Real Estate: To Be or Not to Be, in an LLC

speaker-0: In the legal sphere, if you're not respecting, you yourself as the owner of the LLC are not respecting the fact that it's a separate entity from you, that is called piercing the corporate veil. It's like fancy terminology. You guys can look it up on Google or your favorite LLM. But piercing the corporate veil is where if you don't respect and you treat this LLC like it's your piggy bank, and you don't have a separate bank account for it, you're not maintaining its registration.

You don't have, let's say, a separate email address even to like talk to your tenants through that email address. All of those things start to like kind of chip away at the law wanting or a judge wanting to respect that the liability should be just kept to the LLC and not reach into your own pockets. Because you're just treating it like it's yourself. So why should the law do that for you if something goes wrong?

speaker-1: All right, what is up and welcome back everyone to another episode of the Practical Planner Podcast. I'm your co-host Thomas Kobelman. And here with me is my two co-hosts now, Ann Rhodes and Lisa Weigel. Thanks for joining me.

I mean, I I like that we have three again. Great to be here. I'm excited for this one. So, ⁓ today's episode is really gonna be whether you should own your real estate in LLC.

And I think as advisors, this comes up quite often, it'll at least for me and the type of audience that that I work with. So You know, the question really most times is should I own my rental in an LLC? And I think we'll talk about that. But I also think we'll get into the weeds of like, should you own your primary home in an LLC?

I'm very curious to hear from you guys on this because I'll talk to attorneys all the time. And some attorneys will be like, every rental separate LLC or serial LLC for liability purposes. And then I work with some really amazing attorneys and they're like, Entity, no entity is stopping us from being able to get in here and sue them or come after their personal wealth. Really what matters is insurances.

So, you know, how do you guys really think about this? And maybe we start the conversation on rentals or commercial and then we kind of move to primary homes. speaker-2: Yeah, absolutely. I think it's such a natural reflex to say, ⁓ we have a secondary property property or tertiary property, something other than the primary residence.

Let's put it in an LC. Because of course your mind immediately goes to the liability shielding components of an LLC, which is obviously, you know, can be very helpful. ⁓ you know, if you if especially if it's like an Airbnb type property, you know, you want to make sure that if somebody has a slip and fall at, you know, your beach house. that it's not gonna then you know expose all of your personal assets to that lawsuit.

⁓ the thing to consider, and I think this is definitely the case with most aspects of financial planning and estate planning, is definitely like not everything can be looked at in a vacuum. Most things can't be looked at in a vacuum. So it you have to weigh sometimes the liability shielding concerns, the asset protection concerns with What does this actually translate to for this, you know, client, for this person? what's gonna make the most sense for them?

So in terms of an LLC ownership, like what what exactly is this property doing for them? Is it like an Airbnb? Like they're strictly using it for income purposes, they're renting it out often, or is this like their secondary property that they're going to the summer, you know, their lake house property? ⁓ you know, that might not need as much liability protection concern.

And then we get into the issue of, you know, is that gonna expose them to estate taxes? Are we going to get into property tax considerations? So we can kind of get into those ⁓ with more specifics. speaker-0: One thing that I'll notice, that I'll note, because Thomas, you brought this up, is, you know, ⁓ you know, these LLCs, et cetera, are not stopping us from suing these people.

First of all, this is America. So you can sue anyone and everyone that you want. And so, yeah, instituting the lawsuit, it's not gonna stop that. But whether or not you get anything out of the lawsuit, right, like how much in damages.

⁓ actually putting those rental properties in the LLCs can be very, very useful. That's why they're called limited liability, right? LL. ⁓ but you have to respect that it's a separate entity from yourself.

And this is where a lot of families, to Lisa's point, where it's like, this is actually their vacation home themselves. They don't really think of it as, you know, their rental property, or they're just not very sophisticated. This is their first time going around, you know, and and having a rental property. It can be very easy to think of it as just like, ⁓ any rental income that you get, like, it's my cash.

It like goes straight up to me. I report on the taxes, anyways. It might be includable in my state, anyways. So, like, why would I treat it any differently?

In the legal sphere, if you're not respecting you yourself as the owner of the LLC, are not respecting the fact that it's a separate entity from you, that is called. Piercing the corporate veil. It's like fancy terminology. You guys can look it up on Google or your favorite LLM.

But piercing the corporate veil is where if you don't respect and you treat this LLC like it's your piggy bank, and you don't have a separate bank account for it, you're not maintaining its registration, you don't have, let's say, a separate email address even to like talk to your tenants through that email address, all of those things start to like kind of chip away. at the law wanting or a judge wanting to respect that the liability should be just kept to the LLC and not reach into your own pockets.

Cause you're just treating it like it's yourself. So why should the law do that for you if something goes wrong? speaker-1: It's a big reason why you shouldn't be, you know, a lot of people who own rentals or even business owners in general, they they pierce the corporate veil day in and day out. They put so much impersonal expenses inside these entities to try to get added deductions.

And in reality, it's the worst thing. Like in a regular business, it's like, ⁓ you're planning to sell your business down the line, but you're gonna put personal expenses in there and drive down your profit. Bad decision. In the same way with your rentals, people have their car inside of this LLC that owns the.

You know, real estate because they drive there so much on this long term rental, they don't, or they'll buy food or they'll do whatever. You're setting yourself up for liability issues to say very small dollar amounts. It's just, it's just definitely not worth it. I think that's why attorneys sit there and they say, Well, we're gonna find a way in, because the average person isn't super smart in how they do this.

They just like it's all commingled in certain ways and they don't even track things correctly. So I do agree with you. I I do feel like the right route is to leverage LLCs, right? You know.

Try to button up, try to do it correctly. Sure, it might not be the number, like it might not guarantee that they can't get through there. And you can still add insurances on top, right? Like that's still a recommendation.

It's not a do this and avoid insurances. It's let's add multiple layers of protection. speaker-0: Yeah, and before we get into the taxes of things, there is a rule of thumb that we use as estate planners. And I'd be curious actually if our financial advisors who are listening are hearing anything else as a rule of thumb.

So remember, the LLC means that you're protecting, you're limiting the liability to what's inside the LLC. But it is possible to have such enormous LLCs that the liability is like hundreds of millions of dollars if you put all your eggs in one basket. And it's also possible, you know, for I mean, now we're crossing into territory of like this is just your client's, you know, vacation home, all the way up to like actual commercial real estate, like landlords and what they do to structure their businesses.

Kind of the same concepts will apply, but they might also separate out the property management and the operations of the business from the actual land itself. And so, as an estate planner, when we had clients who really like started getting into the real estate, like a rental income. ⁓ passive income side of things, we would tell them as a rule of thumb, put about a million to two million in a single LLC. And then once you hit that two million mark, think of doing a second LLC, right?

You you want to create more baskets, not fewer. speaker-1: That's the same thing I say. I generally say about a million. I think the hard part is appreciation and equity and like debt pay down.

Like what do you do if you have, let's say, three or four rentals in there and it's starting to appreciate above it? I think you can make your decision on where you go from there. But you know, in certain states like California, obviously is what you're most familiar with, you have a separate fee for every LLC. So then it's like now if you have 10 LLCs and they're all tiny properties and you're paying eight thousand dollars in yearly fees just to have them.

Does it become worthwhile? Does it not? Are you better off just having more umbr commercial umbrella insurance inside of that LLC? I think the wealth level of the person matters, right?

Like for certain people with lower wealth levels, maybe one LLC makes more sense than somebody was like, we have so much wealth in our entire name, plus in each LLC. Like maybe we just separate it because those costs are so minimal. speaker-0: Yeah, for sure. And then you might also want to look at like, is it because they're in different states or car across countries or something like that, you know, so that you you kind of like manage the structure.

But ⁓ there are definitely folks who may have more than one LC. speaker-1: Yeah. I think the other thing to point on here too is just talk about is like the tax side of things. People get mixed up about this all the time, but like it does not change your taxes, right?

Whether this is an LLC structure or whether they're not an LLC structure, you get your depreciation, you get to write off your expenses, but it's gonna be quite a bit harder to track than like you have one bank account dedicated to everything that you a contractor that comes out, the floor that gets fixed, ⁓ you know, maybe you are covering like lawn and everything else, like. You're better off having it probably an LLC for tracking purposes and being like, I use the same lawn care service at my house as the rental, like which one is this and which one is that?

But I do feel like people really mix this up and think that there's like some added or you don't get the depreciation if not, but that's just not the case. speaker-2: Yeah, any LLC that's you know, the the sort of default is that it's treated as an S Corp. It's you know passed through, it goes up to your your income tax, ⁓ your personal income tax. So everything like, and that's where there's so much confusion that that comes in because it all flows up to your income tax.

So to Anne's point, it's like, ⁓ my what's mine? It's theirs. And there it starts to be a blending. But from an income tax perspective, Yes, that's exactly right.

There is an option to treat an LLC as a C Corp. You can make that election and basically cut it off. You can have blocker entities, but for most people, for the type of properties that we're talking about, you know, their their rentals, you know, their second properties, it's probably going to be an S-corp, ⁓ which means it's just gonna flow up to their personal income tax returns. speaker-1: You think on a a rental would be an S an S Corp side?

speaker-2: I would say, I mean, it depends on the structure. Again, if we're talking like somebody who has like massive amounts of like, you know, apartments and rentals or beach homes or whatever. but if it's like, you know, one or two properties here and there, a lot of times, in at least in my experience, I would see them be as treated as S corps. speaker-0: And here we have to mention like the two the owners, right?

Because the tax treatment depends so much on the ownership of your LLC. So here, because this is a personal planning channel or podcast, you know, we assume that 100% is owned by like one individual. Or if it's spouses, for example, that they're somehow like in a community property state or something where it's kind of like one owner effectively. And so That's where it's like a disregarded entity as to those owners.

S-Corp is really also because maybe you start having new owners or the spouses can't treat something as community property. And so all of a sudden, like you have two or more owners and it becomes like either a partnership or some other sort of tax treatment that you can like elect into for tax purposes. speaker-1: I'm curious on the S Corp side of things because ⁓ isn't the downside of real estate S Corps is no step up in basis if it's an S Corp. You can't have a partnership change because if you had three partners and one wanted to no longer be an owner, you actually have a taxable event to move the entity out of the real estate side.

I speaker-0: Think that's correct. And people often do conversions ⁓ over the course of the life, but then there might be income tax hits to that restructuring. speaker-1: Yeah, I'd be curious because on on the C Corp side, I w what's the benefit of a C Corp there too? speaker-0: So what I would say is we see a lot of ⁓ like property management that might be in a C Corp ⁓ and then the ⁓ pass through treatment for the actual real estate owning.

⁓ speaker-1: So yeah, that makes sense. Cause what I most commonly see is like, okay, business here, for example, your real estate's over here in a partnership that you have like a or you know, individual and you have the grouping election here. So you still can use the losses over here, but the you can just run into so many tax issues with different setups. Yeah.

And it's not subject to self employment tax on real estate either. speaker-0: Right. No, that's that's for sure. ⁓ I think the other consideration, right, Lisa, because you practiced out of Illinois, is also state taxes and what happens if you take your real real estate out of your own name and put it into an LLC structure.

So I don't know, Lisa, if you wanted to talk about that. speaker-2: Yeah, that was, I mean, we saw this all the time. Practicing in Chicago, we have a a lot of clients that would have lake homes on Lake Michigan, either on the Michigan side or they'd have a house up in Lake Geneva, Wisconsin. Both of those have no estate taxes.

⁓ basically everyone surrounding Illinois has no estate taxes other than us. ⁓ so what became the issue was again that reflex of like, ⁓ this is my second home. You know, I go here a couple times a year. I don't I want to make sure that I'm, you know, fully covered from a liability perspective.

⁓ let me put it in an LLC. The tricky thing that, you know, sometimes gets lost in translation is if I'm a resident of a state that has a state-estate tax, like Illinois, when I pass away, Illinois is gonna look at everything that's in my personal estate. And that's gonna be real estate that's physically located in Illinois, but it's also all intangible interests, which includes interests in LLCs and any type of sort of business entity. So if I have a house on the Michigan side of Lake Michigan.

And originally I owned it just in my own name, but then I was like, ⁓ let me put it in LLC, get that liability protection. I've converted it from real property to intangible per property. And now I've pulled it into Illinois. Whereas if I had left it just sitting in my own personal name, it would be Michigan's territory and Michigan doesn't have an estate tax.

So that's where we would see people like, ⁓ we need to we need to retitle some of these properties. ⁓ so again, it's like just kind of fighting that ⁓ immediate reflex of like, let's look at the big picture. Where is this gonna get exposed? Similarly, you know, I had clients that had moved from Illinois to Florida, but they had like a fa an interest in a family farm up here in Illinois.

that's one where we definitely want to put that in an a family limited partnership or an LLC because we want that interest in the intangible ⁓ property to flow through to their domicile, which is now Florida, which obviously has no state tax. So it goes it works both ways, but you gotta definitely make sure you're looking at, you know, where where is the person gonna be subject to a state tax from a domicile perspective and where is the property actually located and how best ⁓ to make that work.

And the other thing I'll say too is with Michigan in particular, there's a few states like Michigan that will and I know California and can probably speak to this as well. When you start to retitle real estate and change the way that it's held, if it's like change in some sort of ⁓ percentage of beneficial ownership, then you can potentially uncap in Michigan or cause a reassessment of the property taxes. So it could have been like yours for many, many years. Now you're like, ⁓ let me put this in an LLC.

And you know what? Let me go ahead and add my kid on there because it'll just be convenient. There'll be a manager and a co-owner. ⁓ well, now all of a sudden we've changed the ownership.

Michigan's gonna reassess it and now all of a sudden it's, you know, potentially worth a lot more and I've got to pay huge amounts of property taxes that I was kind of locked in at a lower level. ⁓ not the case in Illinois where you're constantly reassessing and paying more pro speaker-1: Crazy. I can't I'm just picturing how many people give like advice or like an advisor. It's like you're in Illinois, you have a property there, just put an LLC, let's make sure it's protected.

And they just don't know that rule and lead you with state taxes. speaker-0: Yeah. So this is one of the things that's so interesting about LLCs because if you think of the types of like people who can help you put an LLC in place, it's like anyone and everyone, it feels. You could go to like a corporate attorney, you can go to a real estate attorney, you can go to an estate planner.

I mean, like LLCs seem just so like, you know, run of the mill. Like, ⁓ but actually, if you don't have somebody who has this broader view. of like all the implications of using the LLC, you can actually be leaving your clients in a exposed to certain types of taxes or whatnot. speaker-1: Super interesting.

So, okay. So I think like on the commercial and the the rental side, it's pretty similar, right? You never see a business owner that's like, ⁓ I own the building I operate in, and it's just in my name over here. Like that's going to be in an LLC.

It's going to be separate from the business because you want to separate that liability. Even more reason why it's like if if every business owns this in an LLC to separate liability, it's probably going to be a similar recommendation personally on ⁓ rentals. But I'm curious on the the personal side of things because there are people who say, you know, if if you want to be anonymous, own your primary home in an LLC. And there's other people who say like anybody can look up who's the owner of an LLC.

⁓ then there's people who say like never do it because mortgage rates can be higher. And then there's other people who say like, well, do it. You can rent it back to yourself and blah, blah, blah. Like, where do you guys stand on this?

speaker-2: Yeah, I think ⁓ with primary residences, it's even more complicated because number one, ⁓ you know, the first thing that comes to mind is if I'm putting my personal residence into ⁓ any other type of structure other than like holding it myself or with my spouse or you know, individually, you might be giving up a homestead exemption, a homeowner's exemption, you know, these type of personally tied exemptions at the county or state level that can be a huge tax savings.

⁓ so you again, it's like looking at the trade-offs of like, okay, maybe maybe there's more privacy, but maybe not. It really depends ⁓ on the state. Even putting it in a trust, you know, at least in Illinois, it's you still have to put the trustee's name on the deed. So, you know, if it's trust that you have and you're the trustee of your name's going on there either way.

there's other options too for, you know, holding things so privately. It's rare. Illinois, again, is like one of the very rare exceptions. ⁓ we have a thing called a land trust, which is like the most private way of holding real estate.

It's actually a trust that you deposit your your often it is primary residence into that trust. It's, you know, like a trust company holds the title. On the trust, it'll say, you know, owned by land trust numbers, you know, two one five six nine. And that's it.

There's no way to tie it to like an individual person. You as the as the individual, you know, person that lives there are the beneficial owner. of that ⁓ title insur or the the land trust with the title company, but otherwise it's super private. But I there's like I think it might just be Illinois that has land trusts.

I don't, I'm not aware of any other state. ⁓ and so, you know, it's not super, super common, but there are some some vehicles like that if you're looking for like the high privacy side. But again, you're gonna give up some probably pretty lucrative exemptions if you move it out. speaker-0: This ⁓ privacy concern is interesting because it depends so much on careful structuring, but also just careful management of all the people who are involved in helping you or the client purchase that property from the get-go.

And so let me just kind of paint some of the picture a picture of the footfalls that I've seen in private practice. First and foremost, we had a client who was really, really, you know, had. Come into a lot of money through a liquidity event, really wanted to stay private about a Bel Air mansion that he was purchasing. And, you know, we structured it as, you know, a California LLC.

you know, the partner of the law firm that was working on the deal, like went into the LLC as the manager. So that way, for registration purposes, even though this was California and you can look up who, you know, the manager is, it was somebody other than this client. Well, lo and behold, their real estate agent was so excited about having done this deal because it was tens of millions of dollars that they that it got published on the front page of the real estate like Wall Street Journal page.

And so, you know, client is really upset at the law firm, but it's like there's nothing we can do when somebody literally just tells, you know, others that they worked on the deal. So you have to, you know, make sure every person who's part of this transaction. Understands what the privacy concerns of the client are. And then of course, you look at, you know, forum shopping potentially.

What would it cost to maintain this LLC? Is it worth it? Are there registration requirements? I've heard tell that Wyoming LLCs apparently are pretty private.

⁓ so that's something you know that folks have looked into. I personally have never worked on one myself. And then of course, the alternative to the LLC is the trust. But for the trust, to Lisa's point, you have to find somebody who's willing that you trust, trustee, trust, that you trust to be on that deed for you and to actually manage the trust and sign documents for you.

So one of the famous ⁓ sort of ⁓ homes here in San Francisco, you know, a series of homes are the painted ladies. And we worked with one of the clients where their real estate attorney named himself as the trustee. Of one of these nominee trusts. So they're not as protective as the land trusts that Lisa's talking about, which seems to be a very Illinois-specific thing and very, very private and designed for that purpose.

But you can kind of fake it, fake the land trust, or you know, use one of these nominee trusts in another state as long as you have that person willing to be named on your deed and that you trust. So in this case, an attorney went on there. So there are ways. speaker-1: I don't know if each state like has the same ⁓ ability for it to be anonymous, but it basically says that there's Florida, Georgia, Hawaii, Illinois, where they originated from, Indiana, Montana, South Dakota, and Virginia.

speaker-0: I was going to say these things about privacy are so like trend trendy. It's like a political will kind of thing where if you guys will remember, two years ago everybody was like up in arms or like really frantic because of like the corporate transparency act. And so there was this big push towards transparency. That set of rules died.

I'm sure that you know the land trust was so popular in Illinois that Indiana felt like they had to jump on the bandwagon. All of these things are kind of political. speaker-1: Yeah. Yeah.

I mean, I feel like if if you really want to do it and hope it works, it's fine. But like it's definitely not a standard thing to do. And I've seen people be like, Well, then you get the depreciation. It's like, no, like this is not a business.

Like you live in it, like you're not taking passive losses on it. And if so, you're even if you could, you're having depreciation recapture and you're losing your capital gains exclusion. So, you know, doesn't seem like it's the end all be all or the recommendation at all. speaker-2: And this is where, I mean, from an estate planning perspective, we would lean so heavily on financial advisors because if you have a client that's trying to think through these options, do I put in an LLC?

Do I put it in a trust? Do I do a land trust? You know, again, each one you're you might be giving up something else, either the you know, homestead exemption or you know, ⁓ whether it's gonna be exposed to estate taxes. This is where running those types of scenarios that financial advisors can do so much more easily than attorneys can do, usually on the back of a piece of paper.

or a spreadsheet ⁓ that you know they can help sort of look at the big picture and decide what actually does make the most sense for that client. speaker-1: Sure, sure. ⁓ anything else to have for this episode? speaker-2: Yeah, I would say, I mean, you know, Thomas, you you touched on it earlier, but a lot of that consideration of the LLC and and the liability protection, I mean, you can get there a lot of the times with a better umbrella policy.

So definitely I would s urge people if that's really a concern, especially for things they're actually renting out and that they might have, you know, potential liability concerns, ⁓ you know, don't sleep on the insurance analysis because that could that can get you a lot of the way. speaker-1: Yes, and that's a big thing advisors should be doing, right? Personal, all their insurances, but especially on the business side or the rental side. Like it's not very hard.

It's not super expensive, but it is extremely valuable and it's protection you really want to have. ⁓ but perfect. I think this was an episode that we had to do. I know most advisors have these type of questions.

So appreciate you both kind of diving into it and sharing it from your side. And everybody, thanks for listening. Please don't forget to share with another advisor who you think could learn from it. And ⁓ we'll see you back here in a couple of weeks.