How You Hold Your Investment Properties Matters

If you're like most real estate investors, you are supremely focused on making good decisions, based on solid data, which yield positive returns on a consistent basis. Wash. Rinse. Repeat. This is how empires, large and small, are built.

One of those crucial decisions is how you hold your investments. The options are varied and can be very confusing. Do you need an entity, or is it more headache than it's worth? Most smart investors see the value in structuring their holdings with a view to asset protection, and decide to form an entity. But, having answered the threshold question, the investor is met with another, more daunting question:

"Should I hold my properties in an LLC, a corporation, a partnership, a trust, or some combination of those?"

I will resist the urge to give the typical attorney answer, i.e. it depends, and tell you that there is a solution that applies almost universally, with a few limited exceptions. The limited liability company, in most jurisdictions, affords its members (owners) limited liability similar to a that of a corporation (with possibly superior asset protection features in some jurisdictions), flexibility in management structure, as well as tax flexibility.

Limited Liability

The limited liability company's owners are insulated from the debts and obligations of the company and vice versa, in much the same way as the shareholders of a corporation. However, in jurisdictions that have adopted Charging Order Only-type protections, a judgment creditor of an individual member simply has no ability to seize the membership interest as he could corporate stock. In such cases, a judgment creditor has, as his sole remedy, filing a charging order against distributions from the company. This protection is often also available to partners in a limited partnership

It is important to note that this doesn't prevent creditors of the company from executing against property owned by the company to satisfy a judgment against the company.

Management Structure

Another benefit of the limited liability company is its flexibility when it comes to management structure. You have the option here of making it look very much like a corporation, with a board of managers (directors) elected by the members (shareholders), who then elect officers who manage the day to day operations of the company. This is more complicated than most businesses choosing the LLC form need.

If that sounds like you, you may choose to have your LLC managed by the members, much like a general partnership. In this structure, every member has equal say in day to day management decisions, unless your operating agreement provides otherwise.

Your third option is to take the middle ground, and choose management by a manager or managers, who are elected by the members. Members, in their capacity as members, do not play an active role in the day to day operations of the company. The manager functions in similar fashion to a general partner of a limited partnership, but without the attendant unlimited liability.

Tax Flexibility

The third, and final, benefit of the LLC that I will address here is tax flexibility. Many investors are unaware of the tax flexibility of LLCs. What I mean by tax flexibility is that you have the option to choose what the IRS sees when it looks at your company. Is it a partnership/disregarded entity? This is the default treatment. Is it a corporation? If a corporation, is it a C corp or an S corp? You choose. There are pros and cons, as well as deadlines, to each of these, so it's best to consult your CPA or tax attorney before making a decision.

The point is that, with an LLC, you aren't necessarily locked into a particular tax status based on the document you filed with the Secretary of State when you started your business.

Bonus

One aspect many real estate investors find attractive in the limited liability company form is the ability in a few jurisdictions to form a series LLC. A series LLC is a creature of statute that permits the creation of separate series (sometimes called cells) within an LLC. Each series may have distinct ownership, assets, liabilities, management, etc., and no series is subject to the liabilities of any other series or the "master" LLC. All this assumes the members/managers follow all the rules, keep separate records/books, and generally observe the formalities to keep things separate.

A word of caution: this is a relatively new development in the law of LLCs, and there just isn't much case law out there, yet. I would especially caution against operating a series LLC or any individual series in a state without a statute authorizing series LLCs.

Bottom Line

The bottom line here is that operating as an LLC for your real estate investments has a variety of advantages for many investors. If you're smart, you'll want to make the right decision, based on solid data, and get consistent, positive results. I would add an additional ingredient to this formula: wise counsel.