LLCs & Trusts
What is the difference between LLCs and Trusts? When should you set one up? What are the risks and benefits when investing in real estate? These are some of the most common questions I am asked when discussing real estate investing. At our most recent Portland Women Investors meetup, we were lucky enough to have Carly Joyce, attorney and owner of Two Lights Settlement Services, speak to us about just that! Everyone came to the meeting with lots of questions, and Carly did such an excellent job breaking it down for us that we all left with our questions answered and a clear path forward for our own investing. Here are my key takeaways:
Trusts:
Trusts are fiduciary vehicles (established by attorneys, not on your own), where the person setting the trust up appoints a Trustee via a Trust Document. The established Trust holds legal title to the assets that are put into the trust. In real estate, once the Trust is established, a lawyer would then deed your real estate to the Trust (this part is KEY! Don’t forget to put your property into the trust!).
When you pass away, the Trustee will then distribute your assets as laid out in the Trust document to your Beneficiary. While this can also be done through a Will, one key benefit of a Trust is that it is not required to go to probate (which makes it public document), while a Will does. With the Trust, only the Trustee Certificate is recorded.
There are two main types of trusts; a Revocable Living Trust and a Irrevocable Trust. A Revocable Living Trust allows the grantor to keep control of the Trust, and make changes to the Trust, during their lifetime. The Irrevocable Trust is much harder to make changes to, and is very specific to certain people and situations.
So, why do people primarily set up Trusts? There are 3 main reasons:
To avoid probate when someone passes. This can be especially beneficial if there is real estate owned outside of Maine and the person resides in Maine.
Asset protection. For example, Medicaid planning or if a family member has a disability.
Estate tax planning. Someone may set up a Qualified Person Residents Trust or Equal Division of Asset of Spouses Trust
When is putting real estate into a Trust not a great idea?
When multiple family members own a property. For example multiple generations own a family camp in Maine. In these situations an LLC makes more sense as it will be more clear how decisions are made and who benefits.
Some types of mortgages. Lenders typically won’t allow real estate to be owned in an Irrevocable Trust, but sometimes will show flexibility for a Revocable Trust, as the grantor still retains control and can make changes as needed.
Hot Tip: If your reasons for creating a trust are solely to avoid probate, there was a uniform probate code change in 2019 that added a Revocable Trust on Death Deed (known as TODD) – this is recorded on your passing and your property will enter into a trust at that time.
LLCs
LLCs are businesses that combines elements of corporation, partnership, and sole proprietorship. They are less complex than a corporation and offer benefits that may not be available to other types of businesses. LLCs also provide an additional layer of asset protection.
To set up an LCC:
Check online to make sure the LLC name is available
File Certificate of Formation
Choose a registered agent (this can be an attorney, or yourself)
Fill out cover letter and send money to the state to establish LLC
Structure an Operating Agreement for your LLC – this is more complicated and it’s frequently recommended that an attorney set this part up for you
Obtain EIN with the IRS
How does an LLC protect my assets?
Lawsuits. When something goes wrong, an individual can be sued for above what their insurance policy covers, in which case personal assets are up for grabs. With an LLC, it is only that asset that can be sued and personal assets are protected. In another example, if work was done on the property owned by the LLC and it can’t be paid, you are protected from personal liability since the LLC is being sued, not you personally.
Debts & Obligations. For example, there are two partners who own an LLC together, but one partner is negligent in their personal life. The LLC is protected from the first persons negligence. It does not protect you from your own negligence/wrongdoing.
Other Key Points:
Pass through taxation. Don’t need to file a separate tax return, LLCs go on your personal tax return. Note: S Corp & C Corp are separate tax returns.
Make sure you operate your LLC as a separate entity – have separate bank accounts and an accounting system, never co-mingle monies. Leases and contracts need to be made in the LLC name. Keep resolutions, annual filings, etc. up to date to maintain LLC status.
The more you can demonstrate it acts as a separate entity, the more reliable the limitation is on your liability (keeps people from “piercing the corporate veil” at which point they can go after you personally).
If you have more than on rental property, be sure to set up separate LLC for each one. This protects them from each other in the event of a lawsuit. Once a few properties are acquired, it is typical to establish an “Umbrella LLC” that owns the sub-LLCs.
Pro tip: set up LLC for each rental then a property management LLC to collect rents/manage the money so LLC only owns the asset and not the money
Residential loans can’t be done within LLCs, however commercial loans can.
At your passing, LLCs do not go through probate, it instead follows the Operating Agreement. While Single Member LLCs are required to have an Operating Agreement, it is highly recommended to avoid probate and ensure your assets are passed to your wishes.
Common Questions:
When is the right time to set up an LLC?
If you own one rental (and a personal home), it is worth setting it up so that your home is protected.
What about if you Owner Occupy a property also used as a rental?
Insurance will likely make you get a commercial insurance policy which is more expensive.
It’s important to evaluate it from a tax perspective as well (speak with your accountant)
If you own it with someone else, it can be beneficial to put it into an LLC with clear membership interests, decision making powers, etc. Think of it as a pre-nup for your real estate!
If leases are under owner names, then moved to LLC, do new leases need to be signed ASAP or wait until renewal?
Should be ok to wait until renewal.
Do I need a LLC Operating Agreement if I have a Will?
In a single member situation, likely do not need anything additional if a Will is in place, as generally the company dissolves at death and then follows as laid out in Will.