- Hey guys, Clint Coons here,
and in this video we're gonna be discussing
how to structure your California real estate
because I've been getting a lot of questions
on what California residents can do
to avoid the dreaded franchise tax
on business entity structure.
Okay, let's get started.
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So, you have California real estate,
or you live in California,
and you probably are aware of this
that if you try to set up a limited liability company,
you've heard that for each LLC that you have,
you need to pay $800, and it gets worse.
I mean, we're not only talking about California real estate,
but if you're a California resident,
and you own real estate in Texas, New Mexico, Florida,
California has taken the position
that it can tax each of those entities
as if they're doing business in California,
what I mean is if they're doing business,
they say they're doing business in California.
Yeah, the Franchise Tax Board is of the position
that if you're a resident of California
and you hold a membership interest in a foreign LLC,
and you can control it,
or you exercise management decisions,
California wants a piece,
they want $800 because that LLC in their opinion
is doing business in California.
Now, for many Californians
this has actually discouraged them
from creating structures
because think about what I've been teaching,
you know, one property per LLC, you have 10 properties,
what is that gonna amount to, $8,000 a year?
Now don't get me wrong,
even at $800 an LLC to protect a property
that's probably worth 500,000,
if it's in California, or maybe 120 if it's in Florida,
that's still not a bad investment
to know that if something goes wrong
you're gonna be protected.
But again, it's a hard check to cut
come every year when California wants that money
at the beginning of the year.
So, what can we do then for California residents,
people who invest in California
to eliminate this issue of having to pay that $800.
Well, there's a couple of different strategies
that you might wanna consider
when it comes to protecting yourselves.
Number one, there's been a lot of talk about this,
I cut another video on it,
it's called the Delaware Statutory Trust,
or what we'd like to use is that Wyoming Statutory Trust.
So with a statutory trust
it's not subject to the franchise fee
because it's not an LLC, it's not a limited partnership,
it's not a corporation,
so if you live in California and you're investing,
I don't care if it's California, Florida,
Texas, New Mexico, rather than set up LLCs,
you may wanna consider this Delaware statutory,
or what we like to create, a Wyoming statutory trust.
Now, if you haven't watched my video yet
on that particular tool,
I'll just give you a brief example of how it's set up.
So with a trust it's gonna be created in the state,
say Wyoming, so you create this Wyoming trust.
Now like an LLC it has to be registered,
so you have to file something.
It's unlike a land trust,
it does not have to be registered.
With these particular types of trusts
they do require you register it
with the Secretary of State
so you have a registered agent there,
you have an address there.
So you create this trust
and you have to have a Wyoming trustee
and typically what we're gonna use in that case
is a Wyoming LLC that you control
to be the trustee of your trust
and then you're gonna be down here as the beneficiary.
Now, the statute reads that if anything goes wrong,
if you get sued personally,
unlike a situation in a land trust
where you're to be sued personally,
they can take your trust from you,
in Wyoming and Delaware,
if you're a beneficiary and you're sued,
they can't take your trust from you,
they can't get up into the assets.
The trust has charging order protections,
hell, that sounds a lot like
limited liability companies, doesn't it?
In fact, I mean, I think they modeled it after this,
but the other benefit is that
when you have property inside of there,
it works the same way like an LLC.
So if something goes wrong and somebody sues,
then it stays contained within that trust.
Okay, so from a California perspective
then how does this work with the franchise tax?
Well, it doesn't apply,
because the franchise tax only applies
to those business entities, it doesn't apply to trusts.
So by using this type of structure
to hold your California real estate,
setting it up in trusts, rather than business entities,
you're avoiding that dreaded tax.
So just think eight trusts,
that just saved you $6400 by setting it up with trusts
versus a limited liability company.
All right, now, is there a catch?
Well, absolutely, I mean you're probably thinking
this is too good to be true.
Well, the point is when it comes to using these trusts,
there are some unknowns.
How would another court interpret its use
when you're using a trust that provides asset protection
to hold title to real estate in a foreign state,
where it's not located?
I mean, we can all agree, if this was a Wyoming trust,
holding Wyoming property, there's no question there,
but what happens when you take a Wyoming trust
and you use it to hold property in California,
where does that place you,
or a Delaware statutory trust
to use it to hold property in California?
Well, the issue is is that these trusts are looked at
as business trusts in the eyes of California.
So when you use this type of trust in California,
you will have to register it there.
There's a separate process
to register business trusts in California,
so you do have to get them registered
and then the question becomes,
do they wanna tax it, or not?
California, I've looked at the law
and I tell you it's clear as mud on this,
it appears that they may tax them as corporations,
California corporations,
you're not gonna pay that minimum of 800,
but you may have to pay tax on the income,
so that's something that's a little unclear.
The other thing I think is even more important here
is how the court would recognize it
if you're in California and you own property there,
how would they treat that trust
from an asset protection standpoint,
or if you own property like I said in Florida,
and Florida doesn't recognize this entity by statute,
how would they look at it?
So, there are some questions on using the trust.
I'm not saying you shouldn't.
I think that you could use this vehicle
and then possibly wrap it in a Wyoming LLC,
make the Wyoming LLC the beneficiary of that trust
and have multiple statutory trusts set up that way
just as an ounce of added precaution.
Now, if you don't wanna go this route
and utilize the trust,
because you're just not someone who wants to be
the guinea pig, the test case, when something goes wrong.
I got another solution for you, okay?
Now in this scenario we don't have to use the trust,
instead we're gonna use an entity
that's been around for a very long time.
In fact, it's a precursor to the limited liability company.
This was the entity that people used to use all the time
to protect their real estate until the LLC came along.
The entity I'm referring to is a limited partnership.
Now, if you look this up and you talk to a CPA,
and you ask them, you know,
I'm living in California and I own real estate
in a limited partnership,
is it subject to the franchise tax?
They're probably gonna tell you, idiots.
Now, the reason why is they may not be aware
of the recent Franchise Tax Board ruling
on limited partnerships
that are set up in a very specific way.
So let me give you a little background now
on the limited partnership and how typically it's set up
and the tweaks that we use to avoid the problems
associated with that traditional method
from the California franchise tax aspect.
Okay, check this out.
So, you've got a limited partnership,
now the thing about the limited partnership,
when you set one up, it's a great tool.
So if you put property inside of here
and something goes wrong,
it's gonna stay contained inside of that bubble,
it'll stay in there, you're not gonna be sued personally,
because you're gonna be down here
owning this limited partnership as a limited partner, okay?
So that means you have liability protection,
LP, liability protection, for this limited partnership.
Now a limited partnership
also has to have a general partner,
somebody who controls it,
so who's gonna be your GP?
Well, you might be thinking, hey, I'll be the GP,
I wanna be in control it's my real estate.
Well, most people don't wanna do that
because if you're the general partner,
and something goes wrong in here,
it's not gonna come sue you as a limited partner,
but they'll sue you as a general partner,
because general partners they're liable
for whatever happens in a limited partnership.
So it discourages individuals
from wanting to be general partners in their own name,
what do we do instead?
We typically create an entity up here.
This could be a Corp, or LLC that you run
as the general partner of your limited partnership.
So when you record this document,
when you file for the LP, you state,
hey, this is the GP, I am the limited partner.
Okay, so a limited partnership,
because there's two partners,
it's treated as a partnership for federal tax purposes,
and when it's treated as a partnership
for federal tax purposes,
then California is gonna nick you for $800,
okay, and this is how they've always been set up
for a lot of people, set 'em up with two partners like this.
Well, most individuals are not aware
that the IRS allows you to set up a limited partnership
and treat it like a disregarded LLC.
I mean, it's kinda,
it's confusing to individuals 'cause they say,
"No, that's not possible,
a limited partnership is a partnership
and it has to file a tax return."
It does in a lot of circumstances like this,
but there's a way to get around it
if you know where to look.
So the IRS has acquiesced and they have stated
that so long as the tax payers,
that is the GP and the LP, are the same parties,
if they're the same parties,
then the limited partnership is a disregarded entity
for federal tax purposes.
Okay, now you're probably trying to digest that right now,
trying to figure out what did I just say, I get that,
so here's what we gotta do then.
If we wanna make it the same party
one way to do it would be to say, all right,
we've got husband and wife here as a limited partner,
so we're gonna make husband and wife up here
as the general partner.
So we have both individuals in both places, right?
What's the issue with that, if we did that?
Well, liability okay.
So if you're gonna be the general partner,
you have to take on liability.
Now that kind of defeats the purpose of setting this up
from an asset protection standpoint.
Okay, so then what entity can we set up
that will give you liability protection
and you don't have to file a tax return for it,
you can make it a disregarded entity?
In fact, I already told you this answer,
it's a limited liability company, right?
We can set up disregarded LLCs and in order to do so
you have to either have one owner of the LLC,
or if you live in a community property state,
like California, and you have a husband and wife,
or a married couple,
they can serve together in that LLC
and it would be disregarded.
So here's what we do, here's the strategy,
we create a limited liability company
to make it the general partner of our limited partnership
and we make this one a disregarded entity.
So that means that this entity
is disregarded for tax purposes
down to these two individuals.
So the IRS looks through it, they don't,
they don't treat it as a separate partner,
it doesn't have to file a tax return.
Now, because we've done that,
it's disregarded to these individuals,
we then set up an LP that can also classify itself
as a disregarded limited partnership
because these individuals, and this individual,
they're the same tax payer,
that is the strategy you need to use.
Now, that gets us to the point
where the IRS says it doesn't have to file tax return,
so how does California fit into all of this?
Well, last year, just for perspective purposes,
in November of 2019, or early December,
I don't recall the exact date,
there was a Franchise Tax Board rule and this issue came up.
An individual had set up a disregarded limited partnership,
similar to how I described,
and they argued that their limited partnership
was not subject to the franchise tax
because the franchise tax,
the tax code only speaks to disregarded LLCs
being subject to franchise tax.
It does not state,
that limited partnerships that are disregarded,
have to pay the minimum franchise tax of $800.
And you know what they said,
"You're right, they don't."
So this opens up a whole new planning opportunity
for individuals that when you create
a disregarded limited partnership,
in the way I just described,
using an LLC, and an LP here,
and the same taxpayers in both positions,
then that entity is not going to be subject
to franchise taxes.
So here's what you could do.
You could set up multiple LPs in California, just like this,
just like this, to own your rental real estate,
if you have California real estate,
all general partners the same thing,
it's all gonna be that one LLC,
that we've set up.
And let's say we set up another one over here in Texas,
LP, right over here, owning property,
and again, you got it there.
You could have this entire structure
and not one of those entities
would be subject to that $800 franchise tax.
This is a blessing for Californians
'cause they can finally get out of having to pay $800
on an annual basis to have a structure
to protect their assets
now that the government, or the Franchise Tax Board,
has acquiesced and said that the law
does not apply to disregarded limited partnerships.
Great, great strategy, okay.
I was so, so astatic when I came upon this
and I read about this ruling
and I thought I just had to share it with people.
Now, the reason why I didn't come out right away with this
is because you never know,
are they going to pull this back
and make a change to the tax code?
So we've been following the law,
this past year during COVID,
to see what changes have been made,
and thankfully, although the Franchise Tax Board
proposed some legislation that was not picked up
and nothing has changed.
So, here's the asterisk disclaimer, okay?
Although this is a great strategy, and it can work for you,
you have to be aware that they could change the law
at some point in the future
and try to bring that back in and say,
disregarded LPs need to be treated like disregarded LLCs
and we need our money.
I don't know if that's gonna happen,
but if it doesn't this is a great alternative for you
if you invest in California.
I mean what do you got to lose?
Think of it this way,
if they're gonna tax your LLC anyways,
why not go with this route and set it up
'cause they may not change it
and you may, then you'll be in a great position.
Federal taxes it's all disregarded,
we can talk about that
if you wanna get more creative
in what we can do with the money
as far as if you wanna get partnership taxation,
there's other things on the side that we could look at,
but one other thing about this,
if you're gonna set it up,
it's somewhat technical in how you will apply
to the Franchise Tax Board to meet the certification
as a disregarded limited partnership.
So we've been doing this for some of our clients now
to set up their structures and it's working quite well.
Be sure to check out my other videos
on Delaware statutory trust
if you're not sure about how that entity works
so you can familiarize yourself with that particular tool,
but all the best.
I mean all the best with your investing
and stay safe everyone.
Hey, if you liked this video
also give me a like down at the bottom
and be sure to subscribe to the channel as well.
Take care.
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