Create An LLC
Maintain An LLC

I am answering questions in a broad sense on my blog so that nobody gets the idea that I am giving out legal advice or creating a relationship with people.  Feel free to ask your questions, it actually helps me write better blog posts because they are focused.  The following was asked:

“suppose I have four properties and I rent them out and I missed the bus and didn’t form an LLC and can be liable for anything that happens in them, do I form an LLC and group them all in the same LLC together?  Do I form enough LLCs to put each one in its own separate LLC?  And, how does an LLC “get” credit when its brand new?”

There are two questions there.  The first question addresses the need to protect real estate in multiple ways.  The second stems from the desire to make real estate the businesses problem completely.  I will address each in turn.

1. There are multiple ways that real estate can be vulnerable.  How do I protect my real estate?

I get asked about the virtues of “putting a piece of real estate in an LLC” all the time.  Lets consider what the issues might be.  First lets look at the rental.  

So even though your rental might not look like this, the reality is, the property could be such that it is the cause of an injury and thus creates a legal cause of action.  The question to understand here, is that if the house is the source of an injury that creates a legal cause of action, who is on the hook?  In a word, the owner of the property.  This is why people form an LLC and put their piece of property in the LLC.

The LLC was the first entity to offer the corporate veil protection without the corporate tax.  The following diagram explains corporate veil protection.

If the corporation is sued, there is essentially a veil, or barrier that stops the law suit from proceeding to take hold of the shareholders personal assets. Corporate tax law makes the corporation an unsuitable structure for holding property as an investment.  The flow through (partnership or sole proprietorship) tax treatment of the LLC makes it an ideal entity for holding investment properties.  You get the wonderful flow through tax treatment of a partnership enabling you to benefit from passive activity income from the LLC holding the property while enjoying corporate veil protection that separates the LLC any legal causes of action the LLC might create from your personal life.

To quickly explain what I mean about “put your property in an LLC” you follow a three step process.  1) Form an LLC.  STARTright can help you do that with incredible ease.  2) Once the LLC is an entity acknowledged as existing and viable by the state, you create a deed and deed the property over to the LLC.  This is not a fraudulent transfer, and the courts will acknowledge this as perfectly fine because in essence, you are “capitalizing” or putting assets into a business.  People put assets into their business all the time.

Ok, so now to the original question, what if you have two or three of the beauties that we see above? Do I need an LLC for each property?  Well, the sad reality is that there is no definitive answer. There are three options and each have their pros and cons.  The answers are:

1. Put all the eggs in one basket.
2. Put all the eggs in separate baskets (multiple LLCs)
3. Get a basket with multiple compartments (the new series LLC)

1. Put all the eggs in one basket:

• Pro: To many people wait to get any protection for their rentals because they spend all their time dreaming about the massive and intricate “Asset Protection Web” that puts houses in strange trusts and gives beneficial interests back to … blah blah blah.  The pro of forming one LLC and deeding all rentals back to that LLC is that it is cheap, fast, and better than day dreaming about the massive scheme.  Get something in place.   The other problem is that if your LLC does business in California, you will have to pay an additional FTB tax of $800 annually for each additional LLC.  Attorneys never seem to care about the immediate costs to your business when dreaming up the elaborate asset protection scam.  The reality is that very few people actually get sued.  Run your business intelligently from a protection stand point, but also from a “efficacy now” stand point.
• Cons: The reality is that if one of the properties creates a law suit, you are protected personally, but all other properties in the LLC are exposed as loot to satisfy the claim.

2. Putting eggs in separate baskets.

• Pro: I am not a fan of creating a separate LLC for each and every property.  I believe it is overkill and a scheme that attorneys dreamed up to make lots of money.  I prefer the concept of strategic grouping.  If your investment portfolio gets larger than say two or three properties, it may be a good idea to create two or three LLCs, and divide assets between them.  Put quick-flip properties in a different LLC than rentals, and determine which rentals can safely be grouped, and which rentals may need to be isolated in a single LLC.
• Cons: Yes, a completely separate LLC for each property ensures isolation, but as the portfolio grows, it becomes a management and tax headache.   If you are in California, you start paying the annual $800 FTB tax for each LLC.

3. The basket with individual compartments:  much has been made of the series LLC, and yes, “they are all that and the bag of chips.”  A series LLC is best explained if you think of the LLC as a large box.  By putting the property in the box, you isolate all legal actions the property would cause in that box.  The series takes the LLC concept one step further.  It allows you to create “series” inside the LLC by doing nothing more than 1) creating series agreement (this is essentially an operating agreement for the individual series), 2) getting a separate bank account for the series, and 3) registering a DBA for the series.  The series now becomes an isolated and individual compartment within the larger LLC box.  The compartments become completely safe from one another, but for tax purposes it is as though you just threw all your eggs into one basket.

• Pros:  I think the pros are self evident from the above explanation.
• Cons: The biggest problem is that all states do not support series LLC, so forming a series LLC in one state and taking it to another state to do business expecting that they will reverence the laws of your state of formation is always scary to me.  there is literally no case law on how this type of thing would play out.  California seems to hate the idea of the Series LLC already.  They hate it for tax purposes because it totally kills their revenue.  It is in many respects an unknown legally.

So that’s it.  Like a real attorney, I gave the “well it depends answer”.  Hope this is helpful.   Also, I will answer the question about getting credit for new companies on Monday.  Should be good.

Tags: Corporate Veil, LLC, LLC Tax, Protecting Rental Property, Rental Property, Series LLC