Separate entities to manage vacation rentals?

Question

Scott Smith · Answer

I don't know how your current LLC owns those properties or how you are connected, so instead of trying to give you a specific answer I will simply outline a good model to follow along with a comparison.

By placing the properties you own in the LLC you are creating a separation of liability between the LLCs and your personal assets (or potentially other LLCs you might operate.) So currently it sounds like you have your investments in a single traditional LLC. If there is a lawsuit against any of those investment properties that exceeds [or is excluded from] your insurance policy than a settlement/judgement can impact all of the investments you own inside of that LLC.

The benefit of establishing an additional LLC to carry out the operations of your assets is that it can carry the majority of the high-liability operations (paying contractors, property management, collecting rent, interacting with guests/renters,) but you wouldn't end up placing any actual assets in it other than the money it requires to carry out those operations. If there is a lawsuit against the operations LLC, you would only be exposed by the balance that you hold in it's bank account. This requires good bookkeeping and the proper formation, but is not that big of a hassle once to have it established.

One of the strongest strategies I have seen for this is to set up a Series LLC to hold your assets, since it can actually legally separate each property into their own "child series" within the "parent" Series LLC. Then you would establish a traditional LLC as your operational LLC. In this scenario you only have to submit documentation to form two entities while still being able to protect each individual property you have as if it was in it's own LLC. Each "child series" you set up for the individual investment properties is a private document so you don't even need to form it with the state.

I wandered a bit, but I wanted to just lay out a couple of scenarios. I really don't know what your situation looks like, so this isn't advice. If you want to clarify your structure a bit more and ask additional questions you can just TAG me or reply and I will swing back to update this. Best of luck to you moving forward, it sounds like you are doing well!

Luke Carl · Answer

@Vee L. going to need more details here. Assuming the ones you already have a paid for no mortgage and they’re owned by an LLC that shows a profit on annual taxes. Yes?

Need more details and not a lawyer but no you don’t need more LLCs.

Hit the vote button ;)

Mark Miles · Answer

I’ve been advised by a few attorneys to be careful of using a Series LLC in many states as it’s legally untested and/or not recognized in many states. A court in a jurisdiction that doesn’t have Series LLCs could in theory ignore the legal separation between the cells, right? I see that you’re a big proponent of SLLCs, so I’m curious to get your opinion on this & on the practice of holding properties in a SLLC (as opposed to in regular LLCs) even in jurisdictions that don’t necessarily recognize SLLCs? Do you not consider this to be a risk? Just curious. Bc property owners will typically get sued in the jurisdiction where the property is located, not in the jurisdiction where the SLLC was created. And the jurisdiction where the property is located might not even recognize SLLCs.

Mark Miles · Answer

Thanks as always, Scott! Whew, I just learned why you sometimes advise clients not to mention this maneuver to their lender! Amazing how quickly lenders stop responding to your emails when you mention transferring into a trust or mention the St Germain Act to them. Never seen anything turn a bunch of aggressive mortgage bankers into people who no longer want to work with me quite like mentioning this maneuver to them did!

Lesson learned: if you want to get a loan, DO NOT tell lenders you’ll be transferring to a trust after closing. And never mention the St Germain Act to them - apparently that's like poison or kryptonite to a lender.

Scott Smith · Answer

In the end you can prove the chain of ownership, which is what matters in the case of the St. Germain Act. That is what it boils down to. People are free to try and fight it, but it costs a lot of money to litigate and the laws are clear on this type of transfer.

Mark Miles · Answer

Scott - that makes perfect sense, but: "in which the borrower is and remains a beneficiary" - can't a lender claim that since you're naming the LLC as the beneficiary this does, in fact, mean that the BORROWER does not remain a beneficiary? The borrower's LLC becomes the beneficiary but the borrower him/herself is no longer the beneficiary which would seem to violate this clause in the St Germain Act, thus meaning that lenders could in fact enforce due-on-sale in these cases if they so wished?

I mean, even if it's a single-member LLC and I'm the only member, the fact remains that I am in fact naming the LLC as the beneficiary, not myself (the borrower).

Scott Smith · Answer

I end up talking to lenders for my clients IF this becomes an issue. Not all investors on the forums are aware of how these entities work, and the same applies to lenders. It is not a strategy that is implemented as often as it should be, considering it's multiple benefits. The transfer is excluded from the due-on-sale clause under the St Germain Act 12 US Code 1201j-3...       (d) ... Exemption of specified transfers or dispositions - With respect to a real property loan secured by a lien on residential real property containing less than five dwelling units, including a lien on the stock allocated to a dwelling unit in a cooperative housing corporation, or on a residential manufactured home, a lender may not exercise its option pursuant to a due-on-sale clause upon...

(8) ... a transfer into an inter vivos trust in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupancy in the property...

The land trust is an estate planning tool (inter vivos trust) and is an exempted transfer, as long as you are not transferring it into someone else's trust. It can depend on the lender as to how long the conversation lasts - some really don't like this exclusion because they have less security attached to the note and others don't like being wrong if they had put up a fight about it. Ultimately it works, it just depends on whether you need to educate the lender on it or not. The transfer itself often doesn't even trigger the red flags a transfer directly to an LLC would, so some investors don't even tell their lenders in order to avoid the confusion. That is up to the investor's discretion.

Having set up thousands of these and carrying out many conversations of this nature with investors and lenders I ensure you that it works. Easiest way is to just have the attorney who sets it up for you to handle the entity creation and if lenders get upset you would just have the attorney chat with them.

Eric P. · Answer

Scott - I received this response below from a lender when I mentioned the updated FNMA regulations. Am I misunderstanding something or is the lender misunderstanding something? Based on this, sounds like lenders won’t permit borrowers to transfer title after closing? From the lender:

The mortgage instrument ties the responsible individual to the loan and ultimately the collateral (the house).  The verbage in the mortgage note does not allow for the title to be changed, transferred or altered in any way, as it will impact the lenders security in the loan.    Meaning if you stop paying, the collateral is no longer in your name, its in a business name, making it easier for you to walk away from the loan and near impossible for the bank to recoup its losses.So FNMA may allow that, however for any lender who is securing these loans, it makes no sense to allow for that..

Ken Latchers · Answer

Gee, we have $2000 in our bank account. And $100,000 insurance policy. What, 3 people died and we were sued for $25 million?

Fat chance of this getting through court. You need SUFFICIENT resources, or they will most likely pierce the veil.

@Scott Smith

"You would need it to hold enough money to fulfill it's business for a period of time, generally several months. But if that LLC is sued you will be facing smaller risk that having the LLC that holds your entire property exposed."

Scott Smith · Answer

You would need to operate the LLC by the guidelines that are laid out by the state you operate in. But that doesn't mean it needs to hold a massive balance. You would need it to hold enough money to fulfill it's business for a period of time, generally several months. But if that LLC is sued you will be facing smaller risk that having the LLC that holds your entire property exposed. The LLC would essentially function as the property manager for the property (properties.) Large corporations do this all the time by using the popularly termed shell companies to operate their more risky endeavors.

The idea is to create additional layers of defense again lawsuits. However, if you are not abiding by the law they can still dig through these entities to the assets beneath them pretty quickly, which is why it's important for investors to commit to good business practice as a first step toward a solid asset protection strategy. I often try break it down into the 5 Pillars of Asset Protection when explaining it to investors - helps place the initial strategies of asset protection into a better framework.

Separate entities to manage vacation rentals?

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