LLCs are a hot topic among real estate investors. Many people starting out think the first thing they need to do is to create an LLC, myself included. In reality, an LLC is not a necessity for all investors and isn’t the magical asset protection device many believe it to be. For a first time investor buying a small investment, the fees associated with an LLC may not make sense if the property value is less than $100,000. Additionally, after a ruling in Florida exposed the weakness of a single member LLC, we now know your assets are still vulnerable in most cases even if your assets are held in an LLC.
So when is it the right decision to use an LLC to hold your real estate? If the value of the investment is greater than $100,000 and is owned by more than one person, then an LLC is a perfect choice for asset protection. It is much easier to prove that an LLC is truly a business if there is more than one member. This, along with myriad other factors, must be accounted for if trying to have the strongest charging order protection for your LLC. A charging order is used to attempt to seize the assets in your LLC. Nevada and Wyoming have the strongest charging order protection laws and are the best states to incorporate in. However, you must remember that you still have to pay the state taxes for the state you are doing business in, regardless of where the business is incorporated.
Another way to ensure protection is by maintaining corporate compliance of your LLC. Many people erroneously think that their asset protection job is over after they create an LLC. Unfortunately, there is a lot of work that must go into keeping the LLC compliant, such as recording annual meeting minutes, distributing ownership via stock certificates, and keeping updated minutes of what the company can and cannot do. So how does a real estate syndication use LLCs? A syndicate or general partner has a main entity LLC, which is the company’s corporation. For each and every investment acquisition, the general partner forms a new single purpose LLC which holds the new property. This LLC must be maintained for corporate compliance. Next, investors pool their money together and, in exchange for their capital, receive shares of ownership in the single purpose LLC. These shares are class A shares and take precedent over the class B shares which the general partner (such as Menlo Atherton Developments) receives. Through this formula, limited partner investors are extremely protected from liabilities or charging orders. Furthermore, since limited partners own shares in the LLC, they are not liable for the mortgage debt on the property if something were to go wrong. Additionally, loans for larger syndication deals should be non-recourse (I wrote an article about that here).