REAL ESTATE INVESTOR? WHAT YOU NEED TO KNOW ABOUT USING LLCS TO PROTECT AGAINST LIABILITIES
November 15, 2016
We routinely field questions from our clients regarding the use of LLCs to hold real estate. While some of our clients like to think of themselves as “dabbling” in real estate on the side, others have a larger property investment strategy. It’s important from either perspective to not only look at the benefits and potential returns of investing in real estate, but the risks as well.
One of the risks of owning real estate is potential claims by tenants or other third parties who have access to or make use of the land. In such situations, protective contracts as well as good insurance policies can be extremely valuable. Another basic way to protect yourself is to hold the real property in a LLC instead of in your personal name.
As many entrepreneurs know, LLCs are easy to form, register, and maintain—all at minimal cost compared with other types of business entities. In most situations, it’s advisable to set up LLCs for each individual property you own. These types of entities are commonly known as either a single-asset or single-purpose LLCs.
LLCs are used in many businesses that have individual owners or are limited to just a few partners. Real estate is a great application for this entity type, as a properly maintained LLC protects business owners from personal contract liability resulting from their business dealings. When you hold real property within the confines of an LLC, you are protected from personal liability from potential contract claims and other damages up to the value of the investment.
That last point is key, and it’s exactly why having multiple LLCs (even with the added accounting and legal spend), is the optimal solution versus holding all of your assets under one umbrella business entity. If you have a claimant sue you related to one particular property, having one LLC leaves you vulnerable to the amount of all three properties held in that LLC. However, if you take the extra step of creating LLCs to hold each asset, you’ll limit your liability to the single property where the liability occurred. In fact, most lenders will require that LLCs that hold real estate be single-asset entities.
Single-asset LLCs, filed with the Secretary of State, offer some nice flexibilities for owners when executing operating agreements. You can address rights and responsibilities of multiple owners, such as provisions for obtaining financing, hiring property managers, and frameworks and hierarchies for decision-making. Operating agreements can also address estate planning issues such as incapacity and death of a member/owner of the LLC.
As far as maintenance, there are fewer corporate formalities to execute on an annual basis in order to preserve the corporate shield from liability that the LLC gives. As pass-through entities, owners don’t pay tax at both corporate and personal level, simply moving tax considerations to the personal ledger.
Another consideration is the privacy or anonymity that investors may benefit from when holding a property within an LLC. You give the entity an actual business name unrelated to your own surname, and the articles of organization can be prepared without disclosing investor names and personal information.
There are many ways to protect yourself from liability, including legal remedies and insurance policies—and you should explore all of them. The single-asset LLC is advantageous for many investors with multiple properties, as it not only shields owners form personal liability, but also limits damage to the value of the asset held in the entity, leaving assets held within different LLCs protected.
If you are able to procure property in the name of an LLC, it’s a great way to be protected from the inception of your ownership and a bit easier than transferring properties from personal ownership to the business entity. While no business entity can completely protect you from lawsuit damages, the single-asset LLC provides a solid solution that’s flexible and cost-effective for many real estate investors.
For more information on purchasing or leasing commercial property for operating a business or to reach investment goals, email me at the Forrest Firm today.