Investing in real property is one of the more complex and lucrative financial decisions an individual can make. Still, it can come with significant personal risk if the investment is not properly insulated from liability. An investor has several options to safeguard his or her assets. One such option is through a Limited Liability Corporations (LLC). LLCs can be one of the best vehicles available to insulate an investor’s personal assets and, in some cases, allow for favorable estate planning. LLCs provide benefits for managing real property because of their limited liability nature when involved in legal disputes, their flexible management structure, and their tax incentives/benefits.
Generally, LLCs combine certain liability protections common in a traditional corporation (unlike the minimal liability protections generally present in sole proprietorships or partnerships). This allows LLC “members,” or owners, a level of personal asset protection from liability for certain legal disputes. For example, the member of an LLC that is properly formed and maintained may not be personally liable for the majority of liabilities incurred by the LLC. If someone were to file a slip and fall lawsuit related to the real property held in the LLC, the plaintiff, generally, would be unable to attack any of the member’s assets that are separate and apart from the LLC. In that circumstance, the LLC’s liability exposure is the amount available in insurance held by the LLC and the value of the property owned by the LLC. Alternatively, if the title to the real property were held in the name of a married couple instead of an LLC, all of the married couple’s other assets unrelated to the real property (for example: personal bank accounts, the primary residence, investment accounts, and even personal property like art and jewelry) would be exposed and might be at risk.
As for taxation, both single-member and multi-member LLCs can elect to use a “pass-through” method of taxation, much like that of a partnership or S corporation. The “pass-through” method bypasses the double layer of taxation usually found in a traditional C corporation. In an LLC that elects the “pass-through” method of taxation, the profits and losses are allowed to pass through the business to the owners’ personal tax return, much like that of an S corporation and partnership. This election can create beneficial tax treatment on any income derived from the real property or any losses incurred. Before choosing the tax treatment of the LLC, one should also seek advice from a licensed CPA.
Finally, LLCs offer a flexible management and operation structure that can be set up to meet the founder’s requirements. For example, LLCs provide members the option to place the management of the LLC into the hands of a single manager. The manager controls the day-to-day management of the LLC and allows the members to act in a manner similar to that of shareholders in a corporation who do not participate in the day-to-day management and operation. For individuals and investors, this structure is advantageous as it allows a more passive investment into real property without taking on the day-to-day responsibilities of managing the LLC. Alternatively, a group of members who want to be more “hands-on” can choose to manage the day-to-day activities of the LLC. There are many legal, operational, practical, and strategic concerns to consider when determining whether an LLC should be a member-managed LLC or a manager-managed LLC. One should seek advice from a licensed attorney before making that determination.
LLCs can be an efficient vehicle to own and manage real property as it can insulate owners from certain liabilities; provide taxation flexibility and simplify day-to-day operation and management considerations. Even so, an LLC may not be the best entity or method of holding real property and does not suit every circumstance. When determining how best to hold real property, especially investments of real property, it is best to consult an experienced attorney to ensure it is the best choice for you. Carmel & Naccasha LLP attorneys Victor Herrera, Ryan Andrews, and Devin Mikulka regularly assist clients in these matters and are happy to discuss any questions you have. Please get in touch with them for consultation here.
In a future blog, we will discuss the potential estate planning benefits of maintaining assets in LLCs and other entities that provide similar asset protection.