Welcome to the InvestFourMore Real Estate Podcast. My name is Mark Ferguson and I am your host. I am a house flipper, I flip 10 to 15 houses a year, I own 13 rental properties with a goal to buy 100 by 2023. I’m also a real estate agent. I’ve been licensed since ’01, I run a team of nine, we sell close to 200 houses a year. So on this show, we like to interview house flippers, landlords and the best real estate agents in the business.
So stay tuned for some great shows. If you want more information on my rentals, on the numbers, how I buy properties, check out investfourmore.com
Welcome to another episode of the InvestFourMore real estate podcast. I have an awesome guest today, someone who not only will educate you but educate myself as well, a very interesting topic on how to structure legal entities when you’re buying investments, flips.
Clint Coons is with us, he is the founding partner at Anderson Business Advisers and Law Group. Clint’s a lawyer, an attorney, a real estate investor and a speaker. Really happy to have you on the show, how are you doing Clint?
I’m doing great, thanks for having me on.
Great, great. Yeah, happy to have you, really excited to hear what you have to say about legal entities as well as your investing. So I assume you’ve been a lawyer for a while and you start investing in real estate. What drew you to real estate and were you a real estate lawyer before that or did they kind of mesh together? How did that all get started?
Well I often tell everyone that I got started when I was two years old because my father was an avid real estate investor and he wanted to have I think two sons so they’d be indentured servants to him for a number of years to do all of this work. That was really my background growing up.
And then when I was in undergrad, I was a framer for two years. So I really thought my career path was going to take me down the contractor route but right now as we’re talking, I’m looking out my window and it’s pouring down rain outside, it reminds me of what happened in ’92, I found myself in the winter time climbing up on the roofs and fixing bird blocks that people didn’t put in. I really thought to myself, “This sucks. I cannot see myself out here framing in the winter and Washington, it’s just so wet and mucky.”
And so then I realized, I wanted to stick with law. I went on and I got my legal degree. And then I really didn’t get started in real estate again until after I got my — I was investing in the stock market, let me put it this way. I took an account, about $80,000 and I brought it up just shy of a million in about seven and a half months and I thought that my career was going to be to be over and I could retire in three years and then the wheels came off the stock market and I lost it all in about a month and a half.
I know, that was pretty bad. But you know, it’s like going to Vegas, it was just like gambling, it was so easy back then. And then a year after that experience I said to myself and my partners, because I invest with him as well, the stock market is not something that I have any control over, it’s not something I wanna do. I want something that’s tangible, something that I can control and started going out and investing in real estate.
Nice, very cool, yeah, I have a similar experience in stock market, not at that level but yeah, you can’t control it. You can have an awesome company, an awesome stock, if the whole market tanks, it doesn’t matter how awesome that company is, it’s going to go down with it. So I totally get where you’re coming from there.
So how did you first kind of buy your first property, what drew you to that particular property and how did you get started?
Well I think that drew me to my first property was down in Palm Desert and it was because my wife wanted to go down there every once in a while. So that’s why I ended up buying the property and then I started renting it out and then after that it was just a matter of saving up the money, buy another house.
I’m really unique in the fact that I don’t use a lot of leverage in my investing. I use cash. When I save up the money then I go up and buy a property. Save up the money and go out and buy a property. The only thing I’m leveraged on is of the commercial side and those are bigger loans, some of them are upwards of two million dollars so I got to watch that but it’s worked well.
Very cool. You own properties throughout the US. What made you kind of want to buy in different areas of the country, was it diversification or you just wanted to do at the time or where you were at?
Growing up in Washington State, here were have growth management that really restricts your ability to build and as a result of that, you have inflated home values. It’s difficult from a rental market standpoint to really get a good return, cash on cash return on your investment.
When I was growing up, my father, he was able to get great returns on his investments because he has the time to put in the sweat equity. I just don’t have that time. I’m looking for ready made properties to roll into and what we used to do is we would actually move houses, we’d get houses for a dollar, buy a lot, put a foundation on it, pick the house up, move the house and then drop it.
When you’re all said and done and you hooked up all the utilities to their property and fixed anything, you may be into the property for about $50,000 with land and the house is worth a hundred, $120,000. And so he was able to make a lot of money doing that, and he has quite a few rental properties but I just don’t have that time to go out there and do the work on my own. So I had to invest outside of Washington because of the expense of the properties here. So that’s what drew me into different markets like Indie and Tennessee and Dallas around the country.
Very nice, I know there’s a lot of people in the same boat, whether it’s Washington, San Francisco, LA, New York even where you just can’t cash flow because prices are so high. I’m curious, did you use turnkey providers when you bought some of those properties or did you go out there yourself and do the research, how did you end up buying those properties?
I did exactly what you said, I did the research. Before I buy in a market I go out, I check out the market and get a power team in placed in that particular market before I invest. I’ve talked to a number of clients. I have clients all over the US that are real estate investors. And you hear a lot of horror stories about people who do not work with reputable individuals when they go out and they buy a real estate and the market that they’re unfamiliar with because you got to have those individuals in place and make sure they’re not stealing from you.
And you take Indie for example, even though we’ve reviewed the market and met with the flipper down there that setup the house for us, well one of the houses, the property manager we ended up using, he was stealing from us for six months. And then he died and his kids were stealing from us and collecting the rents. And every time we call them up, they’d say, “Oh can’t keep the tenant in there, we get them in, they leave and they’re not paying.” And so finally we went out there and that’s how we found out he was dead because we go knock on the door, the kids answered and they’ve been collecting the rent checks because there were tenants in the property from day one.
Wow. Yeah that’s crazy. What kind of team do you have in place when you go, are you looking for an agent, a property manager, a contractor or what all are you looking for?
Well typically what I’m looking for is a property manager, number one, that’s my primary concern. The other ones is that I’m looking for those companies that are going to go out that find the properties, rehab the properties and then sell them to investors like myself, that just don’t have the time to do it on their own.
The only exception to that is in the Las Vegas market because we have a physical presence there, we have an office down in Las Vegas, we actually set up our own construction company down there and we were buying REO properties from banks. In 2010 through 2012 and we were either flipping those properties or we were turning them to rentals ourselves. Then that kind of dried up as the California investors, a lot of them start coming in the market and they drove up the prices and they drove down our rents.
Yeah, nope, I see that in a lot of places. Not only do you have the single family rentals across the country, you’ve got the commercial property. So did you buy the commercial after the single family? How did that work out getting into the commercial space?
No, actually, I started buying commercial before I bought residential and I was just buying in the path of progress is what I started doing there. I mean I prefer to have commercial over residential but it was just one of those things that we bought some, purchased some residential properties just to balance out our portfolio of assets but it was just buying where we saw that there’s going to be good appreciation in the future. And the price was right.
Right, I’m curious, I don’t do commercial myself, all my investments are residential. What are the biggest differences you see between the commercial, large — I know there’s a lot but what are the biggest differences between those commercial projects and the residential? I know some people feel, you could move real easily from residential but is it a completely different beast?
No, I think there’s more stability in the commercial side and once you get a tenant in there and you get them on a nice five year lease, just sit back and you cash your checks, typically, my experience, they do not leave as long as they’re a stable tenant. But the one drawback to commercial is that in some of the larger properties, we’ve had to use financing.
So when you’re looking at a monthly debt service of 15 to $20,000 a month, and you lose a tenant at the end of your lease and you can’t get another one in there for six months, that hurts. You basically, we end up, we keep a lot of cash on hand, we put it in the bank, save it for those rainy days if something like that happens. And it has happened to me before.
And so it’s just, commercial more money but there’s more expense. I’ve had properties where you’ve had to replace the roof and that can be a $70,000 project right there to go in and fix roofs. More gain but more risks is the way I look at it.
Right. Is your end plan to sell those eventually when they get to a certain point or are you binding for cash flow? What’s your plan for the end of those properties?
For the majority, we’re binding for cash flow. One, we bought with the anticipation that at the right time in that particular market, we will sell the property because it’s just keenly positioned in an area where it’s the last large piece of warehouse property on a freeway. So it’s the perfect example of a property that home depot or somebody would want to come and pick up.
The problem you know, you’re talking about it, experiences and the learning experience. When we bought this property we thought that there could be other opportunities there for a commercial development for maybe a multi-use project, some restaurants and shopping. But right across the street of this particular property, there is a small church in a double wide trailer and the county rules prohibit the serving of alcohol within, I think it’s a hundred yards or 200 yards of a church.
So we cannot put any establishment on this property that serves alcohol because of that double wide trailer. We approached the owner of the church and we asked them if we could buy him out and relocate them, wouldn’t do it. We’ve probably talked to him every year and we got the same answer in it. Because it kind of, it restricts what you can put on that property now as a result of that. That was a mistake, you learn that.
Right, well that’s tough to find out before you buy it too. It’s hard to go through all the due diligence when you see something like that.
I know. And you wouldn’t even know it because when you looked at this thing, it didn’t even cross our mind. Nothing really, when you drove by the property, clued you into the fact that that was a church siting right there. It probably has a congregation of 12.
That’s no fun.
So you’ve got your law practice, your real estate investing, did you do real estate law to begin with or did that morph into something after you started investing in real estate?
Really I’m not a real estate attorney per se. My focus is more on asset protection and tax planning for real estate investors. There’s this confusion that sometimes exist amongst my clients. They’ll want to send me contracts and ask me to review them or draft contracts for their real estate investing, lease options, things like that. I have to tell them, “Hey, I’m not your guy, you need somebody local putting that type of deal together for you that does that day in and day out.”
My practice consist primarily of creating the structures to ensure that hey, if you don’t want anybody know that you’re into real estate, I can set you up so that you’re completely anonymous. If you want to make sure that something does happen on the property that you’re not going to be fully exposed because one of the things that I talk about, and I myself utilize, is risk reduction that when you want to take on this larger projects, you have to make sure that your liabilities are minimized to the greatest extent as possible that if something goes wrong, you haven’t risked everything.
And so putting boundaries around your investments and ensuring that if something does happen, you don’t lose everything I think is vital. I often I tell people, whenever I deal with a commercial lender, I just chuckle. They’ll say, “Hey, we want a personal guarantee. We’re not going to give you a non-recourse loan.” And so I give them a personal guarantee and I think to myself, “It’s not worth the paper it’s written on because if it came after me, you couldn’t get anything because I’m so protected.” That’s really what we do.
And then we have a tax side as well inside of our firm where we prepare tax returns and we look at the tax angled real estate because really, it’s not a one size fits all. So many people out there throw up LLC’s and they think, “Oh if I do an LLC I’m fine and that’s all I need,” and you have to understand that there’s a tax component to it, there’s an asset protection component and then there’s an investing component that lays right on top of that. If you’re dealing with professional that doesn’t understand all three size of that issue, you’re going to be missing out. That’s what we do at Anderson.
Yeah, that’s very interesting and we talked a little bit before this podcast too and that’s what really caught my attention was you made some great points about real estate attorneys, they look at the protection side a lot of the times for investors and how to protect them, the CPA’s, the accountants look at the tax side and how to structure things tax wise. But a lot of the times, they’re on completely different pages working together how to get the best tax protection and the best liability protection together.
So I thought that was really interesting how you brought that, and I get so many questions on my blog about, “Should I set up an LLC? Should I do a series LLC? Do I need one LLC per property? If I’m doing a flip, how do I set,” — it’s insane but I mean I guess that’s one question I have for you is, if someone owns 10 rental properties, what should they be considering as far as liability and tax purposes, how they structure them?
Well, from the rental standpoint, it depends on the state in which you’re into real estate. You brought up series LLC, so if you were in Texas, I would setup a series LLC for you. But it would be with a caveat you understand how to run that particular monster at the same time. If you’re not in Texas or a state that offers a series LLC, then it’s going to be based upon equity. Because at the end of the day, we’re not about putting together, loading people up with entities, okay?
Yeah, it’s from a financial standpoint, it works well for the firm if I put you in 10 LLC’s. But from your standpoint, it’s going to complicate your life to some extent because each of those companies is going to need a bank account. You’re going to have to do certain things to maintain them on an annual basis. And so I recommend that you group properties, no more than five doors for LLC, 250 to $500,000 in equity is what we’re looking at when we’re structuring LLC’s for people’s investments.
In a case of 10 properties, I’d say maybe three at the most and then depending on the rental income that they generate, possibly a corporation to manage it if you’re looking for some additional tax benefits. But if you don’t have the income right now off of those properties and you’re figure in all of your expenses and debt service, then that’s something that you would hold off on and all you would be looking at is the asset protection component.
Okay, very cool. Yeah, I heard someone else mentioned them, series LLC and they talked about Texas. So that makes sense why they were mentioning that because they were in Texas and yup, the state.
Another thing I’ve noticed too is the fees and cost for LLC’s will vary greatly per state. I think that is something people have to consider too is how much it cost to set it up and maintain it per year.
Yeah, I mean look at the people in California, that’s an $800 hit for every LLC they set up there. So knowing their fees beforehand is so very important.
Yeah, in Colorado I think our fee is $50 to set it up and $5 a year now to maintain it. It’s a little different than California. I’ve heard New York is pretty expensive.
But you know at the same time, sometimes certain states like say Nevada, you pay for what you get. You brought up Colorado for instance, you set up an LLC in your state, yes you do have asset protection from a liabilities associated with the property, you know the tenants that decide to sue.
But if you yourself are sued, because you’re managing the asset and you were negligent in some manner, so they sue you individually or name you as an additional party to the lawsuit and a judgment’s entered against you, those LLC’s in Colorado are not protected from your creditor. If you look back at the Albright decision which was handed down a number of years ago in Colorado, it basically stated that charging orders are not your sole remedy, that a creditor can foreclose on your LLC interests and take it from you.
That’s why for a lot of our clients who invest in Colorado we’ll wrap all of their Colorado LLC’s with a Nevada or Wyoming companies. So we isolate that ownership interest away from our client so if they’re ever involved in a lawsuit, they do not own any Colorado LLC’s, it’s their holding company that owns the LLC. And those holding companies are established in jurisdictions where a creditor cannot take the LLC from the client.
Oh wow. That is something I had no idea about. I knew I would be educated on this show.
Well it was an attorney that screwed it up for everybody because she was stealing money and then tried to claim bankruptcy and get out of it and make it all go away, and the court said no. Charging order is not the sole remedy, you can foreclose.
Okay, cool. So I mean, I guess one question too is, in other states, how much protection does an LLC provide? Does it provide enough that that’s all you need or is it just depend on the state and where you’re at?
Yeah, it really depends on the state and where you’re at. Pretty much all the states are going to give you inside liability protection, so whatever happens on the inside that say a mold claim is brought or the property burns down or whatever. The LLC is going to protect you from the liabilities associated with that harm. Where the states differ is on outside creditor protections.
A corporation for instance. If you own stock in a corporation and I have a judgment against you I could take your stock, that’s something that’s personal property, you can levy on it and it then becomes an asset of your creditor. But an LLC is unique in that they make it very difficult for you to separate out the ownership of that particular company from its member and transfer it to a creditor depending on the state where the LLC is set up.
We brought up Colorado, California, Florida, just to name a few. They do not offer creditor protections for the members, so you could take their interest and that’s one of the things we look at when we’re doing our planning is if a client has a decent portfolio, we may want to employ an out of state LLC in Nevada or Wyoming to give them an additional layer of protection. By utilizing this strategy, not only can you gain the additional protection, you can gain anonymity.
So I can create LLC’s throughout the US where nobody knows who owns them, even though you’re in a state like say Arizona that you have to disclose all the information of all the members and managers. Well if you start with an anonymity jurisdiction like Nevada or Wyoming and then you go into Arizona, you can hide all of that.
Where does that leave you as an investor? Well then it opens up additional opportunities to perform some equity stripping where you can then have your holding LLC file a friendly lien on your real estate that’s located say in Colorado and what appears if you borrowed money against the property and there’s debt on it. So that’s a deterrent to an aggressive attorney who has taken on a case that has very little merit that’s mainly shake down value.
Right, that’s great stuff. Like you said, many people, if they’re looking for a lawsuit, they’ll look for properties that are free and clear because they know if they win the lawsuit, they’ve got equity there they can take. But like you said, if you basically take a loan out against from one company to another that appears it’s not free and clear, so you have a smaller chance of getting sued.
Correct. Because the money is not there. One of my clients, we just wrapped up a lawsuit in California and I won’t go into the details of what happened but basically, the insurance or the plaintiff was settling with the night club, settled with the Ballet company for policy limits. But the owner of the property where the accident occurred, they refused to settle for policy limits with the owner of the property. Because a property owner that owned this particular building where the night club is located, well they did an asset search and they found that he was conservatively worth between 25 to $40 million because all of his real estate was in his own name. So they refused to settle with him just for policy limits.
And many times when I talk about that with people, they’re often shocked, “Well how is it that a person who owns a building, how can they be held liable for what happens in a night club?” Well liability is different depending on the state in which you reside in. For example in California, they follow what’s called joint in several liability. You could be 1% negligent but you’re 100% liable for the creditor’s claims, plaintiff’s claims or whatever they win from a damage standpoint.
So this individual was facing a situation where if he got a jury to find him 1% negligent, maybe inadequate lighting or something on the property, which led to the accident, then he could be looking at 10 to $15 million in potential damages. The attorneys knew that and that’s why they pushed him so hard for cash outside of the policy limits.
Wow, that’s a little scary.
Yeah it is.
At the same time I guess that shows why you shouldn’t have $25 million of real estate in your own name, you own a bunch of properties like that.
Yeah, and you know what’s sad, after this went on, I’ve structured him since this accident occurred and the day after settlement was reached, he got in his car, he was 92 years old by the way and he drove out and two blocks away from his building, he clipped somebody in an intersection. It’s just like, “Oh no. Here we are again.” But this time he’s protected so when they do that asset search they’re not popping in his own name again.
I have a question based on that. Let’s say I’ve got 16 rental properties and they’re in LLC’s. If someone wanted to sue me, is it easy for them, the CI have those properties to LLC or…
Do they even care since they’re in an LLC? What’s your take on that?
I mean, okay, the other side of the equation is this, that when you setup a structure around yourself that is a deterrent in and of itself. Attorneys love low hanging fruit and in 18 years of practice, I’ve had very few of my clients find themselves in a situation like I just described.
Now they’ve had judgments entered against them for several million dollars but the creditors tend to walk away with whatever they can collect from the insurance and not proceed against them individually because the likelihood of the outcome being favorable to the plaintiff is so low relative to the cost of trying to litigate that action.
And so really what we’re doing with this companies is creating this barrier to creditors from wanting to go deeper into your personal net worth because there’s no set outcome. It’s all questionable whether or not they could pierce it. Some say it’s like Colorado, of course they make it a little easier but still that wouldn’t be a deterrent to me to protect myself because anything you can put up as a road block is always going to be beneficial to you.
Right. So I think basically, I mean even if you aren’t doing everything correct but you are doing some effort putting in properties in LLC, doing something, there’s going to be some kind of a deterrent to losses because people will see, “Hey, he’s doing something, maybe we won’t go after him, we’ll go after somebody else who has got everything in their name.”
Oh yeah, something’s better than nothing. The way lawsuits work is that if somebody came after you and they get a judgment against you then they could very easily take that judgment and they’ll file in the county where your real estate’s located and at that point in time whenever you try to sell or refinance that property, they get paid off. So they don’t even have to go after and try to take the property from you, they can just sit back and wait because what better investment would you have than a judgment that grows at 10% rate of interest?
Right, right. Very true. I’m curious too, there’s a lot of questions about piercing an LLC and how you have to maintain it. What are the most common mistakes you see people make when they have an LLC and they don’t treat it as an LLC and people end up saying, “Oh it’s not a real LLC because you did this and this, and this.”
Co-mingling of accounts is the biggest one or not even having a bank accounts opened up for their LLC’s. That’s a big problem, they want to take it the easy route. It’s like when I graduated law school, my dad then looked at me and said, “Yeah, you were an indentured servant, now you’re no longer my servant, now you’re just some permanent retainer for life. So the first project I have for you is I want you to structure all my real estate.” So I said, “Well what do you want dad?” He said, “I want one LLC per property alright?”
So I called up my mom who runs everything and collects all the rent and I said, “Mom, dad said one LLC per property,” and she said, “Well, what does that mean?” I said, “It means you’re going to have to have one bank account per LLC so plan on opening about 28 bank accounts.” And she said, “There’s no way I’m going to run 28 bank accounts.” I just knew she wouldn’t either that’s why I called her. And so we grouped them, like we talked about earlier, we grouped the properties together because she would end up, if I created that structure, she would end up running everything through one account and then you might as well not even create the structure. So that’s the big one.
You also have the problems with people who create LLC’s that they don’t draft operating agreements for themselves. They just think that they file it with the state that pay their $50 and now they have protection, so that’s a problem. I see that a lot when I sit down with someone they say, “Oh I have an LLC.” “So show me your operating agreement,” that’s one page with their articles of organization. That won’t protect you.
And then the other issue you run in to a lot more so is that the operating agreements that are put in place, they really don’t reflect what the individual investors are looking for from an asset protection standpoint that they’re passively pieced together and they do not provide the protections you may assume that would be provided in an LLC, just based upon the language of the agreement.
Very good information. I’m curious your thoughts on this. I know you can’t say this for everybody but if someone goes to a lawyer, asks for an LLC, most of the time will they get the documents, the right things they need? Or will they get varying stuff depending on if they go to a real estate lawyer, if they go on an estate lawyer, do you really need to be going to a specialized lawyer to get those documents done right?
So here’s what I see a lot is that they go to the attorney, the attorney doesn’t understand the tax side, so he tells them to go find a CPA to setup to handle the tax side of the setup. Now, the individual then will go to the CPA and the CPA will make an election that does not necessarily correspond with the way the operating agreement was drafted. Most LLC operating agreements are set up as either a single member, disregarded or partnerships. That’s not necessarily the best structure for you.
There’s a case right on point just out of Illinois this year where two real estate investors went to an attorney, they setup an LLC and they started flipping properties. They taxed it as a partnership. The attorney actually took care of it for them, set it up, had a taxed as a partnership because there’s two guys there. Everything runs fine and I tell people, you have your LLC setup and it will be just fine for you until it’s tested.
Theirs got tested on audit and they’d flip a ton of properties at a bunch of rentals that they’d held on to and sold. Everything they claimed is either long term or short term capital gains, the IRS came in and said, “You guys are dealers with the amount of activity you’ve been running through here. Therefore you do not qualify for long term capital gains treatment, you don’t qualify for instalment sales, so all those properties you’d sold and still hadn’t collected the money on yet, that’s all taxable in the year of sale, you couldn’t appreciate any of your real estate, so all your depreciation has to be recaptured now and on top of that, all of your income is active to you.
And their argument was, “Wait a minute, we had an LLC setup, it’s was taxed as a partnership.” Well the attorney didn’t understand that the fundamental tax law with regards to partnership in LLC’s is if you’re a member in an LLC and you work for that LLC then you’re treated as a sole proprietor vis-à-vis that company. They tried to pay themselves salaries, you can’t do that in an LLC where it’s treated as a partnership. So what you find is that if you’re in real estate and you want to put together the right structure that addresses both the tax and the legal side, you really need to work with a real estate investor attorney who understands it.
I mean u can create structures and this is what I really like doing is you look at the individual guys that are getting involved or even if it’s you, you can allocate losses to one party who needs those losses. One of the more advanced strategies I use is for people who invest with their retirement accounts. We’ll say we’ll setup a solo 401(k), they roll some money in then they want to partner with their solo 401(k). So let’s say you’re going to buy a house, it’s $100,000. Each of you are going to put in, you’re going to put in 50k, your solo 401(k) is going to put in $50,000. So you set up an LLC and it allocates the interest between the two of you 50/50.
Under the operating agreement, the income will be split 50/50 but the losses, the depreciation that is, I’m going to allocate all the depreciation to the individual member of the LLC, not to the pension plan. Because the pension plan doesn’t need the depreciation since it doesn’t pay tax. You dump all that down on to the member, it effectively wipes out all of his income that’s associated with that company, so he’s not paying tax on that money that’s coming in. He is essentially deferring his recognition until the property is later sold, that’s when he’s going to have to recapture that.
So that’s just an idea there that I’m throwing out that how a real estate attorney who has been involved in real estate deals would look at something versus just a standard asset protection attorney. They’re not going to dig, they’re not going to ask the right questions typically in my experience.
Very nice. I’ve realized that too and I’ve said it myself. And accountants too, don’t always set things up for the best tax purposes I found for real estate either. Sometimes they’ll do what’s easier for them or what they think is the least likely to ever get questioned. What’s your experience as far as accountants trying to setup things for investors?
Well accountants, they typically will either setup pass-throughs, well anything that’s going to get them a tax return, number one. I can always tell a CPA structure when I look at it and I see eight LLC’s and all of them are filing tax returns. And I’ll look at them and I’ll go, “A CPA to set this up for you.” “How do you know?” I say, “Because he has eight tax returns now he gets to file every year.” I mean you could easily change that and set it up so that you don’t have to file one return.
But the thing here that you notice is that CPA’s again, they focused on taxes and so, they will create structures typically flow through that are designed to minimize the investor’s taxes. They’ll say, “Alright, we’re going to save you 6% or $6,000 or $7,000 a year by doing it this way.” What they fundamentally do not understand is that for some investors, saving taxes, saving six or $7,000 a year is not the primary concern. They need to, as we shared earlier, they want to qualify for loans. And so having more income show up on their 1040 is far more important to them than saving six or $7,000 because they’re going to pay more on that in hard money to put their deals together.
They want conventional financing so that requires you have big fat W2’s. You don’t want tax, you don’t want entity showing up on your 1040 if you can avoid it and when you use pass-through entities, they appear on your 1040. And when you start looking at commercial deals like what I’ve been doing then those tax returns have to be provided to your lender. Not only before you, when you apply for the loan but then on an annual basis and they’re looking at it and they’re wondering, “What is this business doing now that he has over here? Is it making money, is it losing money?”
From my standpoint, that’s always the rub for me, when I know a loan’s coming due, I purposely change how I am spending money inside of my company from a tax perspective so I look better to that lender to get a refi on that loan. Ordinarily I’d try to expense everything out and show as little profit as possible. But from a lender standpoint, that doesn’t look good. So you have to be cognizant of the fact that there’s more going on here than just taxes.
Right, that’s great advice because a lot of investors get into that problem where they’re making money but they don’t show any of it because through expenses, through depreciation, whatever it is and you can’t get a loan, “I’m really making money even though my taxes say I’m not, I promise.”
I know, and the [inaudible] is they don’t understand it.
I mean just as an aside it’s like member with the Exxon Valdez — not Exxon Valdez but the BP platform problem they had the oil spilled down there. You know, I have a cousin who lives in Louisiana and you had all these shrimpers that wanted to collect from BP a couple of hundred thousand dollars a year and they were complaining the BP wasn’t paying out, I don’t know if you remember this on the news or not?
No, what BP did is they said, “Let me see your tax returns.” Well all these shrimpers and fisherman down there, they’ve been cheating on their taxes for years so they’re showing very little in income and BP’s claim was this, “We’ll pay you exactly what you made last year. Well you show you only made $30,000 last year on your taxes, so that’s all you’re getting paid.”
So that’s how it works. When people look at your tax return, that’s what they assume you made and especially if you’re investing in real estate, it can hurt.
Yeah, that’s great advice. Another thing, I’d love to hear your advice on too is you mentioned flipping a little bit, the guys who set up the LLC to flip, I’ve heard people say LLC, I’ve got an [inaudible] set up for my flipping company based on what my accountant said but what are your thoughts on flipping business, if you’re doing five, 10 flips a year?
Wow, okay, so in that situation my typical go to structures and for flippers is going to be either a C Corporation and run all the flips of the C Corp and depending on the level of activity, I may even through an LLC in the mix and have the LLC wholly owned by the C corporation. Because if you’re a flipper, you get to this point where if you’re putting money into advertising for deals and you’re building up a local presence then your most valuable assets becomes your brand and you don’t want to jeopardize your brand by flipping properties in the name of that corporation. So from an asset protection standpoint, you want to move that in to a single member special purpose LLC that’s owned by your Corp.
Now, when I look at that structure also focused on how we’re going to move the income to you, how much do we want in your name for whatever you’re doing in the future versus what we want to put inside of say a pension plan to minimize taxes as well. So you have to be cognizant of what’s going on. Another option that I utilize is if we want to bifurcate income, if you tell me, “Clint, I want this much in active income each year, I need to show this to my lenders,” then I will setup a corporation, C corporation and I will have a limited partnership that the C corporation is part of that it manages.
In that case, you’re able to flip through the limited partnership and bifurcate your income between active, that portion which is paid to your corporation and you draw a salary from and the distributions that come from the limited partnership, which is unearned income. So it’s not subject to employment taxes and just flows down as capital gains.
Wow, okay, I think I’m definitely going to have to talk to you after this podcast is over.
See, it’s not a one size fits all approach and I have this great slide at my workshops where it throws up, you see a bunch of these guys on a dock and they’re all wearing some black g string type bathing suit and they’re big, heavy guys walking all together with these black hats on and cigars. And really, I tell people, it’s like, “How many people in the last month, how many people in the room have setup an LLC?” And probably 90% of the room will raise their hands. And I’ll ask them why, and it’s always the same. “Well my attorney told me I needed an LLC or my CPA told me I needed an LLC.” Just because everyone is doing it doesn’t mean it’s right for you.
That brings up a great question I had. Let’s say an individual wants to buy their first rental property, maybe they own one personal house, they don’t have a ton of assets but they do okay. Do they need to setup an LLC? Can they leave it in their personal name? What’s your opinion on — what kind of protection do they need for just buying one or two properties?
I’m going to tell them to set it up in an LLC just to protect it. You never know, the example I’ll use on occasion for that one particular problem or that situation is an individual I know that became a client, she bought her first rental property in Hawaii, in Honolulu. All she did was insure it. That’s what her attorney said, “Don’t bother with an LLC, just get enough insurance and you’re fine.”
The tenant burned the property down intentionally and the house burned so hot that it destroyed a good portion of the house next door. These are expensive homes and she did not have enough insurance to cover both claims. So she ended up going bankrupt. Now had she had a limited liability that owned the property, she could have saved her other assets but how much insurance are you going to buy? Is there going to be enough there?
So I suggest you just setup an LLC, if you set it up right, there’s very little maintenance for it on an ongoing basis. But what’s key here is understanding as well that if you’re going to use an LLC and you buy your first property and you took out a loan against it, so there’s some debt there, that you should also look at a land trust. And hold that property in a land trust and then assign the beneficial l interest to the LLC to avoid the lender from ever accelerating your note if they discover the fact that it’s been transferred directly into the LLC, and that’s what the land trust will do for you.
Yeah, that’s very interesting point too because many people will get conventional mortgages and buy it in their name and then wonder, “Hey, if I transfer this to an LLC, doesn’t that trigger the due on sale clause?” Lender can come back and say, “You owe all this money,” but if you do the land trust, you’re saying that that would not be the case, right?
That wouldn’t be the case. I mean right now in this environment, or in the last 12 years, I haven’t seen any lenders accelerate notes when property’s been transferred directly in the LLC’s except in situations where the person missed payments or they didn’t — failed to ensure their property because they let it lapse. That triggered something that got the lender’s interest. Or if the lender was audited by its insurer and they saw that the borrower wasn’t on title.
But for the most part, the likelihood, in the market like this where you have stable interest rates or declined interest rates, the likelihood that you’re going to have a lender call your note due is probably pretty small but rates are set to rise. As rates go up, now lenders have an incentive to start looking at who’s on title to the property that they’ve loaned against. If your name’s not on there and the business entity is on there, they’re within their rights to call that note due and make you refi the property. So I think it’s prudent to utilize or use a land trust which takes that out of the due on sale clause of your mortgage and hold title to that way.
Not to mention, when you use the land trust, think of it as a little box, you put the house in a little box and then that’s the only thing that gets recorded with the county. Then wherever you move that box to, be it an LLC number one, two, three or four in the future, nobody knows about that. All they see is that initial transfer into the box and they don’t know where that box resides in the future because that is a private transfer and it’s not recorded.
Wow, that’s great information. That’s a question many people have about switching to LLC’s and if it’s worth it because you might get due on sale clause. One more question I have is, what are your thoughts on people who keep a property in their name but they get an umbrella policy and feel that will protect them instead of the LLC?
I think everyone should have an umbrella policy. Again, it comes down, what is the nature of the claim that is brought. If it’s an environmental claim, you can have as many insurance policies as you want and you’re not going to be covered. Toxic mold is one of those claims that attorneys have latched onto now as a sure fire way to shake people down for their assets. What’s unfortunate is with that particular claim, there isn’t really any hard science behind it to establish whether or not the tenant or this supposed victim is actually damaged as a result of the ingestion of mold spores.
You take Ed McMahon, he got a judgment of $10 million for his dog that died in Florida from toxic mold. Then they reduced it, I think to eight on appeal but it was just crazy stuff. There was this show on ABC, it’s called the Lookout. It’s no longer on TV I believe but I watched the first episode. They brought in mold remediation experts to come in and check this house out and they have the house wired for video and sound and they’d already had it inspected by microbiologist who said it was mold free, well these guys come in and five out of the seven people came back to the housewife who was concerned for mold and their children and they told her, your house is full of mold, and it’s going to cost you 14 to $20,000 to fix it.
Then when they brought them back into the house later on, they brought out the cameras, the guys ran. When I tell that story, people look at me and I ask them, I go, “You know what those people are called?” “Oh they’re called charlatans, rip off artist,” I said, “No, they’re called expert witnesses.” That’s who the plaintiff is bringing in to say that your property is full of mold and the it just becomes a battle, who do the jury believes more? From that standpoint, because this has become a hot bed for attorneys, personal injury attorneys, I would put my property in an LLC and just think of it as cheap insurance because once you set it up, you have very little ongoing maintenance cost with the company.
Right. As a real estate agent, I list REO and HUD homes too, I run into mold a lot with foreclosures and we’ve had mold in some of the properties we’ve bought, we’ve got a really good mold guy and he tells us, “You can do a mold test every single time and it will show mold because it’s naturally occurring in the air. It’s just a matter of what type of mold it is and if you interpret whether it’s bad or not.” So yeah, I can imagine how easy it is for people to try and claim mold is making them sick when it’s everywhere, we’re probably breathing molds right now a little bit.
It’s not the fact you smoke six packs a day and you start drinking at 10 in the morning and you eat fast food. That has nothing to do with your lifestyle.
Right. Very cool. Well Clint, this has been an awesome show, I think those are all the questions I had for right now. Like I said, I’m probably going to contact you after this and run you my stuff. Obviously you helped people out with this. I’ve got a link to go to your webpage so people can find you and talk to you and like I said, I believe you have a free consultation, you’ll talk to people. Tell us a little bit about how you can help people out in their entities?
Yeah, what we do at Anderson, we’ll give you initial consultation for free where we’ll look at your current situation and we’ll make some recommendations to you as to how you can protect yourself. Now obviously we do set up those structures ourselves, we setup the LLC’s, the corporations and land trust. Really what we do to generate clients is just show potential prospects that we’re willing to give away our knowledge for your trust and your business to show you how we can assist you in the areas that we’ve been discussing today.
We work in all 50 states, setting up these structures and we have thousands of clients just like the listeners on this podcast that we’ve helped structure. And so you’re dealing with a firm that we have multiple offices, we’re in two states, Washington and Nevada but we have six offices between the two states and we have staff of about 60 people both CPA’s, tax attorneys, attorneys and EA’s. And so you get a depth of experience there that most local guys just can’t operate at because they haven’t been dealing with the people that are presented with the issues that you’re going to be facing. If I haven’t done it or I have clients that have been involved in it and we can spot the issues much quicker and know how to address them than other individuals.
Right. Well I think just about anybody who is listening to this podcast can tell, you’re extremely knowledgeable about the subject and if they’ve talked into it, a lawyer, a CPA themselves, they’ll probably realize, they don’t know a whole lot compared to someone who knows both sides of the equations, the tax side and the law side. So awesome, any parting advice for people who are looking to get into investing, looking to start a real estate venture whether its entity wise or just basic investing wise?
Yeah, my advice is, don’t get hung up on the entity side of it because sometimes we can be so concerned about asset protection that we lose track as to what the end goal is which is to start building up a passive investment stream of income.
Entities are important but it shouldn’t take the place of the fact of you going out there and putting in offers and buying property. I can see that happen with people before, they’ll call me and say, “Well I need my entity setup before I’m going to do my first deal and I’m just holding off on investing.”
No, you shouldn’t, you should be out there. Because let’s say you’re buying a piece of property and you have to obtain financing. You can’t put an entity together to take that title of that property. So again, there’s no point in not moving forward with your deals. We’ll deal with it after you get the property in your own name, then we’ll protect it.
Yeah, great advice, I’ve had that question too. I can’t move forward, I can’t buy anything so my next step is to get my LLC setup and I have to research it, figure out the best way and it’s like, “Well, you don’t have to.” Like you said, go buy the property, get started then figure that out afterwards.
Correct. You may not even buy it in the state you’re living in and so you set up an entity in your home state and you’re buying it across the country. So it doesn’t do you any good.
Right, very nice. Well Clint, awesome job, I learned a ton about entities and protection, lots of things I didn’t know. I’m sure you helped out a lot of people, like I said, you’re with Anderson Business Advisers and Law Group. We’ll have a link over to your site on our information detailing this podcast. Great to have you on the show, I will be talking to you soon for sure.
Alright, well thanks for having me on, it was a pleasurable way to spend my afternoon, I appreciate it.
Great, glad to hear it, alright, take care.