So you want to buy an investment property in California, but wondering how you should take title? This seemingly simple issue causes a lot of confusion even among seasoned pros.
Many investors in California choose to form a single-property LLC (limited liability company) – or other type of corporation – in order to hold their investment properties. When it comes to commercial-type properties (apartment buildings or offices), corporate ownership is almost always the preferred way to hold title, as it places an additional layer of protection between you and liability arising from your ownership of the property. If the corporate formalities are followed, it should be difficult for a claimant to “pierce the corporate veil” and obtain a judgment that is enforceable against you personally. This does not protect any equity you may have in the property, though, since a claimant can still get a judgment against the LLC or other corporate entity that owns the property.
It gets a little trickier with small residential properties. While it would be great to hold title single-family residential properties in an LLC, there are some countervailing practical factors you need to consider before automatically choosing an LLC. First, although it is not a big deal on a multi-family property, the costs of forming and maintaining an LLC become significant in the context of a small income property. For instance, the state of California requires your LLC to pay a minimum fee of $800 per year just to remain in good standing. Given the present budget problems in the state, it is very possible that this fee could eventually be increased further. Another way to look at that $800 is that it could pay for a massive increase in your insurance limits. Personally, I’d rather take that money and use it to increase my insurance protection (including umbrella coverage) up to a level where the chance of a claimant obtaining a judgment in excess of policy limits becomes too small to lose any sleep over. In fact, if you shop around, you will likely find that it is very inexpensive to purchase additional liability limits (and/or an umbrella policy) to supplement your homeowner’s policy.
It is true that a single corporation or LLC can own multiple properties, however, by keeping multiple properties in a single entity an investor is increasing their risk dramatically. A claimant against the entity can go after any assets held in the structure, included other properties, and any equity they might have.
Besides the costs, there is another practical reason that using an LLC or other corporation to purchase property is not for everyone. If you plan on financing your property purchase, buying it inside an LLC or other corporate structure will reduce your lending options and likely cause you to pay a lot more for financing. There is a big difference between commercial loans (defined as 5+ units) and conventional (1-4 unit) loans. Smaller loans are much easier for the lender to resell on the secondary market and as a result buyers can usually get great fixed rates to purchase 1-4 unit investment properties, and a 30 year term. On the contrary, commercial loans are typically not fixed for longer than ten years (Given the risks of massive inflation in the next ten years, this is not a trivial consideration), and rates will be higher.
You must decide whether the additional protection offered by an LLC is worth these tradeoffs. You should, of course, consult an attorney before you make this decision – just make sure that they have experience in this area, and preferably, that they also own investment properties. That way they are more likely to understand all of the business ramifications of your decision, and not just the legal aspects.
Disclaimer: This is not to be taken as legal advice — the application of law to an individual’s specific circumstances. You should consult a lawyer to seek legal advice on your particular situation.