Creative Combinations Protect Assets While Reducing Taxes

Topics: Asset Protection


What could we accomplish if we combined trusts, corporations, and LLCs? Let’s start by creating as much privacy as possible by placing all real estate properties into separate Illinois-type Land Trusts. Land trust are cheap and easy to form. Moreover, the U.S. Constitution and 100 years of case law support their validity in America. These can be formed under the laws of several States, but Section 55-17.1 of the Code of Virginia would be my first choice. Placing property into a land trust would create privacy by getting the owner’s name out of the public records. This move would probably create a lot of confusion in the enemy camp.

HOW WOULD A LANDLORD PROTECT HIMSELF? Suppose a Delaware corporation and a Florida trust formed a Nevada LLC to hold the land trust’s beneficial shares. Let’s suppose these represented rental properties situated in California that it Master Leased to a California management company who sub-leased it in turn to tenants. Periodically, the rents would be remitted to the LLC under the Master Lease. The LLC would pay the expenses of ownership and financing, and distribute the balance to its owners.

By Master Leasing the property to a professional management company, rather than simply employing it as an agent, no agency is created. Thus the owner isn’t automatically liable for the actions of the Lessee who sub-leases the property to the occupant-tenant. Nor is the Master Lessee the employee of the owner. Thus, the owner escapes employer liabilities that might be created by OSHA, Payroll tax obligations, Workers Compensation Insurance, etc.

Suppose the California tenant were injured because the landlord installed dead bolt locks and the paramedics were thus prevented from entering to render aid. Let’s assume that the tenant sues the landlord despite the fact that he would only have been complying with State law. If the above described title and leasing strategy has been employed, because of the diversity of jurisdictions, the Tenant might be forced to pursue the LLC in Nevada, and if he named the Delaware corporation and Florida Trust, he’d probably have to take his complaint to federal court. That could be prohibitively expensive. If he won, he’d still be several layers away from being able to attach the property held by the LLC or its owners.

The court system is a lot like a poker game. The winner relies as much on having enough money to be able to stay in the game as on holding all the right cards. By raising the costs and lowering the potential rewards of frivolous law suits, landlords can take a giant step toward protecting personal assets. This presupposes that the owner has acted responsibly in managing and maintaining his rental property to keep it compliant with the minimum housing and safety codes.

HOW WOULD TAX SAVINGS BE REALIZED? The Delaware corporation would be named the Managing Member of the LLC, and receive its income characterized as Active income. A corporation isn’t subject to payroll taxes. On the other hand, it would pay the staffing expenses of officers, directors, staff, etc., and provide its employees a tax-free fringe benefit package. It would hold the balance of its profits as relatively low-taxed retained earnings. When all income is earned outside Delaware, corporate earnings aren’t taxed at State level by Delaware.

Because the Trust would be a passive investor in the LLC, without any management involvement, it would receive its share of the rents and pass them on to its beneficiaries as passive earnings, not subject to payroll taxes. Neither individuals nor trusts pay State income taxes in Florida.

The shares of the Delaware corporation and the Trust could ultimately be placed into Living Trusts. Upon the death of either the owner of the Trust or corporate shareholder, the value of the assets of the LLC could be discounted up to 40% or so by virtue of the fact that the estate would be comprised solely of shares, not the assets themselves. If the LLC agreement so stated, it might be continued by the surviving owner. The decedent’s heirs would have inherited only non-voting shares, not the assets themselves. The tax code provides for reduced estate asset valuation based upon marketability and control discounts. These discounts are based upon what a bidder at public auction would pay for non-voting shares in a Nevada corporation that was run either by a Delaware corporation or a Florida trust.

HOW WOULD THIS ENHANCE OPERATING EFFICIENCIES? When a landlord frees himself of day to day management concerns, he can concentrate on acquiring and financing more properties. It’s often hard for entrepreneurs to let others manage their properties, but this can restrict overall profitability. One way to resolve the dilemma is to sign up another entrepreneur who understands the property business as Master Leasee of the property. In some States, using a Master Lease with right to sub-lease circumvents State requirements that a fee property manager be licensed. That enables the owner to use the best qualified manager for his property, and to be able to focus more intently on improving his balance sheet and net worth.

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