“It’s not how much they (the IRS, that is) win; it’s how much they collect that counts.”
I tell my clients this all the time, and it’s plain truth. When it comes to lawsuits of any kind, that adage is gold. And if you’re a real estate investor who understands that distinction, you can hang on to more of your own “gold” by using corporations, land trusts, equity stripping, and LLC companies to minimize your overall risk. The key to using these things well is understanding how they work together in an effective plan.
But that’s an important phrase to remember: how they work together. These ways are specific and can differ from state to state and locale to locale. Hence, your plan needs to be customized to YOUR situation.
That means your asset-protection planner must know the difference between these entities from the standpoint of particular tax rules. He or she needs to know the appropriate state in which to file which entity, and when one type of entity is preferable over the others…and many other “picayune” details that can make or break your tax situation.
The Devil Is in the Details
Just one example:
Recently, while speaking at a workshop in Orlando, I met a real estate investor whom I’ll call Sally. Sally was distraught because her Condo Owners’ Association was about to place a lien on her property — even though she’d transferred the condo to an LLC specifically for asset protection. She explained that she’d read, and then heard, from her local REIA that this was the right way to hold rental property. The only problem was, no one had told her that she’d actually face a FINE for doing this!
Sally was in the midst of learning the hard way that what she was told was basically a sound strategy, as far as it went. However, certain specifics about holding title hadn’t been addressed, and she was about to pay the price for that information gap.
As it turns out, Florida community associations often have limitations on who may own property. If the developer and subsequent owners want to avoid landlords buying up condos and turning the entire community into a “rental pool,” they can prevent this by setting up rules prohibiting business entities from owning properties within the community. Sally had gotten caught on this regulation by little more than a technicality, but it was going to be a costly one.
How could she have avoided this mess? Had she consulted us, we would have advised her to utilize a land trust to hold title to the property. Then, once the property was recorded in the name of that trust, Sally could transfer the TRUST into the LLC, obeyed the letter of the regulation, and no one would bat an eye.
Looking Both Ways before Crossing the Asset-Protection Street
Now, we deal with land trusts in much more detail in other posts, so we won’t go into those specifics here. In Sally’s case, a land trust was the option that would have saved her both stress and cash. The important thing, however, is to get some guidance before you start running across the busy (and hazardous) “street” of tax regulations versus asset protection — and, to my surprise, many people I talked to at this workshop weren’t planning to do so.
Make no mistake: certain things in your financial life, you CAN do on your own. But unless you’re already a certified financial planner and tax-rule expert, the complexities of real estate investment and asset protection may not be among them. Merely because an option “sounds” like the right thing to do doesn’t mean it’ll work for you. Just ask Sally!
In a previous blog post (You Can Get There from Here: Setting Up Trusts in One Place while Living in Another), I talk about using a Nevada or Wyoming LLC, registered in a different state, to hold property. One assumption that trips up lots of investors, however, is thinking that the charging order protections offered by Nevada or Wyoming apply, even if they’re being sued in the state where the LLC is foreign-filed.
In fact, most likely a court will use the foreign state law to deciding what protections a foreign LLC offers its members. In American Institutional Partners, LLC (“AIP”) v. Fairstar Resources LTD (“Fairstar”), this is exactly what transpired.
In this instance, a certain Mark Robbins established AIP in Delaware, then foreign-filed it in Utah to conduct business. When Mr. Robbins was later sued in Utah court, judgment was entered against him for Fairstar. In turn, Fairstar reduced this judgment to a charging order against AIP, then sought to foreclose on Mr. Robbins’ interest in AIP. In other words, Fairstar sought to take AIP from Mr. Robbins.
Mr. Robbins thought he held an ace up his sleeve: since AIP was a Delaware LLC, he argued, Delaware’s statutes would apply, and the charging order would be the sole remedy. Unfortunately for Mr. Robbins, Utah’s LLC statutes are different. They permit a creditor of a member in an LLC to foreclose on his interest, and the “charging order” is not the sole and exclusive remedy. And that is precisely how the court ruled.
Thus, the Utah court issued an order that not Delaware law, but Utah law, applied to all judgment execution proceedings — including the creditor’s foreclosure of the debtor’s interests in limited liability companies, whether such LLCs were domestic or foreign. Only on internal matters of LLC business would Delaware law apply.
Again, how could Mr. Robbins have avoided this mess? Instead of filing a Delaware LLC in Utah, he should have chosen to create a Utah LLC wholly owned by his Delaware LLC. This process would mean that the Utah courts had no jurisdiction over the Delaware LLC; the charging order would have been the sole remedy, and Mr. Robbins might well have walked away unscathed.
An Ounce of Prevention
Complex issues? Definitely, yes. Rife with possibilities for pitfalls? Undoubtedly. As Mark and Sally found out, the courts have wide latitude in interpretation and enforcement of real estate investment tax laws. Expert information can help you outwit the more egregious “loopholes”…something no “one-size-fits-all” or “do-it-yourself” scheme can achieve.
Asset protection is too important (and errors are too costly) to leave to chance or crossing your fingers: call us instead, and be SURE.