Did you know the Witness Protection Program isn’t called the Witness Protection Program? The U.S. Marshals Service’s website refers to it as the Witness Security Program.
Created in 1971, it has “relocated and given new identities to more than 8,300 witnesses and 9,800 of their family members.” Much to my surprise, the U.S. Marshal’s service also reports “no witness security program participant, who followed security guidelines, has been harmed while under the active protection of the U.S. Marshals.”
Fascinating information that debunks the 20-30 movies out there with a plot line that goes like this:
Mobster testifies for the prosecution and puts a lot of bad guys behind bars. Mobster goes into the witness protection (security program). Mafia hit man, who looks and sounds a lot like Joe Pesci, finds said mobster a year later working in Suburbia U.S.A. as a pet shop manager. Mafia hit man kills mobster-turned-prosecution-witness-turned-pet-shop-manager with a baseball bat in the middle of a cornfield.
Many real estate investors use a limited liability company (LLC) or limited partnership (LP) as a business version of the witness security program. They go to great lengths to remain anonymous by creating an LLC and then naming other LLCs or trusts as manager/members of the new entity. Or, in the case of a limited partnership, naming an LLC as the general partner and other LLCs as limited partners. And while there are certainly tax and legal advantages to this approach (I don’t have time to go into those here), creating a 7-layer corporate cake can cause you indigestion, especially when buying short sale properties.
Last summer, I formed a limited partnership to fix and flip properties I buy at the auction and off the multiple listing service (mostly short sales). My LLC acts as the general partner of this limited partnership and I have three limited partners (each an LLC). A few weeks ago this limited partnership company got an offer accepted on a short sale and the bank asked for the following:
- Certificate of partnership for the LP.
- Articles of partnership for the LP.
- Articles of organization for the general partner of the LP (my LLC).
- Articles of organization for the limited partners of the LP (my investors’ LLCs).
- Articles of incorporation for the statutory agent of my LLC.
And of course, the bank negotiator needed all of this documentation within 24 hours. I’ve received similar requirements from banks for an LLC I use to fix and flip short sale deals. This LLC is managed by my S-Corporation.
So why are the bank short sale negotiators making real estate investment companies disclose so much information about their ownership structure these days?
One word – fraud.
Many homeowners have figured out how to capitalize on short selling their properties to investment firms. Together they conspire by devaluing the property (vandalizing the home, removing appliances, kitchen cabinets, etc). Then the bank has no choice but to accept a low offer from the investor. Once the deal closes the investor compensates the seller, either by referral fee or profit from the flip. Lenders finally figured out this end game and now want to make sure the buyer and seller aren’t in business together via the LLC or LP.
Rather than play this game with the banks I decided to create a single-member LLC (my name appears on the articles of organization as the manager and member). It’s not ideal from an accounting, tax or legal standpoint but at least I won’t have to risk losing a deal because the short sale negotiator can’t figure out who owns my company.
And for what it’s worth, I predict banks may soon only accept short sale offers from individuals. When that day comes say goodbye to the real estate investor’s version of the witness security program.