LLC for investment properties

[Julie Harris]

I am a starting up investor, I have registered LLC. Are you using LLC for the title and then use your own SSN/NAME for the finance part? so this way you are protecting yourself? please let m eknow. thank you!

[Jon Holdman]

This is a complex topic, and you cannot get good answers here.

William Bronchick's book "Wealth Protection Secrets from a Millionaire Real Estate Investor" is a pretty good intro. But you will still have questions after you're done. You need to find a good real estate lawyer who can understand your personal situation and help you structure your entities to achieve your goals. As you're aware, what's optimal for asset protection may not be optimal for taxes.

Its tough to do better on taxes than just letting the income flow directly to your personal return. An LLC or S-corp does this. An exception would be SET (self employment tax, i.e., medicare and social security.) If you're doing an active business, like pretty much anything except rentals, you're subject to this tax, about 15%. There are ways to do the activity in an S-corp and avoid some of these taxes by paying yourself a small salary and distributing the rest as dividends. My CPA is quite skeptical this will survive IRS scurtiny unless the "salary" you're paying yourself is consistent with the going rate. He's no newbie to this, and has successfully fought the IRS on real estate and other topics. So, I trust his advice. With rentals this is not an issue.

An entity provides protection in two ways. One is to protect your personal assets from lawsuits that arise from the business activity. The other is to protect the assets of the entity from personal lawsuits.

To achieve the first, the assets must be owned and operated under the entity. For rentals, that means the asset must belong to the entity and must be financed by the entity. Not impossible, but more difficult and more expensive than financing personally. Its my understanding that a multi-member LLC will provide more protection than a single member LLC. Single member LLCs can be deemed an "alter ego" resulting in you and the entity being lumped together. Corporations may or may not give better protection. Corporate officers, which you would be, are personally subject to liability for the actions of the company. You only need to watch the perp walks of folks like Ken Lay and Joe Nacchioto know this is true.

The other direction is to try to keep the entity intact if you're sued personally and found liable. Such a lawsuit can attach your personal assets. There are limitations, though, in such a lawsuit going after a company. Again, think about the big picture. If I own 100 shares in IBM, and I'm sued, the lawsuit might take the shares. But, its not going to wrest control of IBM away from its board and executives. Similar at a smaller scale. A lawsuit can result in a charging order against your LLC, but it can't (usually) take control of the LLCs assets.

Further, the charging order results in certain liabilities on the holder of the order. If the LLC makes a profit, that profit is distributed to the LLCs members. They pay the taxes. That means the holder of the charging order will be responsible for the taxes. However, distributions from the LLC are a separate matter. If you own the LLC, and it generates taxes, you can distribute money from the LLC to pay the taxes. If there is a charging order, but you're still in control of the LLC, you can vote not to make any distribution. That means it actually costs the holder of the charging order money to hold the order.

You will have to have the entity registered in the state where you have the properties. If you do a Nevada corporation, and hold properties in New York, you'll still have to register the corporation with New York.

If you have lots of properties that have lots of equity and you have lots of personal assets, this is a concern. If you have a couple of properties that are mortgaged to the hilt and you're living from paycheck to paycheck. This is not really an issue. You have no assets to protect. Only someone who knows your situation can give you good advise.

Interview some lawyers and CPAs and find ones that know about real estate. Give them all your personal details and let them help you work out a plan.