Should I use a Limited Liability Company to hold investment property?

The ago old question (or at least a question of the past couple of decades) arises again: should I use a limited liability company to hold investment property? To answer the question, let's first start with a brief analysis of why the question is important to answer in the first place, and what options you have.

For clarity let's distinguish the Limited Liability Company, as a formal entity, from a limited liability company, used merely as a descriptive term; the latter describes a liability limiting entity, while the formal is the name given by the state legislature to an Entity formed as a Limited Liability Company. For simplicity, this article will use the shorthand "Entity" to describe all liability limiting entities, including the Limited Liability Company.

Why use an Entity at all?

An important question and necessary starting point.

An Entity creates a legal separation between the operations of a business and your personal assets. In short, it is a protective measure that creates a barrier between your personal assets (cash, condos, and cars, etc.) from being used to satisfy debts of your company. As it applies to investment property, an Entity creates a barrier between your personal assets and liabilities that stem from your property. 

For example, should an injury occur on your property, and insurance (which we will discuss in the near future) is inadequate to solve the problem, then the injured party might look to your personal assets to make up the difference. If the property is owned by or through an entity, the possibility of the injured party getting into your pocket, or piggy bank, is remote.

in almost every circumstance, holding property in an Entity provides security that cannot be reproduced by any other means.

So, what are my Entity options?

By far the most popular Entities used for holding property are the Limited Liability Company (the LLC) and the Limited Partnership (the LP). However, increasingly the Series Limited Liability Company has been employed to hold real estate, with great success, especially when multiple properties are involved.

While there are other liability limiting structures available, namely the Corporation and the Limited Liability Partnership, both structures are vastly inferior when it comes to holding real estate.

The Limited Liability Company; the Experienced Gentleman

Most are familiar with this Entity structure. In many ways it has become the generic term for liability limiting entities in much the same way that Kleenex is the accepted name of tissue for a runny nose. However, the Limited Liability Company, as an Entity is a creative marriage of the liability protection of a corporation with the flexibility of a partnership; in many ways, it contains the best of both worlds, so to speak. 

A properly organized LLC offers its owners (called Members) liability protection from the business operations, but lets the Members organize in flexible ways in terms of payment, management, and profit distribution, among others business aspects. The LLC is increasingly recognized as the standard, making it widely accepted, and even expected in many circumstances. A compelling feature of its design is that an LLC can be owned by another Entity, including another LLC, thereby achieving a sort of layered protection. 

However, there are costs associated with starting an LLC, and an LLC does require some amount of annual maintenance. 

The Limited Partnership; the Aging Grandpa

The Limited Partnership, or LP, is a classic Entity structure, well advanced in age. It is a variation of the General Partnership which offers the limited partners liability protection beyond their initial investment. In short, you risk only what you put in, but nothing more. If the project goes belly up, you may lose your investment, but you won't be hooked for whatever debt or obligation remains.

Historically, this is a popular Entity structure among property developers. First, it is an effective method of raising capital without having to sacrifice management authority. This also illustrates one drawback for the limited partner; the limited partner has NO management authority or responsibility, by law. So, while the risk of the limited partner is localized, the ability to control is completely absent.

Another, and possibly more important, drawback to the structure is that it requires a General Partner; a limited partner can only exist alongside a general partner. As has been discussed in another article, a General Partner is exposed to all company liabilities. 

The initial and ongoing cost to form and maintain an LP may also be prohibitive.

Pro Tip: If the LP structure is required, look at forming an LLC to function as the General Partner in your Limited Partnership.

The Series Limited Liability Company; the Kid

The new kid on the block, relatively speaking, is a variation of the Limited Liability Company, the Series Limited Liability Company. In short, the Series LLC allows its Members to form one Entity but operate as multiple companies under one umbrella. The effect is to achieve the benefits of layered asset protection provided with the use of multiple LLCs without the cost or administrative burden of having to start more than one company. This advantage has proven attractive to real estate investors both as a cost cutting measure and efficient vehicle through which to own and manage their properties.

The Series LLC offers this by, in effect, taking advantage of legal mechanisms which create pools of assets (Series) within one Entity. While these mechanisms have to be used correctly, they are fairly easy to wield and consist of particular phrasing in the Certificate of Formation, the use of Assumed Name Certificates, and treatment of each series as if it was a separate, stand-alone entity. 

While the structure offers tremendous advantages, it is still a relatively untested structure, so err on the side of caution in set-up, documentation and accounting. Overall, the Series LLC is proving to be a welcome Entity iteration for real estate investors.

When considering which approach might fit best for your project consider three basic questions:

1. How much control do I need or want?
2. How many properties will be involved?
3. What are my long-term plans?

These answers will clarify which structure, or which combination of structures, will give you the asset protection you need while adapting to your preferred level of engagement. 

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