LLC and liability protection
An affordable and highly effective method of protecting your assets from attack is to transfer your rental property to a Limited Liability Company (LLC). Title to investment property through an LLC limits the liabilities of the business to only those assets held within the LLC. In the same way that shareholders of a corporation are protected from liability, a properly formed LLC will protect its owners from legal liability, including liability for the acts of its employees and agents.
There are several significant benefits that California LLC can provide to you or your investors. The LLC creates a risk barrier that encourages apartment ownership while protecting the owner’s personal assets from lawsuits and seizures. Double taxation and extensive procedures inherent to traditional corporations are eliminated. When legal action is required against a tenant, such as an eviction, it is the LLC, rather than the individual landlord, that brings the claim. In addition, landlord privacy is enhanced because rent checks are made payable to the LLC, leases are between the LLC and the tenant, and correspondence comes from the LLC.
While high limit liability insurance is important, it is still not adequate to protect property owners from asset loss. Most insurance policies contain exclusions for mold, lead-based paint, and other environmental hazards. Also, they rarely cover judgments arising from discrimination claims. Even with expensive high-limit insurance coverage, a major incident, such as a fire or balcony collapse resulting in numerous claims, could result in liability that far exceeds your policy limit. Even with the best of intentions regarding its tenants, the LLC has become a necessary tool for limiting liability not only for legitimate claims, but also for those where only a brainwashed jury could see merit. The annual state franchise tax deductible of $800 on LLCs is small compared to the enormous benefit provided.
In recent years, the Nevada State LLC has been promoted as an asset protection alternative to the California LLC, since the annual tax is relatively small compared to California. However, in most cases there is little or no financial benefit to forming a Nevada LLC for your California rental property, because ownership of the property in California necessarily means that the business is conducted in California. As such, Nevada LLC must also be registered with the California Secretary of State and pay the initial California registration fee and $800 annual franchise tax, along with California income tax. (California Revision and Tax Code section 17941, California Corporation Code section 17050). For business ventures other than California real estate, where the principal business is not conducted in California, Nevada LLC/Corporation may be an attractive option for investors.
Additional LLC benefits include the ability for LLCs to use 1031 exchanges and the exemption from 3 1/3 withholding on the sale of real property for multi-member LLCs. In addition, a separate federal tax return is generally not required for single-member LLCs, including those owned by a husband and wife or a living trust, and the transfer of ownership to the LLC is almost always is exempt from tax reassessment. And the LLC will work very well in conjunction with a living trust to simultaneously protect and preserve estate assets.
Many apartment owners have executed a living trust to arrange for the distribution of their assets after death, as well as to avoid huge probate costs, reduce or eliminate estate taxes when they die, and avoid court control of their assets in the event of a loss. that they become incapacitated. However, the living trust will not protect against lawsuits. If an apartment building is held by a living trust, all other assets of the trust will be exposed to liability for lawsuits generated by the building. A much better approach is to place your apartment in an LLC, creating a liability barrier to protect all other trust assets. The interests of the LLC members can be safely added to the trust.
When it comes to multiple investments, it is best to have a separate LLC for each rental property so that liability arising from one property cannot be tied to any other property. Even single-family homes with tenants must be in the hands of their own LLC. If paying $800 per year for each of the multiple LLCs is not a viable option, then the properties could be pooled. Owning a total of six investment properties with three in one LLC and three in the other would provide significantly more protection than owning all the properties in your personal name. For investors wishing to transfer multiple properties with annual gross rental income totaling more than $500,000 to a single entity, the use of a limited partnership should be considered. Both the limited partnership and the LLC must pay the $800 franchise tax, but the LLC must pay additional gross receipts tax if annual gross receipts exceed $250,000.
Because landlords are subject to virtually unlimited exposure to lawsuits and financial liabilities arising from ownership of their rental property, they must take every legal means to protect their assets. Once a competent attorney prepares and files the series of legal documents required for initial LLC formation, personal assets will no longer be available to satisfy debts or judgments against the LLC.