How to format your RE's LLC(s)

[Thomas Combs]

How are you limiting liability for your long term real estate business? Is it different for 2 properties versus 10+ properties?

I have not invested in real estate yet, I am just curious to hear some success stories or best practices to optimize tax returns & liability limitation from structuring your LLC's.

[David Gotsill]

@Thomas Combs - I believe that you'd separately mentioned that you were partnering up with some buddies, so I believe you will want an LLC (although you could do it as a general partnership w/o the LLC - not advisable).

For your specific question about limiting liability, there are 2 main things you need to think about. First, your LLC Agreement/Operating Agreement should include a provision that the members are only liable (to the LLC) for the amount of contributions, and are not required to make any further contributions. The effect is that in the normal course your liability is limited to the amount of capital you've contributed.

Second, in order to maintain the separateness of the LLC (separate from the identity of the members), the LLC must follow certain rules referred to as corporate formalities. The biggest one is not co-mingling funds. This means that the LLC should have its own account, and that no member should use the LLC account for personal use. There are other important corporate formalities, such has use of the name and holding yourself out, but I think not co-mingling is most important. These corporate formalities are sometimes listed in an LLC Agreement, and almost always a requirement of any lender who is lending to the LLC.

Liability can be further complicated if the lender requires one or more member to provide a full guarantee or a bad-boy guarantee.  This will be case-by-case.  

You also asked about 1 prop vs. 10 props. A good general way to think about this is that the assets of the LLC may be used to cover debts of the LLC. If the LLC has one property, then when the LLC has a debt (think victor in a lawsuit), only that property is available to cover the debt. If the property is not enough, then generally the victor plaintiff is SOL. If the LLC has 10 properties, then when the LLC has a debt arising from property 1, the victor plaintiff can collect against all properties. This sounds scary and all, but in practice this is usually managed with insurance.

Another consideration is that lenders don't like sharing. So, if the LLC is going to borrow against the property, the lender may require a property-specific LLC. The reasoning is similar to the plaintiff idea. BoA doesn't want to lend to you on property 2, when WellsFargo has a mortgage on property 1, because if Wells forecloses on prop 1 it could make life difficult for BoA.

These are all interesting things to think about, but I would second the advice from @Ilan M Aliphas - don't get caught up in this just yet.  Effort is better spent on the deal.

- Dave