Protect Your Assets

Mike Hambright: Welcome to the FlipNerd.com podcast. This is your host, Mike Hambright and on this show, I will introduce you to VIPs in the real estate investing industry as well as other interesting entrepreneurs whose stories and experiences can help you take your business to the next level. We have three new shows each week which are available in the iTunes store or by visiting FlipNerd.com. So without further ado, let’s get started.

Hey, it’s Mike Hambright with FlipNerd.com. Welcome back for another exciting VIP interview, where I interview some of the most successful real estate investing experts and entrepreneurs in the industry to help you learn and grow. Today, I am joined by Attorney Matthew Mullhofer who has extensive experience in many areas including estate planning and asset protection. Today, Matthew is going to share some great advice and tips on how to protect your assets. So before we get started though, let’s take a moment to recognize our featured sponsors.

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Hey, Matthew. Welcome to the show.

Matthew Mullhofer: Thanks, Mike. Great to be here.

Mike Hambright: Yeah. Glad you’re here. This is a real interesting topic that I think a lot of folks don’t think about until it’s too late. Interestingly enough for real estate investors, we buy houses from a lot of folks that you can tell didn’t have a will in place, or there is a lot of family drama that happens afterwards. So, we should know better than anyone to be structured properly to protect our interests but very often, we’re not. Before we get into that, why don’t you tell us a little bit about you and what your firm does?

Matthew Mullhofer: Thank you, Mike. I’m an attorney licensed in the state of California, by the State Bar of California. I’ve been practicing law here since 1999. My offices are in Santa Ana which are in Orange County, California. Our focus of our practice is asset protection planning and estate planning which encompasses the formation of entities to help our clients protect their assets against lawsuits, judgments, creditor claims and frivolous actions against them.

Mike Hambright: OK. Talk a little bit about, I guess… I guess we could talk about what the right way to set up. Some of the mistakes that you see real estate investors make and then, we can maybe back into folks that are already out of the chute, and if they didn’t get things structured properly, how they can go about doing that? So if you’re getting started, what do you see as a lot of mistakes that new real estate investors make?

Matthew Mullhofer: The keyword is new investors because often, they don’t know if they are doing this as a full-time commitment, or a part-time commitment, or as a hobby. If they are taking the approach of just doing it as a hobby, they are really going to run the risk of potentially losing a lot down the road if they don’t structure their assets and their entities ahead of time. If one is looking to purchase a property and hold on to that property as a long term investment property, we always recommend setting up a business entity ahead of time, prior to getting into escrow or getting under contract for that purchase. Usually, a limited liability company works best.

Mike Hambright: OK. I think there are a ton of folks that ask me all the time if they should set up an LLC or an S Corp. And I know, in all honesty, I’ve had attorneys adamantly believe it should be one way or the other, and maybe that differs a little bit by state, but how do people answer that question? How do you answer that question?

Matthew Mullhofer: Well, if the property invested is a long term hold and they’re going to continue on managing and maintain that property, our rule of thumb is the limited liability company is the better entity. It has better case law that protects the owners of the company in case of a lawsuit, as well as minimum annual filing requirements for the company. Corporations require annual minutes being drafted and placing in to corporate record book of the company each year. The LLCs don’t have that requirement. They do have other corporate formality requirements, but they are much more easier to maintain. And for that note, the investor doesn’t have to worry about the company each year as far as maintaining its minutes.

Mike Hambright: Right, right. Are there any differentiations that you advise people on whether they are partners with somebody that they’re not married to or not related to necessarily? Does that help determine the entity type?

Matthew Mullhofer: Yes, absolutely. So, if you have two investors that are friends, or not husband and wife team, typically, the LLC is the better way to structure that investment. Each individual can hold a membership interest which is like a share certificate or equitable ownership of the company and it is based on 100%. So, each member can hold 50% on each of their ownership interests and it helps keep it clearly a business ownership transaction. It doesn’t co-mingle each owner’s other personal assets into that company. It keeps everything separate so it’s a nice way to provide protection and a proper way to own the asset, as well as tax reporting requirements as well.

Mike Hambright: OK. I don’t know if you have these in California, but do you have much experience with a series LLC?

Matthew Mullhofer: In California, we do not. We are familiar with them. I know Delaware has that type of legislation on their books. We have formed series LLCs in the past for clients, and they do work well in helping the investor that has several properties and not have to set up several LLCs or corporations to hold each property. We do preach the fact that it is very good to put your eggs into separate baskets so that you can protect each property on its own. And, the Series LLC does help provide that type of protection.

Mike Hambright: OK, OK. Talk a little bit about why people would get a legal entity that is outside of the state that they operate in. I know Delaware is probably the easiest example because it is business friendly but just talk about… There are folks that have entities in lots of other states that are not where they reside. Just talk about the pros and cons of doing that.

Matthew Mullhofer: Sure. The pros are many times people can seek to set up an entity outside their home state. A lot of times the reason are, as you just mentioned, for Delaware, is a business-friendly state and their legislation protects the owners of these entities more so than other states. Other reasons are some states provide less cost to maintain the company so their franchise tax fees are quite a bit less than a majority of other states. So, with the investors wanting to maintain the asset and cut down on cost annually to bring in more profits, that is a good way to accomplish that.

On the con side, sometimes, it might not be the best idea for local and state tax purposes. Throughout the country, as you mentioned, each state has their own set of laws and so, it is important to follow the state laws that are in effect in each state. The other con would be, if you owned a company out of state and you’re being sued in your home state, that company needs to qualify itself to do business in your home state before it can defend itself in your home state. So, there’s other court or litigation requirements that the owner would need to follow if they have an out-of-state corporation and that corporation is being sued in their home state.

Mike Hambright: OK. So, what do you generally advise people to do if they’re going to operate in one state to set up their entity in that state or what is a situation where you would advise people to set up somewhere else?

Matthew Mullhofer: So, I’m in California. A lot of our clients will hold real estate assets outside of the state of California. A lot of them have properties in Florida, Texas, New Mexico, and Arizona. And so, we always sit down, consult with the client, analyze their situation. Everybody’s situation is always a little bit different. Unfortunately, there is no perfect cookie-cutter approach to each method of setting up their entity, and choice of jurisdiction, and choice of states. So, when they have an out of state property, they look to set up an out of state entity, and that’s fine. We do that quite often, but we also advise them that the state of California requires that if you hold assets even outside the state of California, the entity that you choose needs to be qualified to do business in California. California has very strict and stringent requirements on corporate choice of states where you file. And even if you are doing business out of the state, California still looks to have your out of state business qualified to do business in California.

Mike Hambright: OK. So, what are some of the mistakes that you see newer investors making, whether it is cutting corners on costs or doing it themselves? Talk a little bit about some of the things you see that you would advise people to make sure they don’t get themselves into.

Matthew Mullhofer: Sure. The new investor, they want to show the rest of the world out there that they’re in this business for real, so they don’t want to look like they’re doing business out of the back of their trunk of their car or garage. So, the first thing they do is incorporate their business. Again, whether it is a corporation, an S Corp, or an LLC, we can talk about that in a minute, but the idea is to show your third parties, your vendors, your escrow companies, your lenders, title potential buyers, and partners that you’re a legitimate corporate entity. So, the word Inc or LLC behind your company name adds credibility to your business model. So, that’s first and foremost.

Second, if they don’t choose the proper corporate entity and they get into a transaction, they can get hit very hard on state, local, and federal taxes if they don’t have the right entity in place at the time that they enter into a transaction. So, that’s important. Lastly, if they don’t have an entity to protect themselves and they are getting into a transaction, and down the road, they have been sued by that party they’ve done business with and they weren’t incorporated, then they would be sued personally and their personal assets would be at risk if they lose that lawsuit.

Mike Hambright: OK. How does somebody go about deciding what the right entity is for them and talk a little bit about…? Maybe you could share some experience or knowledge on trust, and land trust, and things like that. I’ve had a number of guests on the show and they tend to be very adamant about one entity type, or land trusts, or whatever that might be. But, what are your thoughts on trusts, and land trusts, and other similar entities?

Matthew Mullhofer: We set up all different types of trusts. We do living trusts, revocable trusts, irrevocable trusts, land trusts, and the land trusts are a popular type of entity for the real estate investor that is again, holding a property for the long-term. They want to have privacy of ownership. They don’t want their name all over the public record that they own these ten different properties in a certain area and so, that’s what the land trust provides. It’s really a method of holding real estate with privacy so that you’re name is not all over the public record. So, we use that for many of our clients that have a significant number of properties that they’re holding so that it is easy to set up, it is easy to transfer the property into the land trust. It provides them with the privacy and it doesn’t have the annual cost to maintain the entity as corporate entities do. So, a land trust is a good way to hold a title for our investors or clients that have long term holds and look to acquire more properties.

Mike Hambright: And,share some reasons why, just for those who are listening, why people would want to have that anonymity. I can think of a few reasons but there are some that are very adamant about avoiding lawsuits because people can’t find them if something comes down to that. Frivolous lawsuits, let’s say, but talk about some of the reasons why folks would want to consider that.

Matthew Mullhofer: Right, well, we live in a world where it’s very easy to pull up any information or data on anyone through the internet or any other service that provides investigations. So, many of our clients have reasons for wanting to private or anonymous. We’ve had law enforcement officers that invest and that have sometimes, situations where they have people they have put away to jail that they are worried about knowing where they own assets or where they live. That’s one big reason.

Mike Hambright: Oh, wow.

Matthew Mullhofer: We’ve had some former battered wives. We’ve had some clients who are trying to get away from a bad relationship, and they don’t want the world to know where they live or what properties they own. We’ve had some high profile individuals that have reasons not to want the rest of the world to know where their properties are located, or whether or not they own those properties. Many times, people just want that privacy. We have some clients that have not the greatest family situation, and they might have heirs in their family estate that are looking to find assets and find information about them. The clients just want their assets to remain private and we respect that and we help them to achieve that goal.

Mike Hambright: Sure, sure. I know you’re not an accountant, but how are land trusts treated from a tax standpoint relative to other entity types?

Matthew Mullhofer: A land trust is a pass-through entity. It’s similar to a limited liability or a partnership where the assets are… Excuse me, the income or losses will pass through to the actual equitable owners and typically, whatever the income or losses that would be applied to their own personal 1040 tax return.

Mike Hambright: OK. Are land trusts typically set up where they can own…? How many properties would you advise putting into a land trust?

Matthew Mullhofer: Well, as I said earlier, we don’t like to put all of our eggs into one basket, so we would recommend setting up separate trusts, but again, it goes into the analysis. There is no hardline approach. There is no perfect, cookie-cutter approach. We look at the property itself, where it is located, what type of equity the client holds in that property, what type of liability it might pose, if it’s a risky type of property. Is it a building in a rough area or town? Or, is it a beach front property where you’re using it as a vacation home and renting it out to your friends? Or, is it a piece of raw land out in a industrial area? So, we look at all of those items and so, if you have a few properties where there’s not a whole lot of risk of liability, we might recognize or advise to put those into one trust. If you have one property that has potential liability and it could pose a threat, then we would want to put that property its a land trust all on its own.

Mike Hambright: OK. OK. Talk a little bit about moving properties out of the existing entity. Like, if folks wanted to move it into a different type of entity or a land trust, let’s say, I don’t want to focus too much on land trusts, but into other entities, how that typically works. How easy is that? How difficult is it? If you set something up initially and you make a mistake, how do you unwind some of those things? In my experience talking with attorneys that I work with and even accountants, they sometimes say conflicting things because from the accountant standpoint, sometimes moving properties into a different legal entity will trigger a sale, a taxable event. And so, what’s your general thoughts on how to move properties out of one entity into another?

Matthew Mullhofer: Sure. Each state has different rules regarding real property transfers and the deeding process. Even what they call those deeds, you got a quick claim deeds, you got grant deeds, you got warranty deeds, you got gift deeds; so all different types of deeds for each state. What we do is we have vendors out there that we can record a deed in any of the 50 states for our clients because all of our clients have properties all over the United States. We provide that service to them. So, we get involved in the deed transfer. So, if they have it holding title state their name and they want to get it into their LLC, we’ll look at the particular state where the property is located. We’ll also look at how the title is held right now and then, where it will be held in the future.

So typically, you want to show that the grantor, which is the individual, and the grantee, who is the company and the trust, the new owner, are the same parties and they hold the same proportionate interest. That way you get away from the tax issue of any type of a reassessment or any potential taxable events as far as it being recognized as a sale. Some deeds you’ll want to put no consideration or consideration of $10 on the deed. Again, there, you show the world that there is no actual money being made. It’s just a transfer from the individual into their trust or to their new entity. So, you avoid the tax issues, as well as any local reassessment issues as well.

Mike Hambright: OK. And so, for folks that are looking for… Maybe give some advice on how folks find a good attorney in their market if they’re looking for somebody that can help them with real estate? What are some of the things they should look for?

Matthew Mullhofer: Well, you want someone with experience. You want somebody that does this week in and week out. It’s not something that they just do on the side. You look at their website. Look to see what services they provide or talk about on their website. Do they write blogs about this particular type of law that they practice? And, word of mouth. I often have clients ask me, or referrals from other clients, or clients that will give a testimony about us. That’s easy to do and we put those testimonies on our website, but we also offer client testimonies to new clients. So, do your homework. Do your research. Make sure you’re working with the person that’s competent in that area. You wouldn’t want to hire an immigration attorney to set your trust up for you or help transfer your real estate into an LLC. They are good at what they do, but you want to remain focused on someone that specializes in the area.

Mike Hambright: Sure. I know this differs substantially from state to state, but what kind of changes do you see that are coming up? It felt like things have gotten a little more litigious over the past couple of years. Maybe now that the economy is getting a little bit better so maybe that starts to slow down a little bit. What are some of the changes that you see happening overall for real estate investors and some things that they should start to maybe anticipate?

Matthew Mullhofer: Well, we all know it’s still difficult to get loans and that’s one big thing. Hopefully, that will be changing down the road and that will make the economy get even better. It’s good now, but I think it would be better if the lenders would make it easier to loan money to investors. Our state in California is a very litigious state. It’s very easy to file a lawsuit against someone. We see it all the time and that’s why we preach the asset protection planning. When someone is under attack in a lawsuit they are forced to hire an attorney and pay money to defend themselves against this particular case. And sometimes, it’s a legitimate lawsuit; other times, it’s frivolous. But, the problem in our state is there is no mechanism for making the loser pay. So, if someone sues another person and it’s a frivolous cause of action or claim, there is really no mechanism in there that will cause that person to have to pay for the winning side’s attorney’s fees if they do. So, our state remains a very litigious state. And so with that said, the asset protection planning that we set up ahead of time really assist in helping protect our clients’ assets.

Mike Hambright: OK. If folks want to learn more… I know you put out a lot of good information of protecting assets on your website. Do you want to share your website and some of the things they could see there if they want to educate themselves a little bit?

Matthew Mullhofer: Sure. My website is www.protectmyassets.com and on there, we talk about all of the different entities and all the choices of entities that are out there that we recognize and that we recommend using with our clients. So, there is information on limited liability companies, the trusts, the land trusts, the limited partnerships, the different states like Delaware, Nevada, California, states that we use often; and then, information about estate planning which would include your revocable living trust, durable powers of attorney, last wills and testaments. And so, that’s what we focus on. We try to make it very educational and helpful that you can go on. We also have a blog on there as well. And so, we provide content typically on a monthly basis there and so it’s helpful for our clients to go in and review all of the new updated information.

Mike Hambright: Great. Great. Matthew, any other advice you would share for real estate investors out there that may either need to get started or maybe need to reevaluate what they have?

Matthew Mullhofer: Well, there’s other investors… We talked a lot about the long term holds. There are other investors that want to do an assignment of escrow or a flip where they don’t want to hold that property for a long term. And so, what we recommend in that situation is using an S Corporation because now, you’re acting more or less as a business, and you’re actually buying or signing a contract to another individual. And, the S Corporation works better for that. Especially in California, we have a tax that is imposed on gross sales or gross receipts tax, the LLCs. And so, for large transactions, the LLC owner that is doing that flip or that assignment can pay a lot in taxes. The S Corporation is exempt from that particular tax in California. And so, for the parties that are doing the flips or the assigning of escrows, the S Corporation is the more preferred entity to use.

Lastly, these two entities that we talked about, LLCs and S Corporations should really be owned by a living trust. They shouldn’t be owned by the individual person because if something should happen to that person, they die or become incapacitated, then their family is left with the problems of unwinding everything and having to go through probate court process. If you properly structure the company and then, you have your family trust be the owner, member, shareholder of the company, you’ll avoid any probate case situation or conservatorship situation if the person becomes incapacitated thereby making it easy for your family to take over if something should happen to you.

Mike Hambright: And, you just have some sort of operating agreement that gives managements rights to a certain member of the family? Is that how it works?

Matthew Mullhofer: Absolutely. We prepare the operating agreement. We’ll appoint the individual as the manager. If they want a secondary manager or an officer, we can appoint those people so that it’s easy to maintain and operate the business on a day-to-day basis.

Mike Hambright: Sure. Wow, that’s great. Well Matthew, thanks for sharing all of your great insights today. We definitely appreciate your time.

Matthew Mullhofer: You’re welcome, Mike. Thanks for having me.

Mike Hambright: For those who are interested, we’ll put the link down below, ProtectMyAssets.com. I’ve been to your site. There’s a lot of great information out there just for those who even want to educate themselves a bit. So, check that out. Thanks again, Matthew.

Matthew Mullhofer: Thank you, Mike.

Mike Hambright: Have a great day.

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