For California Investors the Solution May Lie in Nevada

llc; land trustCalifornia real estate investors are faced with a unique problem – the State of California.  If you are considering investing in this State, or if you live in California and are considering investing anywhere in the Solar System, pre-planning is necessary to avoid unnecessary delays and costs when creating your asset protection plan.  

The first problem lies in creating your plan of action in California.  If you need asset protection or tax savings immediately, California is not the place to create your plan.  On average it is taking 4 to 5 months to create an entity in the sunshine state.  From the time you submit your business filing, it will appear as if it is a race between the Secretary of State to recognize it or the last judgment to arrive.  This is why it is beneficial to look at other States when deciding where to form your business.

The second and more vexing problem is the Franchise Tax Board, also known as the FTB.  Most rational people could agree that if a LLC is formed in California to transact business, it should fall under the FTB’s taxing authority.  (Whether or not a minimum tax of $800 a year, regardless of revenue, is reasonable is a matter of debate.)   However, common sense begins to wane when the FTB takes the position that any LLC, regardless of the State the entity is formed in, will be considered “doing business” in California if the LLC owner resides in California.  

Consider the situation of my clients Charlie and Sidney Chaplin.  The Chaplin’s are brothers and California residents who created Moon Cheese, LLC, a Lunar limited liability company taxed as a partnership, to own Copernicus crater on the moon. (I think they negotiated the purchase through Governor Jerry “Moonbeam” Brown.) After the creation of Moon Cheese, LLC, Charlie contracted with Marvin Martian to administer a new colony built on this location.  Three years after the formation of Moon Cheese, LLC, the FTB contacted Charlie and Sidney and requested they file California Form 568 for their Lunar limited liability company.  According to this form, the FTB views Moon Cheese, LLC as conducting business in California via Charlie and Sidney’s ownership.  Thus, the FTB subjected the Lunar limited liability company to the $800 annual franchise fee.

After speaking with both Charlie and Sidney, I can attest that they were not happy.  Neither could comprehend how the moon colony was connected to California.  Unfortunately, neither could I, but for some inexplicable stretch of logic (see FTB Instructions for Form 568) the FTB thinks it’s obvious.

You may be asking, what is a person to do who needs a business set up immediately?  How about the real estate investor that does not have the funds or desire to pay the FTB $800 per LLC?  Again, you may need to look outside of California.

land trustSetting Up a New California Business
If you need an entity set up quickly, consider establishing a Nevada entity (these can be filed within 24 hours), then registering it to conduct business in California.  Although this approach will be slightly more expensive, it will give you the asset protection and tax benefits you are seeking much sooner than starting the formation process in California. 

Disregarded LLCs
If you are a California resident setting up an out of state LLC, it is best to create it as a disregarded entity.  If you choose partnership taxation, it will result in a K-1 that will be reported on your California State return.  Charlie and Sidney discovered this to their detriment.  The filing of a partnership return is a direct invitation for the FTB camel to come into your tent and take a look around.  Unfortunately, once he is in the tent, there is no getting him out and you will be forced to pay $800 per year for your out of state LLC.  Alternatively, a disregarded LLC is ignored for tax purposes; thus nothing is attached to your individual return that will invite scrutiny or questions.

Land Trusts for California Real Estate
Typically, a land trust is used as a tool to avoid the “due on sale clause” issue surrounding the transfer of real estate.  If an investor purchases property in Georgia, his first step in protecting the property would be the creation of a land trust, followed by a Georgia LLC to hold the beneficial interest of the trust.  In most situations, we create the land trust and the LLC in the State where the property is located.  However, no legal requirement exists that dictates the LLC must be created in the State where the trust is created.  This is typically done for ease of administration.  However, some may be willing to embrace added complexity if it results in an $800 per year savings.  Here is how:

Step 1 – Create a Nevada LLC land trust
Rather than create the LLC in the State where the property is located i.e., California, the real estate investor holding property in California should consider creating a Nevada LLC treated as a disregarded entity for tax purposes.    When creating the Nevada LLC, be sure to use a Nevada address for your entity.  We provide such a service through our sister company, Business Office Suite Services, “BOSS”.

Step 2 – Create a Land Trust
Set up a California land trust to hold title to your California property.  Deed the property into the trust then assign the beneficial trust interest to the Nevada LLC.  The land trust will need a bank account to receive rents and pay bills.  If the LLC collects the rent then it will be transacting business in California and subject to registration.

A land trust is not subject to the FTB fees, therefore by keeping the rental business contained in the trust and not involving the Nevada LLC in the management of the property, it will remain outside of the FTB’s cross hairs.

Working in and around California can be time consuming and expensive.  Thankfully with a little effort and proper planning, many of these hindrances can be minimized.  

 

18 comments On For California Investors the Solution May Lie in Nevada

  • Clint, this is a great article. Do you have any thoughts on how to craft this if you have a business partner? Is there a way to have a disregarded entity if more than one property owner is involved?

    • CJ,

      If your business partner is a spouse and you live in a community property state then it will not be a problem. If you business partner is other than a spouse then I recommend the use of Nevada Asset Protection Trust (APT). The APT will be owned by the business partners and the APT will own multiple single member LLCs. This is the best solution absent each partner creating their own LLC and holding title to the property as tenants in common. If you would like to discuss this in more detail, here is a link to my calendar to set up a conference call: https://tungle.me/clintcoons

  • I like this plan. How can I find out more about a disregard entity? How does this work?

  • Clint, since the land trust is running the business and collecting the rents, how do to the proceeds flow? Is it from the land trust bank account to the LLC bank account to your personal bank account or can you go from the the land trust directly to your personal bank account?

  • CJ

    Proceeds flow from the land trust to the LLC then out to the members. Do not run the money from the land trust to your personal account.

  • Clint, I have an TX registered IRA LLC and that entity is invested in a CA private company ( Search Initiatives in Temecula). I live in TX. But the CA FTB is demanding I pay the min $800 tax. I don’t believe I have a filing requirement, and neither do the two accountants I have asked (one is in Temecula). But repeated attempts to argue with the FTB have been fruitless. They are now threatening to put a lien on my assets.
    Can they do that? I own nothing in CA. Comments?

    • Karen,

      You do not have to pay the $800 tax. Have you called the franchise tax board? I assume the company you have invested in is a CA LLC. These are typical CA BS tactics to scare people into giving them money.

      • Yes I have written to them AND had a CA accountant call them. They told him no exceptions I owe the money. I don’t know how to get them off my back. I’ve had several accountants tell me I don’t owe the money. May I contact you to discuss this if required?

  • For doing exactly as you outlined, would it be possible for all accounts from each land trust in CA to funnel the money to the beneficiary NV LLC (single member disregarded for tax purposes)? Thus by year end the land trusts are net zero and would not have to file CA state tax, but just NV state tax. Or is this also, in essence, a “direct invitation for the FTB camel to come into your tent and take a look around.”

  • We have a rental property in SF Bay area but we are not California residents and live in WA state. If I create a NV or Wyoming LLC holding a land trust for our real estate in CA, we wouldn’t be doing business in CA in that case and won’t have to pay $800 franchise tax. correct?

    • Vik,

      You are not because the LLC does not own the property. The land trust owns the property. Also, I recommend you avoid Wyoming because of their adoption of the Revised Uniform LLC Act and a recent case piercing single member LLCs in Wyoming. I am working on a blog post covering these developments.

  • Hi Clint,
    I live in California and want to invest in Atlanta. I’m trying to figure out if I should set up the llc in California or Atlanta (or somewhere like Nevada or Wyoming). I don’t want to get taxed in Georgia and again in CA. If my family of 4 people is part of the llc can it still be a disregarded entity?

    • The LLC should be established in GA and held by a living trust to avoid the CA franchise tax. Further, it can be set up as a disregarded entity provided the LLC has only one owner or is owned by a husband and wife.

  • Clint,
    I”m a CA resident and plan to buy a TX property. Would it be most beneficial to put the TX property into a TX land trust that is then owned by a TX LLC (one owner)? Would that avoid the $800 CA FTB fee and protect the property from potential lawsuits?

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