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BE DILIGENT WHEN PURCHASING REAL ESTATE

Potente, Business Lawyer and Company Formation

We are proponents for buying investment real estate (commercial or residential). If properly structured and guided by sound principles, real estate investment can provide for excellent tax planning benefits, income streams, long-term appreciation, and succession planning for future generations of your business and family. We highly recommend that you contact your financial advisor and CPA to discuss these great benefits.

However, over the last couple of years, we have seen some disturbing trends with folks who have hoped to take advantage of the sluggish real estate economy (although trends indicate that it is clearly recovering—albeit in a quirky manner).

Please consider the following when investing in real estate:

1. Liability Protection:

a.When you purchase real estate and lease it out to a third party, you expose your personal assets to any liability that may arise from your ownership of the property. For example, if your tenant is sued for an injury that is found to be the result of negligence associated with the property, you, as the owner will also likely be named in a lawsuit. In order to collect on damages, your personal assets (i.e. your personal residence, your bank accounts, investments, etc…) can be attached to satisfy any judgment.

i.In order to protect against this reality, we highly advise you to form a Limited Liability Company (LLC). An LLC is a separate ownership entity that allows you to shield your personal assets from any liability associated with ownership of the investment property. Think of it as the insurance policy that can’t be denied!

2.Insurance:

a. Insurance plays a very important role in protecting your property and the overall investment. Often times, investors will be surprised to learn that in order to best protect the real estate, they need to have title insurance, earthquake insurance, and liability insurance (at a minimum). These insurance products are a must. One of the biggest mistakes people make is when they under-insure the property in order to pay a smaller premium. This is short-sighted, cheap, and just plain stupid. If you can’t afford the insurance to properly protect your investment (or you are too cheap), then do not make the investment. For example, if your property (the land and improvements) is worth $2,000,000.00 and you insure it for $1,000,000.00, you are exposing yourself to a $1,000,000.00 hit if the property is ever destroyed. Don’t ever think that your property cannot be destroyed.  Do not under-insure your investment. It is a complete mistake.

b. Secondly, if a property is purchased in your personal name and then you transfer to an LLC, you must update the insurance the policies to name the LLC as the insured party (or at least an additional insured). If you do not update the insurance policies, a claim may be denied because the insured party (i.e. the LLC) has not been updated.

3. California Franchise Tax Board:

a. Many folks like to buy real estate, form an LLC, and then are surprised to find out about the minimum $800.00 fee that the State of California charges as the “fee” to do business in California. The knee-jerk laymen’s reaction is to say, “Hey, why not form the entity in a neighboring state where the annual fees are far cheaper.” WRONG! You are liable for the $800.00 fee whether you form in another state or not. For the simple fact that the property exists here in California, you are operating the entity here in California (picking up the phone from your California residence easily triggers this), and you are receiving revenue here in California, requires that you must pay the $800.00 fee. If you don’t want to be exposed to California’s fees and taxes, then don’t live here. It’s that simple.

Estate Planning:

a. Death and taxes. You will never avoid these. It amazes us how many people avoid setting up a proper estate plan. If you pass away without a living trust, your estate is headed to probate. This is an awful process that you want your family to avoid. If you have a living trust, you may avoid probate. However, it’s imperative that any assets, such as your ownership in an LLC, is properly titled in the name of your living trust. Easy solutions—though, often ignored.

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