Why Should Investment Real Property be Held in a Limited Liability Company?
Clients often ask whether real property should be titled in a limited liability company, rather than in individual names, a partnership or some other form of entity. Although this decision requires careful analysis and professional advice, if the property will not be used as a personal residence, our answer is often that the property should be titled in a limited liability company.
A Limited Liability Company is Often the Best Choice of Business Form
The limited liability company, or “LLC,” as it is commonly referred, has become a popular business form for owning investment real property. Much of the allure is that the members (i.e., owners) of the LLC have liability protection similar to that of stockholders of a corporation; yet the LLC may be taxed like a partnership.
It is well known that the stockholders of a corporation are not directly responsible for the liabilities of the corporation. If the corporation gets sued, the value of the stock held by its stockholders may be diminished, but there is no other risk to the shareholders. On the other hand, individual owners of real property and general partners in a partnership (if a
partnership owns the real property) are generally directly responsible for the liabilities associated with owning real property. In Florida, the members of an LLC, by statute, receive virtually the same protection and associated benefits in this regard as the stockholders of a corporation.
How important is it to have this corporation-like protection? Consider that if someone is badly injured on the property, the owner of the property is likely to be sued; even if the property is leased to a tenant and even if the owner did nothing to actually cause the injury. Generally, the owner must be sued in order for the injured person to seek to recover from the owner’s insurance carrier, which may be their primary objective. Obviously, it is never pleasant to be sued, and if there is insufficient insurance coverage the owner’s personal assets may be put at risk. Yes, corporation-like protection is important, and you get it with an LLC.
An LLC Can be Taxed as a Partnership
A potential downside of a corporation is that it may be subject to tax liability at the entity level, which is often less favorable from a tax standpoint than owning the property individually or in a partnership, particularly if the property is producing significant income. When property is owned individually or in a partnership, income is not subject to tax at the entity level. In the case of an LLC taxed as a partnership, income earned by
the LLC will “pass through” to the member, generally with similar tax effect as if the member owned the real property outright.
An LLC actually has a certain amount of latitude to choose how it will be taxed. A multi-member LLC can choose to be taxed as a partnership or corporation, including as an S- Corporation if it qualifies to make the S election. A single member LLC is generally taxed as a “disregarded entity,” which means the entity is not taxed at all; all income is simply accounted for on the member’s individual tax return, as if the investment property
were individually owned.
An LLC Allows for Flexible Management
There is also a great deal of flexibility as to how the LLC can be organized and managed. An LLC can have a single member or multiple members with differing levels of authority over LLC decisions. It can be managed by its members or by a manager. A manager may be given complete control over the LLC, which is a common arrangement in family owned LLC’s, where a parent wants to give substantial membership interests to children, but retain the ability to make all decisions concerning the LLC owned property. LLCs are often used for estate planning to pass wealth to children, while the parent retains control.
LLC Members are Benefited by Charging Order Protection
Yet another desirable LLC attribute is that under Florida law there are significant legal limitations imposed upon a judgment creditor of an LLC member that seeks to look to the member’s interest in the LLC to satisfy a judgment. The law provides that a “charging order” is the sole and exclusive remedy by which a judgment creditor can satisfy a judgment from the debtor’s/member’s interest in an LLC if it has more than one member. A charging order gives the judgment creditor only the right to receive what the member would receive if and when any assets of the LLC are distributed to its members. It does not allow the judgment creditor to seize control of the LLC’s assets or its management. In the case of a closely held LLC, with a properly drafted Operating Agreement, the manager might decide to reinvest and not distribute the income of the LLC, thwarting indefinitely the collection efforts of a judgment creditor.
Under Florida law, a charging order is not the sole and exclusive remedy of a judgment creditor if the LLC has only one member where the court concludes that there are no other sources to satisfy the judgment. Foreclosure of the LLC membership interest is a potential remedy for the judgment creditor when the LLC has just one member. This severely limits the usefulness of Florida single-member LLC’s; however it is possible to
form the LLC in Delaware or another state that affords the same charging order protection to multi-member and single-member LLCs. Careful attention must be given to how and where the LLC is formed to make sure members will receive the full benefit of charging order protection. If there is no alternative to forming a single-member LLC, then consideration should be given to filing the LLC in a state other than Florida.
Use a Separate LLC for Each Property
We routinely caution our clients against “single pot” ownership of multiple investment properties. If multiple properties have common ownership (i.e., are owned by a single entity), an incident causing liability with respect to one property may expose all of the properties to a potential judgment lien and foreclosure. Using a separate LLC to own each investment property will provide protection from this outcome.
An LLC Avoids the Pitfalls of Co-Ownership
We also caution clients against the pitfalls of co-ownership of investment property by individuals. If investment property is titled in the names of multiple, individual owners, the death, incompetency, divorce, bankruptcy or creditor problems of one of the owners can create significant issues that must be resolved before the property owners can sell or even refinance the property. Sometimes a probate, guardianship or other legal proceedings are necessary. Sometimes interests in the property get passed to persons other than the original purchasers. In co-ownership arrangements, it is typical that little or no consideration is given to how decisions will be made and how events, such as the death, incompetency or bankruptcy of a co-owner will be handled. The many favorable attributes of the LLC structure, combined with a well drafted LLC Operating Agreement to govern the LLC’s affairs, provides an appropriate method of avoiding or properly addressing these issues.
There may be downsides to using an LLC that should be considered. These include the responsibility and cost of filing an annual tax return for an LLC with more than one member and potential issues regarding acquiring financing for the LLC. However, generally, the LLC form of ownership should be considered in most situations involving investment real property. The LLC form of ownership is almost never appropriate for the ownership of a Florida homestead by a Florida resident. Titling such property in an LLC will result in it no longer qualifying as homestead property; causing a loss of both the tax and asset protection benefits afforded homestead property in Florida. To avoid the possibility of paying additional documentary stamp tax on the transfer of real property to an LLC, it is best to make the decision to own real property in an LLC prior to the original acquisition of the property and take title in the name of the LLC. Our
attorneys are experienced at assisting clients with forming LLCs and acquiring investment real property in an LLC. We can assist you with the decision to use an LLC, to organize the LLC and to acquire your investment property.
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