In this Distressed Real Estate and Note Investing podcast episode, Attorney Roger McClure of Washington Wealth Counsellors talks with host Brecht Palombo about how to structure and use LLCs to buy and hold real estate and note investments. Roger covers the do’s and don’ts of using LLCs for real estate investing, the differences between various corporations and LLCs, and what investors should know before setting up an LLC to buy or hold notes and real estate.
Visit www.wealthcounsellors.com to learn more about estate planning, business planning, and LLCs and real estate investing from the professionals at Washington Wealth Counsellors.
Brecht Palombo: Hey, I’m very happy to have Roger McClure of the Washington Wealth Counselors, PC here today. Roger has been a practicing attorney for over 40 years and has a lot of experience in entities and setting up entities. So today, we’re going to talk about how to get ourselves set up with whatever the entity, the right entity is for our real estate or our note investing business to make sure that we’re doing it right.
Roger, your bio is – you’ve got such a career here that I would sound like an encyclopedia if I just start reading all this stuff. So why don’t you run through the highlights for us.
Roger McClure: Thank you, Brecht. Great to be with you and your audience.
Basically, mainly about the real estate – I’ve been a real estate investor myself, both in houses and in commercial; I served as past president of the local apartment association. For three years, I had a radio talk show on real estate that I did, and they took me off the air when I ran for office.
So I served in office for about ten years. And, when I told, I don’t know if you know Danny Santucci, but he’s a guy that has been around in real estate for a long time. He said I must have really done something wrong in my prior life to have been committed to ten years in the legislature.
But anyway, basically what I do is I help people in their planning and in their real estate, setting up real estate entities, whether it’s partnerships or LLCs or corporations, both for when people want to inherit things and also for asset protection – and asset protection is a big deal. When you go into distressed real estate, or you’re buying notes, you’re doing something that can end up being very controversial.
And if you end up foreclosing on a house and that lady crying takes her babies to the courthouse, wants to do something with this evil guy or gal who foreclosed on them, you’re not going to be the most sympathetic person. And unfortunately, we have a trend in the courts where the courts don’t necessarily follow the law.
So you’ve got to structure yourself so that you’re protected. And if you own real estate or notes in your own name and that generates litigation or accidents or lawsuits or whatever, then they can come after not only the business, but they can come for everything you have, and only certain things like your 401k might be protected, but they could come after your home. They can come after anything.
And today, when we have this rich and poor divide and all this kind of thing, more and more, it’s not going to get any better, more and more, we’re going to see more litigation and more difficulties with people who build up wealth. Because if you build up wealth, it must not be because you worked 24 hours a day and took huge risks and signed all these notes but because you stole it from other people.
So, you have to understand that there’s that attitude out there. What I’d like to mention is two stories of clients that many years ago I worked with – I’m going to change the names.
Let’s take Ruth, for example. Ruth had a very strong business, and what she would do, she would go to help people who were being foreclosed. She’d advance the money to stop the foreclosure, take a second note, and then, of course, they wouldn’t pay her, and they wouldn’t pay the mortgage, and then she’d foreclose on them, and she’d evict them.
One of the evictions she had, there was a shooting during the eviction – in The Washington Post even, and she became a horrible person, and she lost everything.
Now, she has a wonderful husband and family, but she’s collecting social security and a little bit of money from the government and really can’t own any real estate. She doesn’t have a horrible life, but she doesn’t really have any money.
Another example is Sally. Sally went and started investing in real estate. Well, in single-family homes, and eventually worked into office buildings, warehouses, and also apartment buildings.
And what happened was years ago, we had a big downturn in this area, and she had lots of problems with tenants not paying and those kinds of things. She lost three properties to foreclosure and filed personal bankruptcy. And she had her main property in a partnership and all sorts of stuff that I had put together to make it very complicated.
The bankruptcy court took a look at it and said, this is a mess; we don’t understand it. Get outta here. We’ll just give you your bankruptcy, and you can keep your property. So now this year, many years later, she’s getting ready to cash in, and she’s going to get over $15 million from the transaction.
Brecht Palombo: So, you know, it’s one of the first questions that new folks ask me is do I need to be incorporated to do this. And when they say do this, I think they mean two different things. One is, there’s a lot of folks who get started in this business by, especially when we’re talking about notes, or by wholesaling. Right? So by finding the deals and trying to make a fee off of that and passing that to a buyer.
And then I have other folks who maybe they’ve got some money; it’s not in an IRA or whatever. They’ve got some after-tax money, and they want to start investing in notes, and all the time, I get the question, do I need a corporation for this? It sounds like yes, but you know, what I always have to say is, I’m not an attorney. I can’t offer you any legal counsel on this. You need to talk to someone who is.
So tell us a little bit about what you think about those two things. One is bird-dogging or wholesaling for fees. And the other is acquiring stuff under – what kind of entities should that be, and how should people think about that?
Roger McClure: Okay, well, you don’t have to have a corporation or an LLC to conduct business. You can conduct it on your own, but there’s no privacy, and there’s no protection of your other assets for what happens. So you can start out if you want to, without an entity. And basically today, the corporation is kind of like the old story.
What is really best now is the limited liability company, which has been started up in the last 40 years and was just really the entity of choice for single-family homes or shopping centers today. To replace the partnership and the corporation and the idea of doing that is the same concept of the corporation.
The idea of setting up the corporation was if the corporation owns the sailing ship and it sinks, and you lose everything and everyone, and the widows and everyone wants to sue you for losing the sailors and all the money and all that kind of stuff. The ship is owned by the corporation, and the corporation has $200, then that’s all the creditors get.
They can’t come after you individually, but if they’re owned by you and your friends, then there’s a partnership. They can come after everything you have to conduct business. No, you don’t have to have it, but it’s prudent and wise to do it because you never know what’s going to happen. And you really think, okay, I’m going to set aside $10,000 or $100,000 to go into this enterprise. And you think that’s all I got at risk? No, you have everything, everything you own, and your whole future finances at risk if you don’t use an LLC.
Brecht Palombo: So, talk to me a little bit about – you’re saying corporation – and I’m assuming that you’re meaning like a C Corp.
The ones I’m familiar with, there’s a C Corp, an LLC, and a sub S, which is what my company is, an S Corp. So maybe just talk a little bit about how to think about where any of those is more appropriate than another.
Roger McClure: Well, one answer is if you’re an advanced investor and you have a lot of different properties, you’re going to have LLCs. You’re going to have the S-corporation; you’re going to have C corporations because each has their advantage.
But the big advantage of the LLC is that you can set it up. And you have limited liability like you do in a corporation, but you don’t have a corporation and the LLC, you don’t have to have annual minutes; it’s very easy to set up. You can go online, set up one in almost minutes in Virginia and many other states. And you don’t have to have annual minutes or anything like that.
All the losses are passed through to you individually, the income with an S-corporation. Yeah. That’s supposed to happen, but the problem with S-corporation is there are limitations, and it can be fairly complicated taxation.
C corporations, you have the double tax. You have to pay a tax at the C level and then also at the individual level, which you don’t have with corporations.
Now understand, I have set up LLCs, which we file as S corporations. I’ve set up LLCs that we file as C corporations. One of the things that LLCs have if you set it up in the right state is they have greater protection than corporations.
If you own an S or C corporation share, they then go to the courthouse and say Brecht had this $2 million car accident and insurance only covered a million, so he still owes a million dollars. So I got a judgment for a million dollars against Brecht. I’m going to go to the courthouse, and he’s got this nice business going. It’s in an S-corporation.
Judge, I want you to order the shares of his corporation to be sold to pay my million dollars. And that lawyer that asked for that will get that order in any state.
Brecht Palombo: Wow. So you have less protection as an S than you do as an LLC.
Roger McClure: Well, if you’ve set up the LLC, right. Most states in the United States say, oh if you have that million dollar – Brecht has that million-dollar judgment against him, we can then go to his LLC.
And in most states, you get what’s called a charging order. And if you don’t pay it in some kind of reasonable time, the lawyer for the accident victim can go back to court and have the judge order your shares sold. But, if the LLC is set up in Delaware or Virginia or Texas, or some of the others, they absolutely prohibit the sale of your interest in the company for any problem outside the company.
So those LLCs have a second level of protection, that is – not only are you protected that what’s inside the company can’t migrate out and get to you, but what’s outside can’t get to your company.
Unfortunately, a lot of people don’t know that. And a lot of attorneys don’t know that, say they’re in Maryland. Oh, I’ll set up a Maryland LLC for you. Well, Maryland doesn’t provide that protection.
Brecht Palombo: Well, I was just going to ask you – so, I’ve got one LLC in Delaware, and then I also have the S in Oregon, and it sounds like I made a mistake.
Roger McClure: Well, yeah, the one in Delaware. Now what you can do if you like the S-corporation benefit and there – and my law practice is an S-corporation is for a professional operation or for running a service business. It’s a very good method. And that’s the standard thing that is usually used.
It could be an LLC, but an S-corporation works well for me. What you can do, if you say, okay, I’d like to have the LLC protection is you can set up an LLC, and then you can file a real short form with the IRS saying, I want it taxed as an S corporation. So you get the LLC limited liability benefits in the right state and S-corporation taxation. I recently set up an LLC with C corporation taxation because this particular business does a lot of businesses in many different states.
And the problem is, is every state that you do business in wants money from you. They want you to file a tax return. But if you’re a C corporation and you don’t have any operations – you sell stuff in that state, but you don’t have any operations there, they can’t make you file a tax return. But if it’s an LLC or a partnership, they might be able to.
So depending upon the business, there’s different advantages, and the S corporation or the LLC with the corporate election is one approach.
Brecht Palombo: So when is a corporation better than an LLC?
Roger McClure: Well, the corporation’s better because generally speaking with an LLC, everything just flows through to you.
But if you want to be able to justify having a corporation provide health benefits, you’ll probably get a better retirement plan, if you want the corporation to provide a retirement plan for you, or like, my corporation has a corporate retirement plan that it provides for me, you’re going to get a better one with the corporation.
And, if you’re investing in burnout, horrible pieces of real estate in the places where they have, you know, 50 murders a weekend, you may want to look at a corporation because the dumbest judge understands the corporation is a different entity than an LLC. They’re are not as familiar with LLCs.
And also, S-corporation, for example, is a very good entity to use for managing real estate. So let’s say you have ten properties, and sometimes Property A is producing enough money to pay all the bills, and Property B isn’t. So you use the money from Property A to go to Property B, and the problem is, is then you’ve got all these different accounts and so, you may have, depending upon the size of the property, you may have each of your ten properties and separate LLCs to provide separate protection, but you can have a separate management company that takes in all the rents from everybody. You don’t tell the tenants who owns the property. They deal with the management company.
I set up a management company for a lady. She was worried about being sued, and all the management company owned was desks and chairs and computers. Go ahead. You want to sue them, and if you get an attorney who’s not all that bright, they’ll just sue the management company, and they’ll forget to sue the LLC where the money is.
Brecht Palombo: So I’ve got a note here about having one LLC to do deals and another for long-term hold and actually had a question about that myself. Where should, once you get rolling in business and – I sort of treat one of my sub S’s like a holding company.
Should then the sub S own the LLCs or are we getting too complicated, or are we getting in the weeds?
Roger McClure: Well, first of all, the word “complicated” in most people’s lexicon has a negative context. In my world, it has a positive context. If I go through an IRS audit and I’ve got a very simple setup, they are going to look at all the details.
I’ve got 10 LLCs with all sorts of different stuff. The IRS agent only has so many hours to spend on each case. So I’m going to get away with kind of more stuff. I’m going to get less questions if I have a complicated case. Now, sometimes it’s complicated, and they screw up.
I had a recent case where they wanted $300,000 from one of my clients, and the agent just didn’t understand it, and we had to go to a higher level in the IRS, talk to someone and explain all the structures because there were complicated. And then they said, okay, you know, we understand that, you don’t owe any tax.
So there’s that, but yes, it’s a good idea that if you’re buying and selling, to have one particular LLC that buys and sells because you don’t have the continual liability.
But if it’s going to be a property you’re going to buy and hold, then you would probably want to have that in a separate LLC. So if it’s a holding one, you put it in an LLC.
Now one of the big issues is, okay, I’m buying properties that are worth $100,000 each. Do I set up a separate LLC for each of those? Well, no, that’s a problem because you’ve got annual costs of the LLC and that kind of stuff every year.
Delaware charges you $300 a year for each LLC. So, you gotta pay attention to that. And it all depends upon how threatened the person feels. Some people will put three or four properties in one, LLC. Others will put, uh, only one. I use a million dollars – if the property is a million dollars, you want to have a separate entity for it.
And there is something we don’t have time to go into it today called a series LLC in Delaware and Texas and others that deals with this problem.
Brecht Palombo: Well, talk to me a little bit about, because you got my wheels turning a little bit. Maybe I’ve got a couple of mistakes out there. Maybe we could talk a little bit about some of the mistakes that folks can try and avoid when they’re looking to get started with this, or maybe that they might need to correct if they’re already, you know, in it.
Roger McClure: Okay. One of the key things you need to understand is that successful trial attorneys that sue people and make millions of dollars and have a house on the beach and in the mountains because of all the money they make – only sue people and companies that have lots of money. They don’t sue poor people.
So before they begin the suit, whether it’s a good suit or a bad suit, and the really good attorneys, I mean, ones that make a lot of money, know how to choose their suits. They may turn down most of the suits, most of the cases that come to them, but they’re going to do what’s called an asset search.
If you want to shock yourself someday, go on the web and do an asset search and ask for someone you know to find out; for 200 bucks, you can find out almost everything they own.
So you don’t want to make it easy for people to find how much you own. Now, I will admit that if you hire a $1,000 or $2,000 private investigator, they can find out anything about you, but for the average person, you don’t want to be subject to the asset search.
So what you’ve got to do is maintain privacy. For example, and a mistake is you say, okay, I don’t want to go hire and pay a lawyer or some other company to file the articles of formation for me. I’ll do it myself. But when you do that, that becomes a public record. And then the web crawlers go out and find out that Brecht Palombo formed an LLC in Delaware and put that in their database. And then they know that everything owned by that LLC is owned by you.
But instead, if I form one for you, I form it. So the only paperwork that’s there is my name and my address, and a great thing about Delaware is all you have to do is on the public records; you just put who is the registered owner.
So someone calls me up and says, well, I’m thinking of suing this Brecht guy. It looks like he may own this LLC. Tell me, does he own this property? I said, no, I’m not gonna tell you that. That’s attorney-client privilege, and a judge can’t make me tell you that. And I’m not going to tell you that. I’ll call him and see if he’s interested in talking to you.
Brecht Palombo: Wow. That is quite a bit more protection because today, you could just look me up for sure.
Roger McClure: Right. And then you don’t want a service, like, if you’re in Virginia, someone lives in Virginia, they can be their own registered agent again. Boom. Right there. In less than a minute, you can find out who the registered agent is and who the property owner is.
So if I’m the registered agent or you have a company that’s a registered agent, then they can look up and find out who that person is. Another mistake is people say, well, I’m a prominent physician, and I’m going to call my apartment building the David Smith Properties – never, ever do that.
Do not put your name on your properties. You might call it the DSP Properties or DSP Main Street so you can remember which property that has to deal with. But all of my LLCs that I set up or are initials, and it’s a way for me and the client to figure out what property we’re talking about, but it’s not available to the public as to who is, so we’re trying to maintain privacy as much as possible.
Brecht Palombo: So talk to me a little bit about, and I know we’re coming up on the end of our time here, but talk to me a little bit about – one of the things that comes up a lot is sort of working with other people like JVs (joint ventures) and that sort of thing where maybe you do the work, and someone else has got the money or vice versa.
Can you talk a little bit about how you think about that.
Roger McClure: That’s very important. And on my website Washington Wealth Counsellors, I have a questionnaire that you can go through, and I really recommend if you’re going to be in a partnership with somebody else, you need to go through that questionnaire and figure out what’s going to happen.
I did a situation where seven children were inheriting a farm in Kansas from their parents. We went through a process, and it turned out at the end that three of them dropped out and wanted to be bought out. And that was a good result because they would have not been happy in the partnership in the first place.
And then people don’t believe it, but if someone says, oh, Brecht, you really know what you’re doing with this real estate, and you’re making good money. So I’ll give you this money, and you go buy these properties for me. Well, you have sold a security. That’s subject to the securities regulations, so you have to structure it, so it’s not subject to the securities regulations.
The downside for the person is if you sold security, it’s a slam dunk case against you if you lose money. Real estate can go bad; you can lose money in real estate. And if it goes down the tubes and you sold somebody a security, then they can come after you if you don’t have a piece of paper that says, well, you know, we could lose money on this.
So you have to have a disclosure statement if it’s a security, or you have to set it up, so it’s not a security under the state laws, but a lot of people don’t recognize it.
Brecht Palombo: So what else would you leave us with here?
What else should people be thinking about as they go off into the rest of their day here and they’re thinking about real estate?
Roger McClure: Well, they want to, as I mentioned, choose the right state. They don’t want to sign the articles. They don’t want the name in the LLC. They want to make sure they don’t go to Amazon and buy their clothes using the LLC money.
You gotta make sure they follow the formalities. We want to plan for divorce and death. A big thing I see as they set up the LLC, and they forget to deed the property to the LLC.
And the other thing is entrepreneurs are great at putting together deals, but they don’t often pay the $50 or $100 a year you’re supposed to do with the state, and the LLC gets terminated. I had one yesterday. He’s a fantastic entrepreneur. He’s got over $40 million, but he was selling something from the LLC, and I found out it was terminated.
I’d sent him a letter saying, pay your 125 bucks, and he didn’t do it because he’s just so busy. So what I do with my Virginia clients is I pay it because I stopped that nonsense of the LLCs, and this is not a small problem. This is like 30-50% of the companies I set up get thrown out because they don’t pay the annual registration fees.
Brecht Palombo: It is one of the nuisances of owning businesses. You know, every time I get a letter from the state, I dread opening it; it’s going to be some surprise, some small thing that I didn’t take care of.
Roger McClure: Right. So anyway, on my website, I have the ten biggest mistakes for LLCs. You can download that.
Also, I’ve got this management agreement, and then you have to be careful about recent regulations of the IRS, about how they can apply audit regulations for a two-person LLC that apply to like the hundred mega partnerships. So you have to be very careful about the way you set up things these days.
Brecht Palombo: Well, this has been really helpful for me, and I know that anybody listening to this, it’s probably got their gears turning too.
If you want to get deeper into this, if you’ve got something that you’re looking to buy or you’re just getting started in business or some things came up today where you’re thinking maybe I’m not set up exactly right, then you gotta go over to wealthcounselors.com and talk to Roger McClure. You can get him at [email protected] Is that right?
Roger McClure: Yes. Yeah. You can email me there. And then I’m part of a national organization. I’ve got attorneys in every state in the country.
Brecht Palombo: Fantastic. Roger, it’s been great having you on here. Really appreciate it. Thanks for taking this time and educating everybody here.
Roger McClure: Okay, great. Well, it’s wonderful to be with you.