Brian Chou, Esq. is a partner at Barth Calderon, LLP, a California-based law firm where he focuses on asset protection, estate planning, and business succession planning.
Today we discuss entity structuring for California-based real estate investors including the truth about the $800 minimum California franchise tax, the potential risks of using a Delaware Statutory Trust (DST) as an alternative to an LLC structure, viable alternatives, and much more.
California Franchise Tax
If the properties are located in California, the LLC must be registered in California in order to do business. If an investor resides in California yet holds a property in another state in an LLC registered in that state, it's logical to conclude that the California franchise tax board has no involvement with the operation of this entity. However, the California franchise tax board says that resident managers with control over a foreign (including out of state) entity are also doing business in California and also must register that LLC in California.
If all the business is being done in another state, is it appropriate for California to be a part of this operation?
If you're concerned about the potential liability and you can afford the tax, it's likely advised to just pay the franchise tax and write it off against your income taxes.
Other investors are much more upset about this tax and are looking to avoid paying it. This is not a small group of people. For these people who are looking to avoid the tax, they assume the risk that the California franchise tax board discovers this entity.
Delaware Statutory Trusts
Brian has traditionally seen DSTs used to facilitate 1031 exchanges. Investors can exit an individual property and use the proceeds to enter a DST, which is generally a diverse basket of assets. A DST can be package with like-kind assets to preserve the 1031 exchange.
There has been some discussion about using DSTs as a replacement vehicle for an LLC. Some purport that this strategy may help avoid fees such as the CA franchise tax or registered agent fees. This is a relatively new phenomena that has been marketed primarily to real estate investors. Brian hasn't seen this much in asset protection as a whole, though he has seen this on the rise for real estate specifically.
Brian is going to wait for case law before feeling comfortable recommending this structure to his clients. We haven't seen this model challenged in court. The sentiment is that it's difficult to recommend this as the best solution to a client when the solution hasn't been tested in court.
The higher cost of the DST should also be considered, given that DSTs are generally much more expensive than LLCs. Investors should look to calculate their break even point in years of avoiding the CA franchise tax versus paying up for the DST.
Nevada Domestic Asset Protection Trust
This is an irrevocable trust. Revocable trusts are traditional and more common. In a revocable trust, the owner retains the ability to pull the assets back into their name - so does the court system. In an irrevocable trust, this connection doesn't exist. With an irrevocable trust, it's not possible to pull the assets back into your name.
It's not possible for creditors to access the assets in an irrevocable trust. However, some states don't recognize these trusts if they are created for the same individual that created it, the assets need to be transferred to someone else.
Setting up an LLC or estate plan is not simple. Many people don't see the value in this. Everyone's situations are so different, the analysis of an individual situation is going to bring light to many different areas of consideration. There is a whole host of discussion points that come from this analysis.
Learn more about Brian and his work: https://barthattorneys.com/