The Best and Worst Ways to Hold Real Estate Title – Video
Gary: It’s time to do the good, the bad and the ugly for real estate. Now, the good, the bad and the ugly for business was just a review. The bad was the sole proprietorship, the ugly was the general partnership, the good is the S corp, the C Corp, the LLC, and the LP. Now on the real estate, and really, this is the good, the bad, the ugly on how to take title to real estate.
The bad, one bad way is to hold it in your own name. If you rent out real estate and it’s titled in your own name and a tenant sues, they can reach not only the equity in that piece of real estate, but all your other personal assets, so kind of important that we understand the risks associated with owning real estate in your own name. All right, let’s go to the next slide. Another bad way to hold real estate is as a joint tenancy. Now, many married couples will use joint tenancy. The feature of joint tenancy is the right of survivorship, which means when one passes, the other automatically gets it and we’ll go through how it can work here.
This is a true story. We had the second marriage of Beth and Bob, Bob’s son from the first marriage is Bob Junior, Beth’s daughter from the first marriage is Amanda. True story in Berkeley, California, Beth and Bob were out for a walk. They were in the wrong place at the wrong time, there’s a drive-by shooting. We go to the next slide. We see that Bob died on the scene, died on the street and because we have the right of survivorship, by operation of law, that valuable home in Berkeley automatically became Beth’s property.
Then Beth died at the hospital four hours later. Because the property was Beth’s alone and there was no estate planning done, the property automatically goes to Amanda. I think that’s featured in the next slide. In this case, Beth passes away, Amanda gets everything, Bob Junior gets nothing. I’m sure that’s not what Bob intended, but that’s what can happen with the right of survivorship.
Now, when you’re going out to investors and saying let’s hold title as joint tenants, I don’t know about you, Kathy, but I don’t want to give someone an incentive to benefit from my death. I’m just funny that way, I’m not going to invest in a joint tenancy, unless maybe the guy is 99 years old, then I will, but it’s just not the right way to go. When you’re talking to investors, you’re not going to pursue a joint tenancy for this reason. As well, there’s no asset protection. If a tenant sues and you’re joint tenants, they can go after the property and all your remaining assets, so that’s not a great way to hold title. Let’s go to the next one.
Tenants in common is another bad way to hold title to real estate. In this case, we have a Vegas condo owned by Hillary and Nancy. Hillary’s husband gets sued for a cigar factory incident. All of a sudden, Hillary’s interest is taken by someone, because when someone sues one of the tenants in common, they can take the interest in real estate. Let’s go to the next slide. Here’s what happened in that case, Hillary was sued and all of a sudden, Nancy has a new partner. I’m not sure Nancy really wants Sean as a partner in the Vegas condo.
As well, Sean would have the ability to do a partition sale and force the sale of the asset. Now, Nancy would get her half of the proceeds, but that’s a disruption that you want to avoid. We’re not going to use tenants in common to protect our real estate because again, there’s no asset protection there.
Let’s look at the next slide. There’s one ugly entity for holding real estate and it’s the C Corporation. If you have anybody come to you to suggest that you hold title to real estate in a C Corp, you know they don’t know what they’re doing because with a C Corporation, you have a double tax. You get taxed at the C Corporation level, and then you get taxed at the shareholder level.
For example, on a $400,000 gain on the sale of real estate, you will pay $90,000 more to Uncle Sam than if you had use an LLC or an LP, one of the good entities. That double tax on gains is really a deterrent. One of the things if you take away one thing from tonight’s webinar, it’s that you will never hold real estate in a C Corp. As well, if you have real estate in a C Corp and the bank says, “All right, you want to refinance, transfer the property out of the entity into your name and then you can transfer it back in.”
Well, when you transfer it from the corporation out to you, that’s a taxable event and you’ve got to pay tax on that. You haven’t even sold it, but because you removed it from the corporation, that’s a taxable event. Well, this doesn’t happen with LLCs and LPs, the property moves in and out at its basis. We’re not going to use a C Corporation to hold real estate and if we click the next thing, you’ll see that the professional who suggests putting real estate into a C Corp, what do you say to them? I’ll be leaving now. Because they really just don’t know much about real estate. That’s a major rookie error.
All right, let’s go to the next slide. For some reason, there it is. We can go to the next slide. We’re going to be talking about the good entities. The good entities for real estate are the LLCs and LPs, and that is because they have asset protection via the charging order. Are we able to advance to the next slide?
Kathy: I’m on it, yes.
Gary: There we go. LLCs and LPs, these are the good entities for real estate and the why is because they offer the charging order protection. It depends on the state, California and New York are very weak, Wyoming and Nevada as we’ve mentioned, are very strong, but the charging order procedure is what really offers protection to real estate investors. If we can click that and then go to the next slide, before we get into the charging order and you can click the next slide after this.
I want to talk about the difference between LLCs and LPs, they both offer good asset protection. The key difference is in an LP, when you have a general partner as an individual, they’re personally liable, just like we said with general partnerships earlier, the general partner is personally liable for everything that happens inside the limited partnerships. You set up the limited partnership and you list yourself as the general partner, you haven’t really protected yourself. We need to take one more step and that is we need to form a corporation or an LLC to be the general partner.
We have an LP and that circle should be filled in with the initials LP like it just appeared. We have an LP, that’s an entity that’s formed and then we have to be the general partner, a corporation or an LLC to be the general partner and we have asset protection there. The difference then between LLCs and LPs is with the LLC, everyone’s protected, we don’t need to set up a second entity like we do in a limited partnership.
The difference is an LP for protection requires two entities, the LLC only requires one. In California, to have two entities, it’s $800 per year per entity. Instead of $800 with the LLC, with the LP structure, it’s $1,600. That sounds like a lot, but then we mentioned with the LLC, we have these extra California taxes. At some point with the extra LLC taxes, it’s cheaper to do the limited partnership structure.
There’s a lot to this, I know that we’re going through some complicated stuff, but feel free to call the office and we can go through this and analyze your situation best, but for right now, just know that you need two entities for the LLC and only one for the LP. Mainly, we’re going to be talking about LLCs because of the need for just one entity. Let’s go to the next slide.
Kathy: Can I ask you a quick question?
Gary: This is where we’re going to talk about the charging order.
Kathy: Hey Gary, can I ask a quick question on this page?
Kathy: You said that LLCs in California are taxed higher than other entities. What if it’s a California resident who owns LLCs in other states, that are those states own the properties? The properties are not in California.
Gary: California has changed their rules as of January 1st. If you are a California resident managing a property in Texas, the state of California now says, because you’re a California resident managing a Texas LLC, the Texas LLC is doing business in California, pay us $800.
Kathy: Okay, plus any of those–
Gary: This has got a lot of people upset. We have a lot of people just anecdotally, a lot of people are moving from California because of this. I have probably three clients that are California residents. They own real estate outside the state of California. With California now saying 13.3% and $800 per entity even though the entity is outside the state of California, all the activity is outside the state of California, but that the Franchise Tax Board now wants $800 per year, per out-of-state entity, people are just throwing up their hands and saying, “I’m moving.” That’s what’s at issue here. This is just a brand new rule as of January 1st, Kathy.
Kathy: Okay. All right. Moving on.
Gary: Moving on to the charging order protection. I mentioned on that last slide, there’s no such thing as an FLP, the family limited partnership. There are promoters out there saying, “Oh, just set up an FLP.” Yes. This next one here, there’s no such thing as a family limited partnership. These promoters make it sound like there’s an extra special entity that’s allowed. They’re just limited partnerships that happen to hold family assets. Be very careful of someone who’s selling you an expensive box of forms as the FLP. There’s no such thing as an FLP.