Protecting personal assets is often a matter of great concern for new commercial real estate investors. When forming an entity, more real property investors are now using limited liability companies (LLCs) to protect their personal assets. The LLC is a newer form of business entity and it has benefits that corporations and partnerships lack.
Limited Liability
"One major advantage of an LLC over a partnership is that the liability of the members of an LLC can be limited to their financial investment," said Jack Rose, Chief Strategist at Breakwater Equity Partners. "So if the worst happens, the most the owners can lose are the assets being held by the LLC." In some partnerships, an owner's personal assets or properties might not be protected. When a lawsuit or a bankruptcy or foreclosure arises, the owner's personal property could be at risk.
If your commercial real estate portfolio includes a new retail development in Phoenix, a multifamily property in Cincinnati, or an office complex in Cleveland, most consultants will recommend holding each of the properties in a separate LLC. Holding each property in its own LLC limits your liability to that specific investment and this will help you to implement a diversification strategy. For example, if someone chooses to sue you because he or she slipped and fell at your Cincinnati property, the liability ends with your LLC for the Cincinnati property. Your other investments and personal assets are protected because they are held in different LLCs. If each property is held by a separate LLC, then the lawsuit at the Cincinnati property will leave the other properties in your portfolio unencumbered. You are free to refinance or restructure your other properties and can take whatever actions are necessary to maximize the return on your portfolio.
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Pass-through Taxation
Unlike some corporations, LLCs provide "pass-through" taxation. Basically, an LLC member is not required to pay taxes at the business level. The "pass-through" taxation allows the LLC member to report the company's profits or losses on individual tax returns at a lower rate. Corporation owners, on the other hand, face a double tax - on their business income and their personal income tax statements.
Key Features
Forming and maintaining an LLC is simpler and faster than forming and maintaining a corporation, according to the State of California Franchise Tax Board. LLCs do not issue stock and are not required to hold annual meetings or keep written minutes; however, a corporation must complete those tasks in order to preserve the liability shields for its owners. In general, all the owners (members) are shielded from individual liability for debts and obligations in a LLC. In a corporation, an owner or board member may become liable for events that occur within the organization.
Management Structure
The LLC management structure has fewer restrictions than a corporation. LLCs can be established in any organizational structure agreed upon by the company owners. LLCs can be managed by owners, members, or managers, while corporations must have a board of directors that oversees the major business decisions of the company and officers who manage the day-to-day affairs. An LLC can be owned by individuals or business entities, and can be managed by its owning members or a member-appointed manager.
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Who can form an LLC?
In the past, LLCs were generally used by hedge funds, entrepreneurial ventures, and real estate developers, but now LLCs are becoming the primary choice for all types and sizes of businesses. Anyone with significant assets, capital, inventory, or service offering can benefit financially from an LLC. Many business professionals are savvy enough to create an LLC on their own. The articles of organization, including the name and registered agent, and the operating agreement simply have to be filed with the state in which the LLC is created. However, complications can arise when creating an LLC. Many commercial real estate investors seek out professional help for the creation of their LLC entity and assistance can be found at most commercial real estate advisory firms.
* Warning: This information is not intended to constitute legal, financial, or tax advice and should not be used in lieu of any professional's advice.
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