Shawn McBride interviewed with Holly Signorelli, CPA (also known as The Money Therapist — www.moneytherapist.com ) about LLCs, Real Estate Investment and other issues on November 16, 2016.
You can find the full interview here: https://www.facebook.com/hollysignorelli/videos/10210455145955883/
Holly: Hey. Here we are. Hi everybody. This is Ask Holly Live. I’m Holly Signorelli, The Money Therapist, helping business owners save taxes, and then put that money into tax deductible investments for your future. I’m here with Shawn McBride, my very good friend who is an attorney, and a CPA, and has an excellent book called Business Blunders.
R. Shawn McBride: Hey there. I’m excited to be here.
Holly: Hello again. I’m going to get the volume up a little bit here. Okay, let’s talk about what is your biggest blunder in your book? I love this book, by the way, because it’s so easy to read. Anybody who has a new business or a small business or a growing business, they can just really read through this very easily. You don’t talk over people’s heads like a lot of people do, and that doesn’t help people.
R. Shawn McBride: Right. Exactly. You know, it’s hard to pick just one blunder. People always say, “What’s the top blunder?” They weren’t really ranked when I built the book. It’s ten things I kept seeing too much of.
R. Shawn McBride: One thing I think a lot of people are in the dark on, it really shocks audiences when I speak, it’s the fact that just because you form an LLC or a corporation doesn’t mean you have liability protection.
R. Shawn McBride: You can still get your personal assets attacked. You can have a problem, because people will come in and say you didn’t run the company properly. You didn’t keep the right records. You weren’t treating it as a business, accounting issues come in there.
R. Shawn McBride: A lot of people are surprised that they think, “Oh, well I just formed my company. I filed with the state. All my assets are protected. I don’t have to worry. I can sleep at night.” It’s not really that simple. That’s an important one for business owners to think about. Build those LLCs and corporations, but build them correctly to really protect your personal assets.
Holly: Yeah. I work with a lot of people that have multiple LLCs, which I think is important because of lawsuits and things like that. Also, just to keep them separate. Then, they are always pushing money back and forth between other entities. Is that a bad thing to do if it’s set up properly, or should it just be avoided altogether?
R. Shawn McBride: No. It can be done properly, but that is the key. It has to be done properly. You can have separate companies, and the law recognizes the fact that you may have independent businesses and sometimes they’re affiliated or to uphold that. Just because you build a lot of boxes, also, doesn’t mean necessarily you’re going to get that protection. A lot of people think, “Well, if I hold residential real estate,” I see this a lot, “I’ll put one real estate company in one LLC. I’ll put another real estate company in another LLC. Another piece of real estate in a third LLC.” Don’t worry about is it necessarily going to say those are three separate businesses, therefore, if something happens at LLC on property one, property three is safe. It’s not that simple. It takes a lot more planning and work to really make that kind of strategy work. You need to be thinking about how do you do it properly, and how do I keep the right records, and how do I build something that the court would recognize if that worst case scenario would happen, which is what you’re really trying to plan for.
Holly: Yeah. I see that a lot as well, because a lot of entrepreneurs like to have some kind of real estate. A lot of them don’t actually set up an LLC, and they should. Typically, I find it with a partnership, too, because maybe the entrepreneur wants to have the real estate, but they want to bring in a partner either to finance it, or maybe they’re financing it and somebody else is working in it. What I kind of see is a trend, is people don’t want to put more than ten properties in an LLC. What do you think about that? Should there be one for each one, or is there a reason just to have ten in there?
R. Shawn McBride: Well, I think you need to figure out what the businesses are. Where you’re going to draw the lines and the contours between them. Some people will put each one in a separate LLC. You can do that, but you may not be getting liability protection. Now, you’re paying state fees, you have additional filings, expenses, and you’re not getting the desired result.
R. Shawn McBride: It really comes to, how are the assets accumulated? How valuable are the assets? Is it ten inexpensive properties, or is it ten high end hotels? Are they being run separately? There’s a lot of argument if I have a portfolio of hotels, each hotel may really be a separate business. Then, it may make sense to treat each hotel as a separate corporation or LLC.
Holly: Yeah. If it’s given that as potential liabilities?
R. Shawn McBride: You know, potential liabilities. It’s got its own customer base. Each hotel is going to have a unique location. It’s going to have different benefits, things. It’s probably going to have its own management team. There are a lot of people involved. It’s being run as a business.
Now, if I have a bunch of rental houses, and I put each one in a separate LLC, now I’ve got a three hundred dollar filing fee for each if we’re filing in Texas. Plus, the additional paperwork. A court is probably going to come in at some point, and say “If somebody got hurt on one of the rental properties,” they’re going to say, “How’s this rental property different from that rental property? Were these really different instances?” Probably run by the same management team. Probably the same review of the credit. Probably the same process for renting. They’re probably going to say, “These are all one business. We’re going to bring them back together anyway.” You really need to look at what could happen. Let’s say, “How do we defend these as being separate businesses?”
Holly: Right. Yeah.
R. Shawn McBride: Are we including county records? Do we have separate financials? Are we blending these businesses together? You really have to look at how it operates, which is where you need to get some other people involved to say, “How does this look from an outside perspective, and is it being done correctly?
Holly: What about the entrepreneur, and I’ve done a ton of these, where they buy their own building and occupy it, you know? Couldn’t they have a separate LLC for their real estate, because sometimes they’re also renting some rooms, but they’re also occupying it?
R. Shawn McBride: Yeah. Well, definitely, if you’re renting rooms to somebody else, then now you’re starting to say, “Okay. We’ve got third party liabilities. What if somebody gets injured in that other tenant’s space? Do I want to separate that from my business?” If we don’t separate that into a separate company, you’ve got your main business over here, you’ve got the separate business over there, and from a liability perspective you’ve now merged them together. If somebody gets injured on that rental property, your accounting business, or consulting business, or paper supply business, whatever business you’re in, now those assets are being attacked.
R. Shawn McBride: Here’s where you have a place where you have two differential businesses, different types of operation. You probably, definitely, want to split them into different entities.
R. Shawn McBride: I, also, know the huge planning opportunity by separating the operations from the real estate holding. A lot of times as people mature or the business matures, it gives you a planning opportunity, because you can treat the real estate portfolio, buy or sell that. Do a 10-31 exchange – exchange it for a different property, separate from what you’re doing with the business. You may sell this business, but keep the piece of real estate or vice versa. Keep or exchange the real estate and not sell the business. You’ve got a lot of planning opportunities here that you’re missing.
Holly: Yes. For everybody out there, the 10-31 exchange is an opportunity, when you go through a third party, and you sell something the money goes into kind of an escrow account, right? Is it called an escrow account, or just somebody else is handling the money? Then, you buy a new property, so it has to be alike, like real estate to real estate something like that. A lot of people that do real estate investing, they don’t know this. They’ll sell a property, and they’ll make a lot money. Then, they’ll put all the money into the next real estate. Then, they owe a ton of taxes that they had no idea, because they’re like “Well, I reinvested it.” Guess what? You still have to pay taxes. I’ve seen people get really burned by not knowing that rule. You don’t have to know everything out there, you guys, about 10-31s. Just know that if you’re selling a property, and you’re going to reinvest it into another property, then you need to talk to your CPA or attorney about the 10-31 exchange.
R. Shawn McBride: Yes. It was originally designed for property A, property B and the owners would actually do a physical exchange. The IRS has been a little bit generous in this case. They actually will allow some timing differentials and uses of escrow and other things. They can be planned. The important thing is, yes, if you have a long term holding strategy on real estate, you may want to mix in there this idea of at some point I’ll exchange it for another piece of real estate. That’s something, planning wise, you want to think about. That’s another great reason, back to the original question, of why we separate these entities out. If we separate them, we’ve opened this planning door where we can go one direction or the other.
Holly: Another strategic thing, too, is a lot of people with real estate don’t realize that there’s an active or a passive participation. For everybody out there, if you’re active, you are literally actively involved. You don’t have a management team. You’re taking care of any problems with the real estate. If you’re passive, you’ve just put money into, like sometimes people put money into an LLC, but somebody else is taking care of it, and you’re just getting a dividend. What a lot of people don’t realize is if you have some passive losses on your tax return, which a lot of people do, you can’t take those losses, because you’re not actively involved. If you have passive income, that passive income can go against those passive losses. It’s kind of like free money. If you’re one of those people out there that has passive losses on your tax returns and that you’re not being able to take.
Even if you don’t know enough about this tax wise, we don’t have to get into the tax rules, you probably know, because you’ve done your tax return and you can see that there’s some losses that you couldn’t take. Then, what you would want to do is invest into passive real estate through someone else, so that you can at least get some free money here, because you’ve gotten those losses already.
R. Shawn McBride: Exactly. It is a part of the portfolio planning of how do you play all these financial pieces together. That’s why you need to get the team involved early in the process. The more you think about these things at the beginning when you’re starting to invest in the real estate, starting to set your company up structuring this. If you’re looking to the fact, “I may have passive income. I may have passive losses. How do I pull these together?” If you’re fortunate enough to have passive income, then an investment in real estate that has passive losses may be more palatable to you than somebody else, because you can actually use them for a tax benefit by offsetting the income. You can play based on your particular strategy.
Holly: Yeah. For everybody out there, too, just remember we’re trying to give you the broad scope of everything. Don’t worry about memorizing everything. It’s just understanding. Tracy, I see that you said that you wish you had thought of the 10-31 or knew about it six months ago. That’s okay. You’re not alone. I can’t tell you how many people don’t know about it. Now that you do, you’ll know to reach out next time when you’re swapping a property.
R. Shawn McBride: Exactly. You can use it as a more powerful tool next time you’re involved in a potential transaction, or you’re looking to your future. It’s a great planning tool to have in your portfolio.
Holly: Yeah. Let’s talk about on the LLC. A lot of people set up an LLC, and they don’t realize that they have to actually decide what kind of LLC to be. For everybody out there, when you have set up an LLC, if you don’t decide what kind of LLC to be, then you’re going to basically be taxed just like a sole proprietor. You’re going to have to pay not just federal tax, but social security tax. 15.3% on top of your federal rate for being a single member LLC, which means that you did not incorporate into a C-Corp, an S-Corp, or a partnership. I know a lot of people, they’ve heard of S-Corps, because they’re always saying, “Should I be an S-Corp?” They don’t know what it is, but they’ve heard about it. S-Corps are for small business where you’re actively involved most of the time. It might be a typical small business that you’re making … What is it? What is the income amount now? Is it ten million or less, or is it more than that?
R. Shawn McBride: I can’t remember the numbers off my top of the head, but you move up the tax brackets pretty darn quickly these days.
Holly: Yeah. Exactly. If you are setting up an LLC, just remember that there are several different types of LLCs to choose between. It really depends, like with real estate a lot of times it’s best to be a partnership. It’s always good to talk to somebody first, because a lot of times people come to me at the end of the year, and they didn’t set it up right. Then, they have to pay a lot of taxes, like ten thousand dollars more in taxes than they need to.
R. Shawn McBride: Right.
Holly: Just remember that if you have a new business out there, you may not be ready to be on retainer yet. Pay for that hour and find out … The paying for the hour will save you tens of thousands of dollars or even just thousands of dollars.
R. Shawn McBride: Yeah. That’s right. I tell people a lot of times my highest value added per hour is those initial hours. First hour or two hours, you can find some real problems. Really influence the entire structure of how a deal’s going to go, or how somebody is going to run their business. The first one or two hours can be extremely valuable in setting the right path for the future.
Holly: Yeah. What’s your next blunder? I know you said you didn’t do it in order, and I get the same thing with my book, because it’s nine emotions that cause people to do very bad things with their money. Everybody always asks for my top three. What is one of your favorite ones to talk about?
R. Shawn McBride: You know, I think, one big one is record keeping. A lot of people … It’s a boring subject. Who wants to keep records? Who wants to worry about what’s going on in the business? Guess what? Most of us have an exit plan at some point. At some point, we’re exiting our business. Usually, we’re going to sell the business. For those people that buy and hold until they die, your family is going to have to come in and run that business. In either case, you’re selling to a third party or letting it go through your entire lifetime through your family. Somebody’s got to step in and run that business. In the acquisition situation, they’re going to do what they call due diligence, which is essentially an exercise where they come through and they look at everything. If you don’t keep great records, you’re going to hurt your price. You’re getting less money. It’s going to cost you dollars out of your pocket. Of course, if you want to keep it until you die and it transitions to your family, if you don’t have records in good order, they’re probably going to have some operational issues stepping into business.
Holly: Yeah. I see a lot of that. With life insurance, too, with businesses where the spouse didn’t get the money that was meant to be for her, so that they could buy the spouse out of the business whether it’s the husband or the wife. It ends up going to the business, and that wasn’t even the original intention.
R. Shawn McBride: Right.
Holly: Now, a lot of times with any kind of partnership or any business that you’re in with different partners, a lot of times people don’t take the time to actually really talk about it. We send stuff to attorneys, and we can’t even read, I can’t really read those contracts. Sometimes we just have to talk one on one with the people in addition to the contracts to make sure everybody’s on the same page.
R. Shawn McBride: Right. Partners are rarely going to leave at the same time. A lot of people go into partnership together saying, “Great. We have a great collaboration. We’re going to make a lot of money together.” They go out, and if it’s successful, they do start making money together. They have different lives, different needs in their families, different personal situations. Very rarely are both partners going to come in and leave at the same time, so we’ve got to build plans that allow them to leave at different times and keep the business in good condition and maximize that value.
A big thing I’ve been working on with a lot of families with recently, kind of just tangentially off what we’re talking before is, what happens to the value of the business in the event that the key manager or the owner dies, gets disable, they have a car accident? What happens to that business? Really a lot of times people don’t know. Maybe you’re star salesperson is suddenly out looking for a new job. Somebody is out taking all your customers, because you didn’t have a comprehensive plan in place. You can do some planning on the front end to make your business stronger in the event something happens to somebody on the management team. Have a plan in place. Let your employees know everything is going to be okay, so that value doesn’t immediately erode. You have value to give to the family.
Holly: Yeah. You know, the company that I had before, I had all of that in place. I mean, I do this for a living, but I can understand why a lot of people don’t even think about it. They even do their wills, but they don’t include their business. Even in my business, I had included that my key employees that if something happened to me untimely would get a percentage of the sale. It was going to be a small percentage, but they would be motivated to stay on, so that the company could be sold properly. I think those are things people just don’t think about, but if that’s your life’s work and something happens to you, you would want your beneficiaries to get that gain.
R. Shawn McBride: These are minor tweaks that you can make in your things. A small percentage to an employee. Just having a plan in place to have others to take over the business if something happens to you. It may be the difference between all of your employees fleeing, and them saying, “We love the company. We like working here. We’re going to stay here.” That can be the difference in the value. I mean, that can be a difference between here and here. Unfortunately, in a worst case scenario, you can have a company completely evaporate. You lose your star salesperson. You lose your operations person. Then, you get in such disarray that the company falls apart, because of an unfortunately accident to the owner. Then, there’s nothing left for the family, and that’s what we want to avoid. We want to protect this for everybody.
Holly: Yeah. Everybody out there, you need to have backup plans. Sometimes people are afraid to have a backup plan, but it actually makes you feel better when you do have wills and estates, an exit plan if you and your partner break up. I see this all the time. Every year people come in, and they love each other, they’re best friends, they’re going to start this company. By the end of the year, they can’t even come to the office at the same time, because they hate each other guts. It’s all about having an exit plan, because when you have an exit plan you’re not creating an event. It’s just that it’s so common that at least you’ll know if something happens that everybody’s going to be okay, because you have the plan. When people do that, and they do end up going their separate ways, they might not be talking, but at least everybody gets what they’re supposed to get.
R. Shawn McBride: You know, here’s a funny thing. I always tell people to protect the wealth. That’s always the goal, right? Make sure that money in the business stays in the business.
R. Shawn McBride: Here’s another thing, just by having a mechanism to end a dispute, whether it’s a buy/sell where one buys out the other, sell it to a third party at an auction, a lot of different ways you can do a buy out or a rearrangement of the owners to end a disagreement. Just by having that mechanism, I’ve found companies are much more likely to work to a resolution. They don’t go all the way there, but they don’t end up in the courthouse fighting each other for years completely destroying the value of the business. They keep the business moving forward. Even though you may never use it, if you need it, you want to have a mechanism there. You can renegotiate something different. If you’re still talking at that point, and you have a little bit of a disagreement, you find out you have a different life plan, you can do something different than what’s written in your document. You’re not stuck with it, but having something there that keeps you out of the courthouse keeps everything moving forward. It can make a tremendous difference in how this outcome plays out.
Holly: Quick recap today. If you have a company, even if it’s just a little bit profitable like even if it’s fifteen thousand or thirty thousand, I know that it will still benefit you to have an LLC. Make sure you set up the kind of LLC that you want. I do have a very inexpensive course on my website at www.TheMoneyTherapist.com . It’s one hundred and fifty dollars, and it’s seven modules on how to build and sell a business. You can also have a consultation with me or Shawn. Where might they find you Shawn?
R. Shawn McBride: The best way to find me is www.McBrideForBusiness.com . That is my strategy firm, and we work with a lot of clients on setting up plans and strategy. I also have a law firm that’s separate from the strategy firm. I do some speaking. If you go to www.McBrideForBusiness.com , get in touch with me. We have some, also, helpful tools there. If you go to www.McBrideForBusiness.com/thankyou , you can get an evaluate your business checklist where you can see where your weak spots are and what to do better.
Holly: Excellent. Amy says that, “Shawn rocks.”
R. Shawn McBride: I always appreciate people who are fans. I hope we’re helping someone …
Holly: All right everybody. Thank you for joining us today, Shawn McBride, attorney and CPA. I’m Holly Signorelli, The Money Therapist. We’ll be back on Friday. Bye.
R. Shawn McBride: Bye.
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This posting is intended to be a tool to familiarize readers with some of the issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. Each case is unique. Past results do not guarantee future outcomes. This article should not be treated as legal advice to any person or entity. FreeImages.com Photographer Donna Mac.
Shawn McBride is the Chief Innovation Officer at McBride For Business, LLC. His signature keynote, The 3 Laws of Empowerment (www.rshawnmcbridelive.com ), gives audiences an entertaining look at how they can prepare, plan and protect themselves. You can reach R. Shawn McBride at firstname.lastname@example.org or (214) 418-0258.
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