Estate Planning with Limited Liability Companies and the Problem with California

In my estate planning practice, in certain circumstances, I utilize limited liability companies as a means of transferring investment assets, including real estate, to the beneficiaries under the client’s Last Will and Testament or Revocable Living Trust.  Aside from asset protection (protection from creditors and other third party claims), I recommend LLCs to avoid probate in States other than the State (i.e., Washington) that the client resides.  For example, if a client lives in Washington but owns a condominium in Sunriver, Oregon, when the client dies without proper planning, the personal representative will have to initiate probate in Washington (obviously) and in Oregon where the condo is located.  This can substantially increase the cost of settling the client’s estate.

So, if the client is renting out the condo to others in addition to using it as a vacation home, I recommend placing the condo into a limited liability company.  This “transmutes” the ownership interest from a real property (tangible) interest into a membership (intangible) interest.  Under Washington law, an intangible ownership interest follows the owner, not the asset.  So, by virtue of placing the condo in the LLC, the client’s estate will avoid probate in Oregon (and maybe even in Washington if the client set up a revocable living trust).

Which brings us to California.  Under normal circumstances, I would again recommend placing a rental property into an LLC for the reasons highlighted above.  However, California assesses a $800 franchise fee (tax) each year for the privilege of operating a business in California, which makes the idea of setting up an LLC cost-prohibitive.  Does the client really want to pay $800 a year for liability protection and probate avoidance?  The following article further describes the application of the California franchise tax and how one business was able to avoid paying it.  The arguments presented in this case wouldn’t likely apply to renting out real estate due to the necessity of actual property management in these types of cases, but it’s worth noting that there is this additional fee.  There are alternatives to avoiding probate in California (and one does not want to go through probate in California due to the high fees involved in probate proceedings), so if you own property in California and wish to avoid probate there, please contact my office to schedule an appointment to discuss your options.