Key Legal Considerations When Scaling a Rental Business

0:00A lot of lawyers say one LLC to one property and I think that that is very very nice if you have five properties. I have a hundred. Yeah, I it's not going to work for me, right? And I think that that sort of becomes the big thing is things are only protective if they're working. And if you have one LLC to each property, but you're not doing your bookkeeping, right? You're not consolidating your books, you're not using QuickBooks, you're not doing all of that, then it's good as good as not having an LLC, right? Because the purpose of the liability protection is to act like a business and I just don't think that that's feasible for those of us in the real estate industry.

0:37I think it's really feasible for somebody who has one great but I have a hundred and that becomes difficult. So for me I usually do a little bit of a hybrid where I do LLC's for my rentals regardless if they're short-term or long-term hold but I divide them with the amount of equity that I have in the properties. So, I basically have like, you know, if I have $10 of equity in 10 properties, they're going in one LLC and maybe the next 10 that I have are worth $6. So, I have more room to have more properties in that LLC.

1:10But the reason I do it that way is that if I do end up in a legal situation in that one company or that one LLC that I have structured, I can sort of cut it off from the chain of things that I have and the rest of it is not really growing down. And I have basically all of my what I call client or consumerf facing businesses in their own LLC's. And the reason I do that is because I just if you sue me for the law firm or the real estate firm or anything else, it's a consumer-based business.

1:42It's going to stand on its own. My rental property stand in their own LLC's. All of it pays into a holding company. And that holding company nobody really knows the name of. So at any given time, my revenue going into my businesses is never really high. So for example, just for easy numbers, right? Let's say I have $10 worth of profit going into LLC1, $10 worth of profit going across the board. Every month when I'm done, those companies have about $2 in their bank account. The holding company gets paid almost like a service fee for the profits.

2:17That's where I make my money. The holding company is holding everything. It's paying my mortgage. It's paying, you know, my cars that are business entities. Nobody can really identify that business because it's it's not registered in the state where my consumer-based businesses are. It's registered in Wyoming or Nevada. And I pay myself a W2 paycheck there as well. So, the holding company is actually not running a profit either because by the time it pays off everything and pays me a W2, I'm not paying business taxes, I'm now paying personal taxes.

2:49And then that's all the holding company is owned by my trust. So on paper, I actually have very little profit across the board. All the businesses are running their own business expenses. They're consumerf facing. So if I end up getting sued, I'm not quite worried about losing that business or entity. The holding company's holding most of the money. And even that's kind of strategically structured. Wow. Interesting. Okay. And I've I've heard of this structure with with the holding company before. I personally don't have that that structure.

3:21But I I know several people who do, I guess. What's the the big advantage to that? And then is that a corporation or is that taxed as a a pass through as well? So, that's a corporation. And the the big benefit for that is that I literally just get to I get to have all of my businesses that are consumerf facing, they're protected with insurance. I'm not really worried about ever getting audited. You know, even if I get audited, even if you want to look at my profit structure, I've limited that liability to that company.

3:54And because it's consumerf facing, I know that that's sort of not where my money's going to go. And the holding company is so hard to identify, I feel a little bit more comfortable having kind of my big lucid structure there. On paper, because I don't own anything personally. If you sue me personally for fraud or anything like that, good luck getting anything because I have a trust, I have a holding company, I have multiple LLC's, and the way I sort of say it is I've structured these walls. So, good luck finding where all of my income actually is. Yeah. Got it.

4:25Okay. So, so if like let's say somebody wanted to sue you in the law firm, they couldn't really name your holding company because it's so difficult to find. So, okay. And that's where all the money flows up to. So, it's it's a way, you know, to really shield your your assets a lot better, right? And if you look up, you know, where I live or you look up my house or you look up my cars, they're owned by my title, I'm sorry, by my trust. And my trust is private.

4:55So, nobody's really entitled to see what's in the trust except for what you find on public record. So, if you ask me, well, what holding companies in your trust? I don't have to provide that information even in a subpoena. I see. Okay. Yeah, that makes sense. Wow. Okay. And then for the LLC's, you know, you mentioned, you know, you you divide it based on the equity, which makes sense because that's typically what they're going after in a lawsuit when there is one.

5:27But what happens like over time? Obviously, equity changes, values increase. Do you reshuffle your assets then and like move them, quick claim them to another LLC? Or how how do you handle that situation? It really depends. So I also look at kind of the structures and what I'm doing. Am I doing a long-term hold? Am I doing, you know, short-term hold? What am I going to do with the property? I have a couple properties that I know are going to go to my kids. So I kind of look at both equity and kind of the goals. I don't really do quick claim deeds from one LLC to the other because at least in the state of Maryland, that's still considered a consideration type of quick claim.

6:02So, I would have to pay taxes on it. So, I wouldn't do that. I would just grow another LLC. If I'm doing any sort of fix and flip, which is I do a lot of those as well. All of my fix and flips are LLC's that I start and close when that transaction's done because again that is a high threshold liability level. Got it. Okay. And are those LLC's where you do fix and flips, is is that a S corp or is that a pass through? It's pass through. In the state of Maryland, it has a resident agent can't find who I am. So that way, open, close, move on.

6:35So that way I'm not worried about any liability because you have to remember for a lot of the statute of limitations, at least in the state of Maryland, and I think in a lot of other states, it's based on discovery of an issue, not when you did the fix and flip. So if a seller has, you know, if a new buyer is in the property for 3 years and they discover an issue, my statue is now 3 years from that time and I could have 10 other properties in that time frame and now all of a sudden I'm screwing myself. So I just do open close at the same time, call it a day.

7:06So that way I know that the liability threshold on that is going to end for the time frame that it existed. Oh wow. Okay. Interesting. So for for someone who's just starting out, then what would be the the starting structure? Do they start with getting a holding company and an LLC for their say they're buying their first rental property? And then what state do you recommend filing both those in? So I would recommend an LLC to start with and I would start in the state that you're in.

7:39I would not get too fancy with it because that's again consumerf facing. You want to have your insurance. You want to have your rental insurance, your umbrella policy, all of that to cover to cover you for worst case. I actually wouldn't go to a holding company next just because you're not going to be very profitable in the beginning. What I would do is I I would do actually a personal trust for your personal assets and I would have those kind of own the LLC and kind of pay into your holding comp into your trust directly. And then as you advance and you have more money coming in, then I would do the holding company as sort of that peace meal between the two.

8:15Okay. Got it. And when you say pay in your trust, like just pay you personally, but it's your list. All your assets are listed in into the trust. Yep. So, and I know people local to Maryland have heard me say this repeatedly. When I talk about trust, I sort of say that, you know, if you think about a backpack, everything you're born in goes into this backpack, whatever it is. So, your, you know, your personal structure goes into that. Your anything that has a monetary value. When you have a rental property, that's equivalent of putting a water bottle in there.

8:46And if you don't have it in a business structure, when you get sued, the idea really is that I'm taking a knife and I'm pierce just kind of stabbing inside the bag. If I pierce the water bottle, all of your personal assets are getting wet. When you essentially have an LLC, that's the same as kind of having a knapsack inside the water bottle and then inside the bag. When you create a trust, what you're essentially doing is you're creating a brand new backpack and you're saying, "I don't own this backpack. It actually belongs to my child. It belongs to my kids. It belongs to somebody else, a third party that I'm gifting this entity I've created.

9:20But while I'm alive, I'm going to control it. They don't get this gift until I've passed. And then what I do is I take all of my personal assets and I put it into the trust. I remove it from the bag I'm born with and I put it into the trust. I leave the LLC inside that personal bag. So now if you pierce the corporate veil or you try to sue me and water spills into my personal assets, there's nothing in that bag. It's all in the trust because I don't own the trust. It's actually just I control it. You can't really jump from one bag to the other unless you have a lot of proof that I was trying to avoid a lawsuit.

9:54Got it. Okay. So, you So, for just an example then, you're driving down the street, you accidentally or you get in a car accident and you're found to be at fault personally. Mhm. If you have a trust, that's your your personal property is owned by if it's owned by the trust, your your personal home would be protected in that case. Correct. Yes. My home would not be impacted because I don't own my home. So, if I'm at fault myself, only the items in my personal bag would be responsible.

10:28And for the lawyers listening to this, I do realize it's a lot more complex than that. I'm just, you know, narrowing it down. There's lots of paperwork behind all of these assets. There's types of trust, but that's essentially the idea is that on paper, Diana Khan doesn't own anything. Yeah. How complicate for people who we just got our trust completed. It was long overdue. But how how complicated should it be for somebody to expect, you know, when they're setting up a trust? If you're working with the right lawyer, it's really not that complicated.

11:00We just need to know all of your assets. And as long as you have that pretty well documented, your lawyer really should be doing most of the work. And then you should work with a good CPA that knows what they're doing. And you know, CPAs and lawyers and really anything are not all oneizefits-all, right? At least for trusts in the state of Maryland, just to kind of scare people, is like every lawyer can write a trust. We're not really required to like have a lot of knowledge, but they're the most litigated. So, if your lawyer has never written a trust before, they're certainly not going to write a good one for somebody in real estate industry.

11:32So, it's the same thing with CPAs. You don't really want to work with CPA that focuses on, I don't know, veterinary clinics because they're not going to know the structure or setup that's going to work with the high liability structure of, you know, rental income. Yeah. Got it. Okay. And then one last question on on entity formations. Do you ever recommend a series LLC? I I really don't. I feel like, you know, I have I have some people who have done it. I feel like it's an outdated antiquated way that investors used to do it.

12:05I think now it's there's a lot of more different ways we could do it that's taxed easier and looks better for your taxes. I know that investors used to have them a lot. I don't necessarily think they're a horrible idea. I just think that there's other better ways out there. Got it. Okay. Yeah. Yeah. Well, you agree with my last attorney guest then because that was one thing he was emphatic about is do not ever set up a series LLC and he said it was going to be a nightmare for you. But sounds like you're not quite as emphatic, but it but you do agree with that as well.

12:38I mean, listen, it's it's a I feel like I can't as a lawyer ever tell you there's one way to do things because the truth of the matter is you're going to come in my office for a few days and then you're going to leave. And if you're not practicing what you're supposed to be doing, no system's going to work. It's like a CRM system. It's the same thing, right? Like every CRM works as long as you're working it. And if you have a system that's not going to work for the way you're doing your business structure, I can set up the most safe thing in the world and it's not going to work for you.

13:09Yeah, that makes sense. And across all your real estate investor clients, what are the biggest mistakes that you see like pop up and that have caused the biggest heartache for for landlords and and maybe it's again it's different for short-term versus long-term rentals. Gosh, you know, a lot of the time it's it's a lot of I think at least in Maryland where I am, there's just a lot of issues with not having the the proper entity structure and waiting too long. I think that's something that we all have sort of me included.

13:42I'm I'm going to put myself right out there. I did not expect to have 100 rental properties, right? Like I didn't expect to grow that fast. And I think we just kind of tumble and tumble and tumble and next thing you know, we're like really big. And I think nobody expects it. It's really you can go five years be like this and then in a year just kind of curtail. And people don't set themselves up until it's too late. And I think don't wait. That's the best advice I could do. Spend the money up front. Invest in yourself. Believe you're going to do it right. And then just do it right before problems arise, whether or not it's short-term or long-term. Yeah, that makes sense.

14:14Yeah, that's a great point too on on the scaling because I think everyone everyone obviously starts with their first property and then you know you think oh my goal is if I get 10 of these I'm good to go and then you get to 10 and you're like this was fun like what if we do 20 and you know then it grows from there. So as people scale it it feels like to me like the risk level always goes up. I'm like you know I can do more I don't necessarily need to do more. Am I just creating more liability for myself? Are there different things you think people should be thinking about, landlords or or rental property owners should be thinking about with five properties as opposed to 50 or 100 properties?

14:57I think just scaling, right? Like when you scale anything, you need to think about how to make your life easier. And that's looks very different at five properties than at 10. You know, self-managing five properties pretty easy. You want to get to 20, self-managing is not going to work. And I think you have to figure out what are your values as you grow these, you know, your investments. What are they? And always check in with them because at five versus 15, it's very different. And I just I see a lot of investors get into this industry and they're like, "Oh, I can do failure to pay rents. Like I can go to courthouse all day." And I'm like, "Why would you want to?" And they're like, "Well, you do it." And I'm like, "Yeah, but I have a law firm.

15:31I have staff." You know, like as somebody who's doing these for a living, like what are your values? What are you doing this for? Are you doing this because you do want to spend, you know, 3 hours in courthouse and bulk file 100 failure to pay rents or do you want to just be making passive income and retire at the age of 50? And neither answer is wrong, but figure out what your value structure is and base your business structure and your rental investments into that structure. If you're not really doing that, you're not investing in the right type of portfolio. You know, short-term rentals work really well if that's the value structure that you want to have.

16:05Long-term rentals work really well if that's the value structure you want to have. I'm only 36. I want to retire at the age of 50. For me right now, equity building is more important to me than having lots of money in my bank. And the reason being is cuz when I'm at 50, I want to be holding lots and lots of rentals and just living off of that, retiring off of that. Yeah. Living off rentals. There you go. There you go. That that's such a great point though because I see the shiny object thing pop up so much like especially with new people.

16:37You talk to them and you're like so what are you investing in? Well, anything that's a deal, you know, and then they'll buy one office complex, one flex space, one commercial property, and then doing a flip at the same time and don't really have a system for any of it. They're just kind of flying by the seat of their pants. But it's such a great point that like figure out the end game and then align your systems based on that. It just it it makes a world of difference I found. Yep. I think there's a lot to be said, sorry.

17:10There's a lot to be said about do a little bit of everything. Figure out what you like. Figure out what you're good at. I'm not turning you away from that. You know, there's I wouldn't have known I was good at commercial until, you know, I bought my first, you know, huge industry commercial building. You don't know until you try. But if you know, give a commitment that's in line with your values and stay long enough to figure out if you're good at it. But don't stay over that.