Investing in Real Estate: How Real Estate Investors Can Protect Their Assets with an LLC (Video)

Building a portfolio of rental properties can be your ticket to financial freedom. But it also exposes you to risks and the need for asset protection. One way to do this is by transferring your investment properties into an LLC, or another kind of legal entity, like a land trust.

That topic inspires many questions among new investors including where they should set up their LLCs. In this episode, we hear from tax and asset protection attorney, Clint Coons, who will answer that question and many more with easy to understand explanations. Among the topics he’ll cover are the where, the why, and the how you might want to set up your LLC along with the difference between LLCs and other entities.

You can schedule a free session with someone at Clint's firm or watch the replay of a recent webinar by Clint on our website. You need to be a Real Wealth member to access the webinar replay inside our investor portal, but joining is easy and free at www.realwealthshow.com.

Audio Transcript:

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Announcer: You're listening to The Real Wealth Show with Kathy Fettke, the real estate investors resource.

Kathy Fettke: A common question we get from our Real Wealth members is where should I set up my LLC for the best asset protection? Well, it's not that simple. I'm Kathy Fettke. Welcome to The Real Wealth Show. Today's guest is full of information on how to protect your assets from lawsuits. I learned so much from this interview, and I'm so glad I don't have to figure this stuff out on my own. We've got an expert here to do that for us. Clint, welcome back to The Real Wealth Show.

Clint Coons: Thanks for having me.

Kathy: I got an email recently from somebody saying is it illegal to have an entity in another state from where you live? Thinking that you're tricking the IRS into thinking that you live in that state if you have an entity there. What's your response to that?

Clint: That's incorrect. Obviously, you can set up a business entity wherever you want. If you're going to own real estate in another state, take, for example, Florida, then you're legally required to have an LLC set up there or registered to do business there. For example, if you lived in California, and you had property in Florida, you take your California LLC, and you would register it in Florida to conduct business. It is doing business there. It doesn't matter where you sit, where you live, and where the entity is located.

In the eyes of the IRS, it all flows back to you, and you're going to pay taxes on that money, regardless. They don't care where it's set up.

Kathy: What you don't want to do is say open up a Nevada LLC, and say you live there when you really live in California or something like that. That would not be okay.

Clint: That's a different strategy. That is basically tax avoidance where people will-- This was [00:02:00] really popular back in the early 2000s. There'll be a lot of advertising, "Hey, set up an entity in tax-free Nevada and pay zero tax." People would do that with the thinking that if they had an entity there, they wouldn't be subject to federal income tax or state income tax on their business that is derived from a particular state.

What we found back in those times that you'd have a lot of Californians would set up Nevada entities, run an active business through their Nevada entity that's actually taking place in California and try to avoid all California state tax. Some people even think that they didn't have to pay federal tax. Those people ended up wearing orange jumpsuits out of them or else having a lot of fines when they were caught.

Kathy: You don't want to lie about where you live. In our case, our business is in all kinds of states, but we live in California. No matter what, we got to pay California tax unless we moved. In that case, if we moved, you have to live at least more than six months of the year somewhere else. Is that right?

Clint: Yes. If you wanted to change your domicile out of a particular state to a different state, then you would have to establish residency, and that would typically require that you register to vote there, you get a driver's license in that state, and more importantly, the way they track it as well as on utility bills. They would look at your utility bills that are in your name, and they would determine whether or not you actually reside in that property for six months if they wanted to be aggressive.

I've seen this happen before with individuals who claim residency in Nevada when in reality, they were not residents there and the home state would request their utility bills for that time, the six months they said they lived there. They would find there was no water usage, no electricity usage. They're like, "You weren't really living there. You were just stating you are." That can get you in trouble. What you have to do is put your mother-in-law or somebody in your property during that time.

Kathy: [00:04:00] I don't know if it's true, but I've heard that they can even see where your phone is. These days your phone can tell you where you are. I don't know if they go that far.

Clint: No. It's one of the things that-- People go to so much trouble trying to avoid state taxes. I just don't think the stress is worth it at the end of the day. Pay your taxes, if you don't want to live in that state then move and just visit it every once in a while, or set up a secondary home.

Kathy: Exactly. That's the thing is you can live somewhere else and just visit a lot, travel a lot. Anyway, let's explain, I know I've used the word entity and for some of our listeners, they might not really understand what that is. What am I talking about when I say entities?

Clint: You're talking about a limited liability company, land trust, corporation. It's just something that is formed under state law or not that is used for a specific purpose.

We talk about real estate a lot. We're looking at a title-holding entity, something that is going to hold your real estate for a few different purposes. One, it's typically in the asset protection. If anything happens with the property, you're not going to be personally liable.

If you get sued individually, your property would be removed from that potential claim. That's per our judgment that would be entered against you. Then there's tax motivations as well that you're looking to control how your tax returns look from the real estate when it hits your 1040. There's lots of reasons why we focus on using entities for real estate investors.

Kathy: Most investors, most real estate investors use LLCs. Why is that versus anything else, an S Corp, or a C Corp, or something like that?

Clint: It really comes down to the tax benefits the LLC offers an individual who's a passive real estate investor. You want to have flexibility number one in order to move property [00:06:00] in and out and not be hit with a transfer tax, or basically, actually, income tax is what can happen when you have a C or an S Corp. Take the example of I have three properties in an S Corporation, and I decided that I want to pull two of them out and move them to a different company. Those properties have appreciated in value over the last 10 years, and there's $400,000 in gain there. Just by deeding that property out to myself, I'll have to pay tax on that built-in gain even though I didn't sell it.

An LLC, you don't have that concern, because you're typically going to set them up to be either disregarded, which means the IRS just looks through it and you're considered to be the owner, or a partnership, which, again, it looks through, and you're going to pay the taxes on the income and you put that income on your 1040. It's treated a lot different than an S or a C Corp from being able to move assets in and out and not having to recognize tax on that built-in gain.

That's why they tend to gravitate towards an LLC versus a Corp and more importantly, the asset protection. They're easy to set up. It doesn't require a lot of maintenance from you or as a corporation, you got to have these annual meetings, possibly even quarterly meetings. LLC, set it up, forget it, set a bank account, collect your rents inside of there, and you're off to the races.

Kathy: Do the S Corp, C Corp, and LLC has the same asset protection?

Clint: When you talk about S and C Corp, what you're really referring to is federal taxation unless you're thinking about the actual form of a corporation. From a tax standpoint, an LLC can be treated as a C or an S Corp. From the physical attributes of the entity, if I were to say set up an entity in Texas, and I chose