Limited Liability Companies (LLCs) are popular business entities known for their flexible structure and liability protection. One advantage of an LLC is its ability to own property, including real estate, in different states. However, when an LLC acquires property outside its home state, it may be required to register as a foreign entity in that state. In this article, we will explore the concept of LLCs owning out-of-state property and discuss whether registration as a foreign entity is necessary.
An LLC is a legal entity that combines aspects of a corporation and a partnership. It offers the limited liability protection of a corporation while providing the flexibility and tax advantages of a partnership. LLCs are created by filing formation documents with the appropriate state authority, usually the Secretary of State’s office, where the business is established.
Ownership of Out-of-State Property
One of the significant benefits of an LLC is its ability to own property in multiple states. This feature allows businesses to expand their operations and investment opportunities beyond their home state’s borders. However, the ownership of property in a state where the LLC is not registered can have legal implications.
Foreign Entity Registration
When an LLC wants to own property in a state where it is not registered, it may be required to register as a foreign entity. The specific rules and requirements for foreign entity registration vary from state to state, and it is essential to understand the laws of the respective state in question.
The main purpose of foreign entity registration is to ensure that the state can exercise jurisdiction over the LLC and hold it accountable for its activities within its borders. By registering as a foreign entity, the LLC agrees to comply with the state’s laws, including taxation, reporting, and legal requirements.
Factors Influencing Foreign Entity Registration
The need for an LLC to register as a foreign entity when owning out-of-state property depends on several factors, including:
- State Laws: Each state has its own regulations regarding foreign entity registration. Some states may have specific thresholds or triggers that determine when registration is required, such as owning property, conducting business, or generating income within the state.
- Property Usage: The way the LLC utilizes the out-of-state property may influence the need for foreign entity registration. If the property is purely an investment, such as a rental property, some states may not require registration. However, if the LLC conducts active business operations or generates substantial income from the property, registration might be necessary.
- Compliance and Penalties: Failure to register as a foreign entity when required can result in various consequences, such as fines, loss of legal protections, and inability to enforce contracts in the state.
Given the complexity and variations in state laws, it is advisable to consult legal and tax professionals with expertise in the respective state where the out-of-state property is located. They can provide guidance on whether foreign entity registration is necessary, ensure compliance with local laws, and help navigate the registration process if required.
LLCs offer a versatile structure for businesses and individuals to own property across different states. However, when an LLC acquires out-of-state property, it may need to register as a foreign entity depending on the state’s specific laws and the nature of property usage. Understanding and complying with the registration requirements is crucial to avoid potential legal and financial consequences. Seeking professional advice can help ensure compliance and protect the LLC’s interests when owning out-of-state property.
I received a great question today. Can my business buy rental property in another state without registering as a foreign entity? So here is the setup. Imagine you have an LLC. You might be in Minnesota, where I am, and you want to buy property, or real estate in another state. You are going to buy that property; you are going to rent it out. Maybe on Airbnb, maybe to a long-term renter.
But what you are wondering about is if you buy the property inside an LLC, which is always a good idea, do you need to register that LLC there in the state where you are buying the property? In other words, Does your local LLC have to be registered in that state? The law says yes, but a lot of people don’t do it. And so you might be wondering, what is the consequence if I don’t do it? I get that it is a pain to register. It costs money. It takes time. There is typically an annual renewal. Sometimes there is a fee for that. It depends on the state. It can be nearly a thousand dollars or up to a thousand dollars, so a lot of people don’t want to do it. What happens if they don’t? In short, they may not know if they get sued.
Let me explain. So you use your LLC, you buy property in New York. They are in New York. You have a deed for the property, and that deed lists the owner as your LLC. You do not register the LLC in New York because you don’t want to pay the fee. So instead, you just put the property up on, let’s say, Airbnb or VRBO, and you have renters come in from time to time. So far, so good. No problem. You think, “Hey, this is great. I am saving money. I am not reporting this to the state.”
Why would I actually register as a foreign entity or a foreign LLC in New York? Let’s just not register. Well, here is why:
Imagine somebody at the property gets hurt, and they then go to sue the owner of the property for negligently maintaining the property. Well, who is the owner? It is an LLC. But that LLC isn’t registered in that state, so under most state’s laws, the person filing the lawsuit can serve that lawsuit, not on you, but on a state government office, like a Secretary of State or Department of Commerce, or a similar office that handles the registrations of foreign entities. Now, keep in mind, you are not registered there, so when that paperwork comes into the government, they don’t necessarily know what to do with it.
So you don’t know about the lawsuit, but legally you have been served the lawsuit because the plaintiff, the party initiating the lawsuit, did what they had to do to start the lawsuit. So guess what happens? You don’t respond to the lawsuit. And so then, now the plaintiff gets to win by default. The court issues a judgment in favor of the plaintiff.
So now you have lost in trial, or your LLC has lost in trial. What happens next? A couple of things. First, often that judgment will become a lien on the real estate in that state. Now, if you bought that real estate with cash and there is no mortgage on it, you now have a lien on your property for the full value of the judgment. And since you didn’t have an opportunity to defend yourself, the judgment is for whatever the plaintiff asked for. That scenario is the first problem. But let’s say you had a mortgage on the property, so you don’t really care about that lien.
Now what the plaintiff can do is figure out where is your LLC actually registered. It is not too hard to do that with little internet searching, and then they transfer that judgment to your state. From there, then they can garnish and levy anything you own or anything the LLC owns. That includes bank accounts, so any cash there. They can also send you a post-judgment discovery request to find out who owes you money. So well, who owes the LLC money? Probably the tenants, maybe Airbnb or VRBO. Then they can go after and garnish that. So you can see the problem. If you are not registered as a foreign entity in a state where you are doing business, and that includes owning property, then you may not know if you ever get served a lawsuit.
A lot of people don’t register their LLC as a foreign entity, and until they get served a lawsuit, it is not a big deal. Nobody may ever know; the government may never do anything about it.
What Is the Risk of Somebody Actually Serving the Lawsuit on a Government Entity Rather Than You?
It depends on the circumstances because think about it. If the tenant or renter decides to initiate a lawsuit, they know where the LLC is located. They know where the checks go. The name of the LLC is right there. What I find, though, is its plaintiffs who initiate a lawsuit who are trying to avoid you knowing about the lawsuit that then serve the government office.
So there is definitely some risk in not doing a foreign entity registration. So, for example, if you have a Minnesota LLC like I do, and then you go and do business in another state. If you want to know about whether any lawsuits are against your LLC in that state, you need to register as a foreign entity in that state.
Now, I didn’t get into any issues of taxes. Taxes are a separate matter as far as state tax and owing money there. That is an issue where you should talk to a CPA. CPAs are very knowledgeable on that.
I am Aaron Hall, an attorney for business owners and entrepreneurs. If you find this helpful and you would like other videos like this, you are welcome to subscribe to the channel. But another thing, I give out a free handout for common problems faced by business owners and how to avoid it, and then subsequently send out free videos on how to better understand those problems and prevent them in your business. The whole goal of me doing this YouTube channel is to use the years I have as a business attorney to help business owners avoid problems. So hopefully, you can have a successful company and a successful life.