officers that require lots of documentation to ensure corporate veil protection.  An LLC usually requires the owner to keep his business and personal finances separate and that will generally ensure legal protections.  Much easier.

Now we will look at the other way the liability pendulum will swing. Most business owners realize that they want to protect their personal lives from their business, but what they often fail to do is to protect their business from their personal life.  By forming an LLC, a business owner ensures that anyone who sues him personally will not get instant and unlimited access to the business and its assets.  Instead, the LLC is protected by state statutes that require a judge to limit the plaintiffs access to the business.  This is called a charging order.  Unlike a state corporation where a plaintiff could take all the shares and control the corporation including forcing it into liquidation, by forming an LLC, you ensure that you as the business owner retain control of the LLC management even if you are sued personally.  I will write more on charging orders later, and this is supposed to just be a quick overview.  It is important to understand the limitations involved with a single member LLC when it comes to statutory business asset protections also.  Please read “The Single Member Hitch” for more on Single Member LLC Protections.

Create an LLC, Maintain an LLC: How STARTright helps LLC Owners

STARTright Available for Utah LLC, California LLC and Arizona LLC

For those who do not know, STARTrightllc.com is a new web site where business owners may go to create and maintain an LLC.   The Utah LLC was the first to be available this summer in July.  The California LLC and the Arizona LLC followed quickly in  late July early August.   The main question I have heard from individuals however is, “What do you mean we can create an LLC and maintain an LLC?  Let me make this simple.  I will divide the STARTright LLC services into the “Form an LLC”  and the “maintain an LLC” functions of the website.

Form an LLC

STARTright is based on the solid legal research that shows that in all states, the LLC may be structured into 16 main LLC types.  These 16 LLC types are based upon 3 different factors.  Those factors are:

1. The number and type of members in the LLC
2. The management structure of the LLC
3. The tax structure of the LLC

From these three factors comes a numerous, but finite number of LLC types that may be formed.  STARTright takes these three LLC factors and builds its decision making process based on the three LLC factors.  Let me explain.   

When I was a kid, we read these books called “choose your own adventures”.  You would start the book and read along until you came to a point in the story where the hero (which was supposed to be you) had a decision to make.  If you chose decision “A”, you would turn to a page in the book that took up the story based upon that decision.  If you chose decision “B”, you went to a page in the book that took the story up from choice B.   By the end of the story, you had made 9 or 10 decisions.  If you laid out the decisions in a flow chart, it looked something like this.

 

LLC choose your own adventure

The way in which we have structured the LLC creation process in STARTright is very much the same.  The critical part of the LLC formation formula is not laying out the “choose your own LLC adventure” correctly.  As business lawyer, I have done that numerous times and understand how that works.  The critical component to STARTright working is whether the business owner who is using STARTright understands his options based on those LLC factors sufficiently to make the decision that will meet his business needs.   

The STARTright LLC video collection was developed to help the user understand the concepts surrounding the LLC.  At each step in the LLC creation process, the user can watch a video that explains concepts about the LLC.  By watching these videos the user understands where he or she is at in the decision process and can make the right choice and build an LLC that fits their needs.  These choices build the LLC articles of organization and a decision specific LLC operating agreement.  If the user then runs the LLC by this user agreement, they will ensure the protections promised them in the state LLC Act.

Maintain an LLC

STARTright maintains the LLC in three ways.  First, when the user receives the Articles of Organization back from the state, the user can log into the My STARTright portal and may enter the LLC state file number and date of formation.  Following this, a list of tasks that are commonly necessary in the state to finish proper business setup will appear in the tasks list.   By following these tasks, the user can get all of the necessary business registrations finished.  The second way in which the My STARTright portal helps to maintain an LLC is to provide a place for documents to be kept.  Most people struggle to hold on to their Articles of Organization and Operating Agreement.  In both cases, you can print these documents off, and then upload a signed copy.  This will ensure that you always have access to the most recent copy of your LLC documents.  The final way the LLC is maintained in the STARTright portal is to remind the LLC owner of any state filings that must be made. 

STARTright is the most efficient way to form an LLC on the web.  For a Utah LLC, California LLC or Arizona LLC, the cost is a mere $149 to create an account.  Once this account is set up, you can create multiple LLCs all year.

Create a Utah LLC! STARTright released for Utah LLCs

STARTright vSeries was made available for Utah business owners starting on July 9th.  It is the easiest and most effective way to create and maintain a Utah LLC.   The STARTright vSeries is a combination of two applications: vCreate and vMaintain.  

vCreate helps the business owner create and understand the LLC.  The documents are filled out in state approved pdf formats for the user to print off and file with the state filing agency.  The step by step process is extremely easy and made even easier with the use of performance support videos.  These 3D animated videos are there at every step to make the concepts about an LLC very clear and understandable.  

The second application is called vMaintain.  It picks up where vCreate ends.  After the documents are filed with the state and your LLC is set up, vMaintain is the place to keep track of your documents and find out about additional setup tasks for your business.  It is pretty cool and very useful for any business owner.

The entire application with a year subscription to vMaintain is $149.   It makes it easy for people to get set up correctly from the beginning.  

Go there now!     www.startrightllc.com

Follow Up To LLC Part 1: Getting that other LLC Member

Last week one of the readers left me a comment asking me whether or not he could use his spouse as the minority partner.  Here was my comment:

Generally the best way to avoid losing charging order protection is to get another member.  Because you do not want to lose control, it is best that you give that member a very small portion of the LLC.   I will write a post on this later, but most states give the LLC members a great deal of flexibility.  The California LLC Act allows members to break free from the California LLC Act’s standards by writing into an operating agreement the way the members want the LLC to operate.  This means you can make the call.  You get to write this operating agreement in a way that benefits you as the primary member.   If the other member has 5% or less, and decisions are made by a 65% member or manager vote, (corporate super majority) then you really can run the LLC on your own terms. You need to make sure you address two things however.  

1. Either you need to also write into the operating agreement that the members holding 65% or more do not need to notify the other members to make these decisions, or you need to always call some sort of phone or other meeting when you are making decisions that would generally require a meeting of the members or managers.  It is always good to show that you are following what is in the operating agreement.
2. Second, if you have another member, the money has to be split their way also.  Make sure you assess the tax consequences and necessity of giving that member his portion of distributions if you distribute money out.

A spouse is not a good option for a junior member. The point is to distribute the injury of having an unwanted member in a bankruptcy suit. You and your wife are considered one.

Definition of an LLC: Part-1 The Single Member Hitch

Especially useful for small business owners, the LLC can mold to almost any business model.  Most of the concepts explained below are better explained in the STARTright videos available in your member account.  Limited Liability Companies mesh the best parts of the corporation and partnership.     

Like anything, an LLC is weak when used in ways it was not intended.  I am writing a series of blog entries addressing best practices when using an LLC.  As always, I will follow the STARTright philosophy and try and convey basic concepts using visual diagrams.  This allows you the business owner to make the right decisions.  

Today, lets talk about single member LLCs. Unlike partnerships or corporations, the limited liability company provides two directions of protection.  

• The corporate veil protection: The veil protects the members personal life if the LLC is sued.

LLC has Corporate Veil Protection

• The partnership / charging order protection: The charging order protects the company and the member’s investment if one of the members is sued in his or her personal life.

 

LLCs receive Partnership Charging Order Protection

Single member LLCs are potentially weak if the owner is hoping to protect the LLC if he gets sued himself.  I say potentially, because in law everything is a matter of a two step analysis:

1. Initial Philosophy: laws are usually created to meet a societal need.   
2. Evolving Trends: After a law is introduced, the courts assess whether to change the original interpretation of the law to meet evolving societal needs. 

The original charging order philosophy protected guys A, B from having to accept D as an unwanted partner if C, the person they originally went into business with gets sued.  They don’t want to have to deal with D.  

 

LLC charging order protection intended to stop unwanted partner.

To prevent this unwanted member scenario as shown in figure 3, the charging order is all D can get out of C’s membership as shown in figure 2 above.  The charging order limits D.  He must wait for A and B to decide to distribute money.  No distributions = no money. 

The Single Member Hitch: When a the member of a single member LLC is sued, there is no other members to protect from D.

 

LLC has no one else to protect.

Two bankruptcy courts have used this flaw in the LLC protection to allow creditors of a business owner to completely take over his LLC and liquidate it for cash.  The first case was in Colorado and the nation held its breath to see what would happen next.  The next case was in Idaho and actually used the Colorado case to base its decision on.  This means the trend is starting to move in the direction of denying charging order protection to single member LLCs.  The two cases are linked in pdf format below.  Next I will talk about how a single member LLC owner can remedy this problem.

Albriet: Colorado Bankruptcy Case

A-Z Electronics: Idaho Bankruptcy Case