Does filing one tax return for multiple LLCs negate asset protection?

Question

My wife and I own 2 rental properties in Colorado that we are working on getting into LLCs for asset protection purposes. I also have a single member LLC for work. We have a Wyoming LLC owned 50/50 between the two of us that is a holding company for the 3 Colorado LLCs, all owned 100% by the Wyoming LLC. My wife and I file our taxes jointly. Our tax CPA said they can file one tax return with the LLCs being tax-through entities, but they are concerned this may negate the asset protection of the LLCs. I am wondering if filing using Schedule C or E with all of the LLCs on the same tax return will allow for someone to go after all of the assets together if we were to get sued. Any advice would be amazing!

Jerry W. · Answer

I don't know if this will help anyone since state laws can vary a lot, but I went through a continuing legal education course a few months ago on piercing LLCs, and there was a lot of information and confusion. There are probably millions of LLCs and hundreds of thousands of lawsuits and so no answer is absolute. Here is a very quick summary. There were about 38 different tests they analyzed that judges used in considering to pierce the veil, but not all are given the same weight. The number one criteria used was intentional undercapitalization. So all of those guys saying I keep maximum mortgages on my LLC properties are they main reason to pierce them. You think they cannot see where the money from that mortgage went? That is closely tied to using the LLC to perpetrate a fraud. Those two concepts obviously go hand in hand. Lots of folks like using an LLC to enter into some kind of favorable contract, then sell off the benefit to another company they control, then collapse the obligations of the contract in an LLC shell that has no assets. So without going into 4 hours of droning and hundreds of pages of typing, don't undercapitalize and don't do fraud. The alter ego thing kind of falls into the same area as the two above. If you siphon off your groceries, house payment, credit card bills from the LLC then you intentionally took that money from the business instead of using it to pay bills. Sometimes the accounting is a pain because you didn't keep the books separate so why should the court bother to try to sort it out?

So don't undercapitalize your business, don't use it to do fraud, and keep your finances in decent shape. While there are other, those are the big dogs, and they make sense.

Very few courts worried about keeping corporate minutes, as they do not look at LLCs like they do corporations. I hope this helps a little. It's nice to see the same high quality of @Michael Plaks that I have seen for so many years and @Basit Siddiqi has always been nice to read. I am also very impressed by @Account Closed who has few posts but obviously put some real meat in his comments. Thanks for contributing everyone.

So don't undercapitalize your business, don't use it to do fraud, and keep your finances in decent shape.  While there are other, those are the big dogs, and they make sense.

Very few courts worried about keeping corporate minutes, as they do not look at LLCs like they do corporations.  I hope this helps a little.  It's nice to see the same high quality of @Michael Plaks that I have seen for so many years and @Basit Siddiqi has always been nice to read.  I am also very impressed by Account Closed who has few posts but obviously put some real meat in his comments.  Thanks for contributing everyone.

Jerry W. · Answer

Account Closed, most banks can invoke the due on sale clause despite what lots of Gurus claim, the fact is most banks historically have not cared enough to do it.  Now that the original loan was at 3% and their new loan rate is 8%, on a $500K loan that nets them about $25K more in interest per year the odds of calling are dramatically higher.  There are transfers that banks cannot call a loan due on like the death of the borrower or transferring the property to an trust for estate planning purposes.  My recollection is it like St Garn, or ST. Germain Act.  The one things guys selling or buying under these subject to deals need to worry about is what happens when things go wrong.  Then everyone gets sued.  Have I done some of these?  Yes, but there is a real danger.  I saw one go before a bankruptcy trustee once involved he stepped all over the "subject to" and let the bank foreclose under the relief of stay.  If the bank ever gets in liquidity trouble it is real scary.  They will start calling these things due to try to infuse much needed capital to stay afloat.  Yes banks can hire loads of attorneys too.  Subject to is a viable tool, but it needs to be used with your eyes open to the dangers, and not use them recklessly and do huge damage to some poor seller who thought the worst was over and restarted his life and gets hit with a foreclosure on a house he thought he sold two years ago.  You should always have plan B ready to pay off the mortgage if it gets called.  I had to do that just this year on a 2.5% interest loan and I had to replace it with a 9.25% loan ack!  There is still room for profit, but my margins really shrunk.  Unfortunately this bank was very serious about it's clause, but this one required the borrower to live in the house the entire time that the loan was in effect.  None of us involved really believed they would force going into foreclosure, but we were wrong.  It was some sort of community improvement loan.  Perhaps the bank had liquidity problems.  Anyway, use with caution.

David M. · Answer

@Luke Perrin

Interesting.. another "Pace Morby disciple.."

Oh for sure, the LLC is over sold many times.  We have this all over BP.  Honestly, if you are doing this on the "cheap," don't do it...  You see what sort of issues you are running into..

Running with LLC's still "costs" you more.. filing fees.. accountant fees...  financing fees (you can't get residential conforming loans).. overhead (more complicated operations).  You "pay" for the additional limited liability protection...  And you still need insurance for your LLC, so you don't save there either...  you save no where.

Get some professional assistance and see what you can do with your existing structure.  Learn how to operate them correctly, and get a real "assessment" of what you really need.  Of course, just about every attorney will "sell" you on setting up a LLC.  I find it a catch-22 problem...

Happy to chat.  Good luck.

Michael Plaks · Answer

@Luke Perrin

I would have given you the exact same advice were you my client. There is no tax benefit in filing multiple tax returns, one per LLC, however some attorneys insist that it is required to maintain legal protection.

I'm not an attorney, so my opinion does not matter, but there is NO consensus on this issue between attorneys, either. You'll have to decide which attorneys to believe, as they disagree with one another.

One extremely important point was brought up by @Christian Block: in your state, forming a husband-wife LLC will force you to file a partnership tax return, separate from your personal tax return. This involves substantial extra hassle and extra cost. Beware.

Account Closed · Answer

I am not a lawyer, but I can offer some general information that might help guide you. For legal and specific advice tailored to your situation, it's crucial to consult with an attorney who specializes in real estate and asset protection.

Generally, the structure you've described with individual LLCs for each property and a holding LLC (Wyoming LLC) is a common strategy for asset protection and organization. However, the tax treatment of these LLCs can impact the separation of assets and liability protection. Let's discuss a few points:

• Tax Treatment of LLCs:An LLC can be taxed as a disregarded entity (reported on Schedule C of your personal tax return), a partnership, an S corporation, or a C corporation. The choice of tax treatment can impact the asset protection features of the LLC.
• An LLC can be taxed as a disregarded entity (reported on Schedule C of your personal tax return), a partnership, an S corporation, or a C corporation. The choice of tax treatment can impact the asset protection features of the LLC.
• Single-Member LLCs and Disregarded Entities:Single-member LLCs are often treated as disregarded entities for tax purposes, meaning their income and expenses are reported on Schedule C of your personal tax return. While this simplifies tax reporting, it might not provide the same level of liability protection as a multi-member LLC.
• Single-member LLCs are often treated as disregarded entities for tax purposes, meaning their income and expenses are reported on Schedule C of your personal tax return. While this simplifies tax reporting, it might not provide the same level of liability protection as a multi-member LLC.
• Separate Tax Returns for Each LLC:While it might be more administratively burdensome, having separate tax returns for each LLC could strengthen the separation of assets for liability protection purposes. It helps maintain clear distinctions between the entities.
• While it might be more administratively burdensome, having separate tax returns for each LLC could strengthen the separation of assets for liability protection purposes. It helps maintain clear distinctions between the entities.
• Liability Concerns:If all the LLCs are reported on the same Schedule C or E, there could be concerns about the separation of assets. In the event of legal action against one property, having them all reported together might make it easier for someone to go after all assets collectively.
• If all the LLCs are reported on the same Schedule C or E, there could be concerns about the separation of assets. In the event of legal action against one property, having them all reported together might make it easier for someone to go after all assets collectively.
• Professional Advice:It's essential to consult with both a tax professional and an attorney who specializes in real estate and asset protection. They can provide guidance on the best tax treatment for your situation while ensuring that your legal structure aligns with your asset protection goals.
• It's essential to consult with both a tax professional and an attorney who specializes in real estate and asset protection. They can provide guidance on the best tax treatment for your situation while ensuring that your legal structure aligns with your asset protection goals.
• Consider the Costs and Benefits:Balancing the administrative simplicity of filing one tax return against the potential benefits of stronger asset protection is a key consideration. The costs and benefits should be evaluated based on your specific circumstances and risk tolerance.
• Balancing the administrative simplicity of filing one tax return against the potential benefits of stronger asset protection is a key consideration. The costs and benefits should be evaluated based on your specific circumstances and risk tolerance.

• An LLC can be taxed as a disregarded entity (reported on Schedule C of your personal tax return), a partnership, an S corporation, or a C corporation. The choice of tax treatment can impact the asset protection features of the LLC.

• Single-member LLCs are often treated as disregarded entities for tax purposes, meaning their income and expenses are reported on Schedule C of your personal tax return. While this simplifies tax reporting, it might not provide the same level of liability protection as a multi-member LLC.

• While it might be more administratively burdensome, having separate tax returns for each LLC could strengthen the separation of assets for liability protection purposes. It helps maintain clear distinctions between the entities.

• If all the LLCs are reported on the same Schedule C or E, there could be concerns about the separation of assets. In the event of legal action against one property, having them all reported together might make it easier for someone to go after all assets collectively.

• It's essential to consult with both a tax professional and an attorney who specializes in real estate and asset protection. They can provide guidance on the best tax treatment for your situation while ensuring that your legal structure aligns with your asset protection goals.

• Balancing the administrative simplicity of filing one tax return against the potential benefits of stronger asset protection is a key consideration. The costs and benefits should be evaluated based on your specific circumstances and risk tolerance.

Remember that laws can vary, and this information is not a substitute for professional advice. Given the complexity of your structure and the importance of asset protection, consulting with professionals who can provide personalized guidance is crucial.

Michael Plaks · Answer

Correct, you do not have a state tax return to file. But your real estate business - which is rental properties at the moment - needs to be reported to the IRS on your federal tax return(s).

Normally, without an LLC, this would mean filing ONE tax return, your personal tax return aka Form 1040, which will include a few additional pages (Schedule E and some other pages) reporting your rentals.

With an LLC, and in your state, you need at least two tax returns: a partnership tax return aka Form 1065 for your LLC reporting the rental business, and then the results of that business will flow from your partnership to your personal tax return. Two tax returns instead of one, and partnership tax returns are a lot more complicated, so you basically triple your tax preparation cost - and with NO CHANGE to your bottom line. Same amount of taxes in the end.

With multiple LLCs, it gets real crazy: multiple partnership tax returns to file. Whether the (alleged) additional legal protection, if any, justifies this monumental increase in cost and complexity is a big question mark.

Also, never listen to legal or tax advice coming from real estate gurus, none of them. They may understand real estate business (not all of them, actually, but it's another conversation altogether), but they are definitely NOT qualified to teach taxes or legal. They regurgitate what they heard or read, often from unverified sources, and always distorted by their personal interpretations.

David M. · Answer

just to jump in on the Due on Sale discussion with the rate hikes....  I assume everybody is referring specifically to portfolio loans where the loans are held on the originating bank's/lender's books.

Otherwise, most loans are conforming loans which are sold off to the secondary market.  They are securitized and sold off again..  The ultimate/current Note holder is the one with the right to call.  With these securitizations, they have little reason to call the note.  Early paybacks decreases the return --- if you really dispute that, then you should file a claim, I guess with the SEC for one, for fraudulent claims on all the various public filings.  Remember, its a net interest game plus all the bond discounts.  The importance is the rate spread, not the rate's value.

Furthermore, even if a portfolio loan was called, they still run the risk of being able to lend that money back out again.  Transactions are down.  With even tighter underwriting standards, it can be harder to qualify a customer --- or, as some argue the system just disenfranchises more people in the country.

Mitchell Zoll · Answer

The due on sale clause was really started in the 70s and 80s when interest rates shot up and folks were trying to hold onto lower mortgages as they transferred property. They were tested in the Courts and found valid and enforceable.  We have been in an era of low and lower interest rates, so there was no incentive for a bank to call a 5% loan if the current rate was 3%. However, we are now in an environment when interest rates are rising.  We are also in a time when Banks can simply run reports and crunch data on ownership mismatches across their entire portfolio with a click of a button (not researching each and every property one by one, state by state). Are banks going to start massive waves of calling loans? Probably not. Banks don't want to own the real estate - they just want their notes paid. But the days in which it was not to their advantage to do so are behind us at least for the foreseeable future and it is a very real consideration.  Folks blindly putting properties in LLCs for "asset protection" may actually be creating liability.

Basit Siddiqi · Answer

I am not an attorney but I find it hard to beleive that a judge would say, "oh this is a single member LLC, I will not recognize it and therefore you can be sued personally".I think it is moreso the assumption that individuals do not treat single member LLC's as a separate business structure which can lead them into trouble.

Mitchell Zoll · Answer

How you operate is more important than how you set it up. Get with someone you can call to teach you how to operate your LLC and answer these questions. Walk through this structure you have created and find out if it is really what you need or if you have created more problems for yourself.  Check your local bar association if that helps you find someone local.

Does filing one tax return for multiple LLCs negate asset protection?

Most Popular Reply