Today we are talking about the legal aspects of forming your LLC when investing in commercial real estate. We are talking with Garrett Sutton, a corporate attorney, asset protection expert and best selling author who has sold more than 900,000 books to guide entrepreneurs and investors. He has run his practice for over 30 years, assisting entrepreneurs and real estate investors in protecting their assets and maximizing their financial goals through sound management and asset protection strategies.
Tell us a little bit about you.
I grew up in the San Francisco Bay Area and went to UC Berkeley, and then across the Bay to Hastings Law School in San Francisco. I always enjoyed corporate law, and then I moved to Nevada, and Nevada is a great state for corporate and LLC law. So I’ve just made it my practice to focus on those areas, asset protection, maintaining and using corporations and LLCs to your advantage. I was very fortunate to become associated with Robert Kiyosaki 20 years ago, and I have written a number of books in the Rich Dad advisor series. I have a new book coming out called Scam Proof Your Assets: Guarding Against Widespread Deception. That book comes out shortly and it talks about how we have to deal with all the criminality, the cyber criminality that’s coming at us every day. You need to protect your assets by knowing how to defend yourself against cyber criminality. I live in Reno, Nevada, and I practice with Robert, we travel around the world talking about asset protection and financial education, I go to the Summit at Sea where you go and just enjoy going to those types of events where people can gain information that we don’t get in school.
Let’s dive into the basics of LLC because it can be a little bit confusing, especially for a beginner investor investing i n real estate. How should a real estate investor organize their LLC’s for best protection?
We like having an LLC set up in the state where the property is located. If you buy a property in Oregon, we set up an Oregon LLC to be on title to the Oregon property. And in all 50 states if a tenant sues, or the law where the property is located is going to apply, if we have a number of LLC’s and we want to protect against the outside attack, that tenant suing is the inside attack, they have a claim directly against the LLC that holds the real estate, the outside attack is you get in a car wreck. It has nothing to do with the real estate but your insurance doesn’t cover the claim. And they’d like to get at your other assets. We have to protect against the outside attack as well. And in that case, we like Wyoming and Nevada to own the Oregon LLC. If you have a property in Utah, we’d have an Utah LLC.
Wyoming and Nevada provide excellent asset protection against the outside attack where the car wreck victim wants to get at your Oregon property, but they have to fight through the Wyoming LLC to even get at Oregon. And with the Wyoming LLC, we have what’s called the charging order, which is a lien on distributions. In California, the laws are very weak, a creditor, or the car wreck victim can go right through the California LLC and force a sale of a property. They can’t do that with Wyoming and Nevada. So that’s basically how we structure. We have an LLC set up in the state where the property is located. We have that LLC in turn owned by a Wyoming LLC for the better asset protection.
And on top of that, if you are living outside of Oregon, you need to create one on in your state as well correct?
Not necessarily. You could say you live in Utah, you set up the Oregon LLC, the Oregon LLC is owned by the Wyoming LLC, you wouldn’t have to set up a Utah LLC in that case, even though you’re an Utah resident. That rule changes for California. We have to play an extra for California. In California, the Wyoming LLC that you manage from California would have to be qualified to do business in the state of California. So just know that if you live in California, we have to do some extra planning.
You mentioned Nevada and Wyoming, what is the difference between these two? Is there anything significant that someone needs to watch out for?
Nevada, Wyoming and Delaware compete against each other to have the best law, which is good, we like that. Nevada is $350 a year. Wyoming is only $50 a year, and Nevada will put your name on the state website, Wyoming does not, so Wyoming offers lower cost and greater privacy, which is why most of our clients use Wyoming LLC.
Some investors may already know that attorneys should always be speaking with our CPA’s. However, should you be speaking with our CPA’s before forming an LLC?
I like a team approach where you certainly have a CPA on your team. And they will give you guidance on how the LLC can be taxed. You need an attorney on your team to set up the LLC and advise you on how the LLC should be operated. I work with CPAs all the time. The LLC is very flexible, you can have it taxed however you want. And so the CPA advice on how to tax the LLC is useful. The attorney advice on how to use the LLC for asset protection is equally useful.
But the attorney and the CPA don’t necessarily have to be speaking prior to forming it. Is that correct?
No, you have time, you set up the LLC, if you know that you’re going to buy a piece of real estate. And if you know you’re going to close, then we set up the LLC, and then you have time to talk to your CPA about how that LLC should be taxed. The important thing is you’re going to take title to the new property in the name of the LLC. That is important.
With that in mind, how long before the close should they start forming the LLC?
It varies from state to state. In Nevada, we can get an LLC set up in a matter of a day. Some states like California can take a couple of weeks. So it varies state to state. I’d say at least two weeks.
Let’s dive into all of the documentation that you guys will be sending us after an LLC is formed. We receive the operating agreement, the Certificate of Formation, the Certificate of Filing, the EIN, and the Articles of Organization. Do you mind elaborating a little bit on what the purpose is for each one of them?
We submit the Articles of Organization to the state. And it’s a very short form because this one document is a matter of public record. Anybody can go look it up and see what’s on it. So we don’t want to put too much information on that. So the Articles of Organization for an LLC are called Articles of Incorporation for a corporation. So they’re two different names for essentially the same document. But the Articles of Organization for the LLC are going to say that we seek a state charter, we’re going to set it up, here’s who the Registered Agent is. That’s about it.
Then behind that public document, you’re going to have the Operating Agreement, which is kind of the roadmap for how you’re going to operate the LLC. Who are the members of the LLC? What percentages do they own? When are we going to have meetings? Can we have telephonic meetings? All of that is in the Operating Agreement. And our Operating Agreement is 30 or more pages. Some of these operating agreements that you see from these online services are six pages, and they just don’t cover all the issues that you have in operating an LLC. So that is a key document. And it’s a tailored document. It’s not just a form document, we tailor it for your specific situation.
You’re also going to have the Certificate of Formation that comes back from the state saying, Yes, you’re formed, and the filing.
And then the EIN stands for Employer Identification Number. And that’s like a social security number for your business. The IRS wants that EIN number to be issued, so that they can keep track of you. And they’re going to do it anyway, but you need that EIN number to open up a bank account with a corporate or an LLC bank account. So before you even go to the bank, and try and open an account, you’ve to get this number from the IRS. And we help you with that. It’s not hard to do, but you just need to have that document and that number before you go open the bank account.
And it’s really important to open that LLC bank account, you can’t use your own personal bank account for LLC operations, it has to be in a separate LLC bank account. If you commingle personal money with business monies, in various accounts, you can get into trouble. So those are the main documents we have.
We also have minutes of the first meeting, that’s important.
We also issue the membership certificate. It’s like a stock certificate. And you really need to have that if the IRS ever comes calling, they want to see that you’ve issued the membership certificate and a lot of these online companies never do so. And that just is going to get you in trouble with the IRS later. So we offer the complete package, including the membership certificates.
You touched on the minutes a little bit. How often should we create those minutes? Is it once a year?
Once a year is what’s required. Some states say you don’t have to do minutes, but then you walk into court and your minute book is empty and the judge rules against you. So it’s better to have annual minutes, and we prepare those for you if you want. When you set up an LLC with us, we give you a book that shows you how to do the minutes yourself. It’s a template form that you can do. So you can certainly do them yourselves. But a lot of people never get around to it. It’s a big pain for them, like going to the dentist. So we’ll prepare the minutes for you if you need that service.
Can you talk a little bit about how does an investor pays himself with an LLC?
That’s a really good question. Let’s say you’re an operating business, you’re running a business through your LLC. We talked to the CPA, maybe you’re taxed as an S Corp. With a business, you would pay yourself a salary because you’re involved in a trader business. And on the salary the IRS wants to see you paying payroll taxes that go to the Social Security and Medicare system. So you would pay yourself a salary from that business operating LLC. If you have real estate, and you’re just holding and receiving income from real estate, and we consider it passive, then the money would flow from the LLC to you as a distribution and you’re going to owe tax on that as well. But you’d write a check from the LLC, to you personally and then you would cash that check and put it into your personal bank account. So we’d have money coming into the LLC from rents, let’s say you own a duplex, the rents come into the LLC, you pay all the expenses at the LLC level, and then you make a distribution from the LLC to yourself. And that would be a check from the LLC business bank account to you personally, and you would deposit it in your personal account.
That is very helpful, I’m sure there are a lot of people that are wondering that.
We want the money. We got to do it the right way, though.
What else do you think is important for our audience to know whether they’re a beginner, an intermediate, or someone who is an experienced investor?
For all three types, beginner, intermediate and expert, it’s really important to know that when you set up the LLC, you’re setting it up for limited liability, you’re setting it up so that your personal assets are not exposed. But there are ongoing requirements to keep that protection in place.
1. Every year you have to pay a fee to the state, like we mentioned, Wyoming is $50 a year.
2. You have to have a Registered Agent in the state where you’ve set up the LLC and a state where you’ve qualified to do business, like a Wyoming LLC qualified in California, you’d have to have a Registered Agent in Wyoming and California in that case.
3. You need to have the separate bank account, as we mentioned, you can’t co-mingle funds.
4. You need to do the minutes every year.
5. You need to make sure that on all documentation, you’re using XYZ LLC and you’re signing as manager, not as a personal owner of the property, you wouldn’t sign your name as just XYZ. Make sure it says XYZ LLC, and that you sign as manager.
Now these are all called corporate formalities. And they sound boring. But what happens is, if you don’t follow them, someone can pierce the corporate veil, meaning you didn’t follow the corporate formalities. And they want to go after you personally for a claim they have against the corporation. So you’ve set up the LLC, you’ve done the right thing. But you’ve got to make sure you follow these corporate formalities on an annual basis so that you stay protected.
Signing as manager, that’s something that I did not know.
You want to sign that you’re the manager of the LLC.
How many properties can you have per LLC?
That’s a great question. Because you can have 10 properties in one LLC. The problem is, if a tenant sues the LLC over something bad that happened at one property, they can get what’s inside that LLC, which would be the nine other properties as well. So we don’t want to create a target rich LLC. Now I have some clients that will put just one property. in each LLC, they’ll have a separate LLC for every single property. I have some clients that say, these properties are only worth $50,000-$60,000 each, I’ll put three properties in one LLC. I certainly would not put 10 properties into one LLC. It’s really a judgment call, it’s whatever you feel comfortable with. But having too many properties in one LLC can be a bad thing, because you become a more attractive target for a tenant and their attorney who’s on a contingency fee.
We don’t talk about residential investing here, and I was always wondering how do these people manage multiple homes when they have more than 10 or 100 homes? How do they divide and conquer? That’s very helpful. Is there anything else that you think our audience should know?
I just think it’s important to set these up at the start, we’ve had situations where people say, You know what, I’m just going to take title in my name, I’ll transfer it into an LLC at a later date, and they never get around to doing it. They get busy, they forget. And then they get sued. And then it’s too late if you get sued when title is in your individual name. All of your personal assets are exposed. So it’s best to just set that LLC up right at the start, take title in the name of the LLC, so that you’re protected from day one. Once you’ve been sued, it’s too late to transfer title into an LLC, a court can reverse that.