Forming LLC to govern the rest of LLCs
Brownstown, MI · Member since 2014 · 344 posts · 98 votes
This will likely be an easy question for some of you.
So, if I generate 3 LLCs, 2 of which hold 1 rental home in each, and the 3rd which is the main LLC that owns all other LLCs under it...
How do I make that true? What I mean is, how do I get the hierarchy on paper?
ABC LLC governs YY LLC and ZZ LLC. But how do I make it on paper so that this is true?
After I create 3 separate LLCs, then how do I get the ABC LLC to have possession and ownership of the other 3?
At the moment I do not have any LLCs created. Do I need to make ABC LLC first, and then if that matters, how do I fill out the articles of organization (or whatever other form is required) to make YY LLC and ZZ LLC a holding?
I'm sorry if I'm confusing the question...
This is my opinion, not legal advice...I agree with the others that are questioning the reasoning for this structure. If you are out there screwing people, they'll find a way to pierce the corporate veil and get to you personally, LLC or no LLC. If you aren't out there screwing people, most of your exposure is from frivolous suits and accidents. That's what insurance is for, so no gain from the LLC here, either. Your biggest exposure is legal fees to defend yourself, not judgments, and having an LLC won't eliminate the need to defend yourself should the occasion arise (and if you get bigger, the need will arise, trust me).
There may be some value in LLCs if you have substantial assets and are concerned about the exposure to those assets resulting from personal negligence. For example, you run over a kid on your way to the grocery store and your insurance limit is exceeded and your millions in real estate is placed at risk. But...umbrella policies are designed for this type of risk. Get a big policy.
Your proposed structure would likely result in three tax returns to file and their associated cost to prepare, plus state fees that may be assessed on each on an annual basis. The cost of which likely far exceeds the cost of insurance.
If you are determined to move forward as you outlined, you form the "manager LLC" first, and then the subsidiaries. If your state asks for the names of the manager, the subsidiaries name the "manager LLC". Each LLC needs an operating agreement, and the operating agreements of the subsidiaries would name the "manager LLC" as either the sole member or the manager, and would vest ownership in all of the units in the name of the "managerLLC".
I have the exact structure that you describe, but I have it to seperate equity investors in one opportunity with investors in another. For example, an apartment complex with one set of capital investors is in one LLC, while a portfolio of single family homes with a different set of capital investors is owned by a different LLC, and the LLC's are all managed by another LLC or corporation. It's not about asset protection, it's about segregating a variety of investment structures.
I suggest that you get the advice of a business attorney, CPA, and insurance consultant before you decide on your ownership structure. Beware of the "asset protection" attorneys, and don't make your decisions based on what you hear from well meaning friends, even those of us here on BP. Good luck!
@David Roberts why not ask your attorney how effective a single member LLC is anyway. It sounds like she just wants to get into your pockets.
The attorney that speaks about RE to our REIA keeps all his properties that have mortgages in his name. The apartments that he has with partners he has in an LLC.
You will be so busy with paperwork you will never get to the meat of the subject which is investing and maintaining RE IMO.
Oh yeah, when you go to eviction court you will need an attorney because the legal ramifications of defending yourself/entity is insane and complicated.
You need an operating agreement for each LLC. I agree with others that having each property in it's own LLC is overkill. I talked to my lawyer about this a while ago. He said insurance is your best defense. He also told me that he was involved in a lawsuit where the landlord had no smoke detectors, house burned down, and children died. When it was all said and done, the family settled for the $1 million insurance payout. They wanted their cash and didn't want to wait years to try and get more.
In Michigan, slip and fall lawsuits don't exist. As long as you run your business properly, a frivolous lawsuit will be the least of your problems.
You might also want to read this thread:
Read Keith Barton's post from November 25, 2011 on page 2. It's very interesting the way he lays out different scenarios.
I thought operating agreements were only for if you had multiple members. If I'm the only member in an LLC what would I need an operating agreement for?
Also about insurance, as it is now I get insurance on my single family homes from my typical insurance agent. I have 500k in liability. Is there different insurance for an LLC or can Ijust continue to get this kind of coverage for each home?
I thought operating agreements were only for if you had multiple members. If I'm the only member in an LLC what would I need an operating agreement for?
Also about insurance, as it is now I get insurance on my single family homes from my typical insurance agent. I have 500k in liability. Is there different insurance for an LLC or can Ijust continue to get this kind of coverage for each home?
The operating agreement states how the LLC is run. When I got a commercial loan for my single member LLC, the bank wanted the operating agreement.
As far as liability, talk to your insurance agent about getting more. I would rather have a house in my personal name with a million liability coverage than have the same house in an LLC with only half a million.
I just read those scenarios in the thread that was offered. Fantastic. Thank you very much. So the key is when there's work needing to be done, have a pro do it.
I thought operating agreements were only for if you had multiple members. If I'm the only member in an LLC what would I need an operating agreement for?
Also about insurance, as it is now I get insurance on my single family homes from my typical insurance agent. I have 500k in liability. Is there different insurance for an LLC or can Ijust continue to get this kind of coverage for each home?
The operating agreement states how the LLC is run. When I got a commercial loan for my single member LLC, the bank wanted the operating agreement.
As far as liability, talk to your insurance agent about getting more. I would rather have a house in my personal name with a million liability coverage than have the same house in an LLC with only half a million.
But if it is just me as the sole member and I'm doing single family homes and not apartments or other commercial buildings, do I still need the operating agreement?
But if it is just me as the sole member and I'm doing single family homes and not apartments or other commercial buildings, do I still need the operating agreement?
Yes. Check out this link:
1 property per LLC sounds a little over the top [unless each property is $500k+].
IMO - I prefer the Rich Dad Education method of having a S-Corp as my "parent" or "umbrella" and the put properties into LLC's. Once I reach my threshold [some say $400-$500k] I then start another LLC.
I also use seperate LLC's for any JV or partner deals.
@Brandon Hall Interesting idea about forming your own property management company to interact with tenants. When I've had property managers, as the owner, I've still signed the leases with the tenants. Would it be possible to have the LLC be on the lease?
Now that you would be running a property management business, do you have to get a business insurance policy?
Does it really provide any protection because of the blurred line of whether you are acting as the owner, or the property manager?
@Shawn Holsapple Out of curiosity, is your limit $500k in property value or equity?
@Shawn Holsapple Out of curiosity, is your limit $500k in property value or equity?
I'm sure everyone has their threshold. Here in the mid-west, $500k will buy about 9-10 SFH, whereas, on the West Coast - that may get you a van down by the river.
My me, $500k is about my threshold.
I hope all this entity analysis isn't stopping you from going out and finding deals! I have found with SFHs, the lender won't loan to an entity anyway, even with personal gaurantee. Insurance is tougher, too, ensuring entities. That said, I have done what @Brandon Hall and @Shawn Holsapple suggest. I have a mgt co (in an S-corp) and my multi-families are in an LLC. Commercial lenders & LLs will carry/finance an LLC-titled property. All rents go to my mgt s-corp. All properties have an in-house mgt agreement with my mgt co. All mileage for taxes goes through the mgt co, not each property. I can bill my properties for work I do through my mgt co and I don't need a RE license for that, as I only manage what I have a vested interest in. You can do all this for 13 different accounts and file all the tax returns for same if you want. The CPAs and attorneys will be thrilled. Don't worry about it and go find that first deal!
It's not stopping me. Just trying to figure things out. I think if you do one LLC per house, you still need to get the loan in your name. So if you are buying with a loan to start, buy it personally, then quit claim to LLC. If you are paying cash, buy it with LLC, when it comes time to refi then quit claim back to your name, get the loan, then quit claim back to LLC. I checked with my insurance agent and she said it wasn't any problem to get insured but every property had to have its own insurance, and an umbrella policy for additional liability could be obtained. So far this is what i've been told.
Lots of paperwork for sure.
In Michigan if I'm the only member it is 50 to start and 25 to maintain I believe. Not bad.
I just want to do the smartest thing. I don't know what that is. I only know what I've heard from others, and what my lawyer advised. But, lawyers want to make money too so their advice should be considered as such I suppose.
My lawyer wants 300 per LLC to do it for me, but I think it is very simple for me to set one up, especially if I'm not having any partners.
David - I know there are a lot of naysayers here, but I and my partners have exactly this sort of arrangement. It is not difficult to manage at all. Yes, we have a separate bank account for each unit. Yes, we complete a 1065 tax return for each unit, which is a pass-through to the "master LLC." They are not difficult to do and I do most of it on my own with TurboTax Business.
You are right about the cost to set up and maintain - $50/$25. This is also not difficult and you can do it yourself very easily. For the $300 for the lawyer, I am guessing this is for the Operating Agreement that calls out all the details of the LLC. If that is the case, once it is written the same format can be used for additional LLCs. That seems like a good investment to me. Your lawyer should also be able to let you know what things you need to do for annual meeting minutes, not co-mingling funds, etc., to maintain the LLCs.
Lastly, there was just a podcast on this exact topic - it is pretty good and is well worth a listen. http://www.biggerpockets.com/renewsblog/2015/02/12...
Good luck!
Joe
This is my opinion, not legal advice...I agree with the others that are questioning the reasoning for this structure. If you are out there screwing people, they'll find a way to pierce the corporate veil and get to you personally, LLC or no LLC. If you aren't out there screwing people, most of your exposure is from frivolous suits and accidents. That's what insurance is for, so no gain from the LLC here, either. Your biggest exposure is legal fees to defend yourself, not judgments, and having an LLC won't eliminate the need to defend yourself should the occasion arise (and if you get bigger, the need will arise, trust me).
@Brian Burke
Have you ever been sued from a tenant? If yes, for what reason and what was the outcome?
What about situations where it's not the tenant's fault? Say there was some arguement and someone gets killed or raped or whatever and the tenant sues you because you didn't provide adequet security measures? Or something similar to that scenario.
I would like to hear from people who operate under the "no LLC, high insurance" coverage model who have been sued how things have worked out.
Also, if you run your business correctly, then they shouldn't be able to pierce the corporate veil. The LLC was created exactly for this type of protection. If you are neglegant then yes you then become personally responsible, but if we are doing our jobs properly, as most people in BP advocate we are good landlords and not slumlords, then I'm assuming we would run the business properly. This is why every lawyer, doctor, cpa, etc... all have LLC's setup: to protect against personal liability.
I do think 1 LLC per property is overkill and i agree with others who have said that you could do maybe 5-10 properties per LLC.
@David Roberts check out podcast 109 with BP member and Atty Scott Smith. He goes in depth with regards to the different types of entities eg. LLC or Trust you can create to better protect yourself and your assets.
This is my opinion, not legal advice...I agree with the others that are questioning the reasoning for this structure. If you are out there screwing people, they'll find a way to pierce the corporate veil and get to you personally, LLC or no LLC. If you aren't out there screwing people, most of your exposure is from frivolous suits and accidents. That's what insurance is for, so no gain from the LLC here, either. Your biggest exposure is legal fees to defend yourself, not judgments, and having an LLC won't eliminate the need to defend yourself should the occasion arise (and if you get bigger, the need will arise, trust me).
@Brian Burke
Have you ever been sued from a tenant? If yes, for what reason and what was the outcome?
What about situations where it's not the tenant's fault? Say there was some arguement and someone gets killed or raped or whatever and the tenant sues you because you didn't provide adequet security measures? Or something similar to that scenario.
I would like to hear from people who operate under the "no LLC, high insurance" coverage model who have been sued how things have worked out.
Also, if you run your business correctly, then they shouldn't be able to pierce the corporate veil. The LLC was created exactly for this type of protection. If you are neglegant then yes you then become personally responsible, but if we are doing our jobs properly, as most people in BP advocate we are good landlords and not slumlords, then I'm assuming we would run the business properly. This is why every lawyer, doctor, cpa, etc... all have LLC's setup: to protect against personal liability.
I do think 1 LLC per property is overkill and i agree with others who have said that you could do maybe 5-10 properties per LLC.
I've been sued by tenants twice. The first time was about 10 years ago, the tenant was claiming that their living conditions were substandard (of course this suit was filed after an eviction was started for non-payment of rent--go figure). The tenant was suing in small claims court for $5K and had video evidence of the horrendous state of their apartment. Too bad for them that their video helped me more than them (straight from the judge's mouth) and the judgement was in my favor with plaintiff awarded nothing. My loss was travel costs and a wasted day to defend myself.
The second time was a couple of weeks ago. The tenant claimed that they didn't get their security deposit back. Well, they did, and we had the cancelled check to prove it. Oddly, they didn't even show up to court so their suit was tossed. My loss was nothing because my property manager appeared on my behalf at no charge.
You ask what if someone is raped or killed? That's why I have insurance, and a lot of it for that matter. The plaintiffs will go for the low-hanging fruit--the policy. The insurance will cover my cost of defense (as long as I didn't commit an intentional act). The question was once posed here on the BP forum seeking anyone whose assets were saved by their LLCs after a lawsuit. No takers. Interesting...
So I don't see how spending thousands of dollars on all of those entities would have helped me. But what do I know? I'm no lawyer nor insurance guy. I only have between 400 and 500 units and I've only been landlording for 15 or so years, so maybe I just don't have enough exposure yet.
You are obviously very successful so I'm jus trying to find out why you do what you do. My post was not an attack on you so I'm sorry if that's how it came across. I'm jus trying to understand the logic/legality better.
A couple of follow up questions:
1) The properties you own by yourself, are they just in your name or some entity? Meaning, did you form a single LLC for all your properties you fully owned by yourself or just put them in your own name?
2) The tenants that sued you, were they in a property that you had set up as an LLC with other partners/investors or one that you personally owned?
Thanks in advance.
No attack perceived at all, @Alexander Merritt . I totally understand and respect your view and to entity or not entity is a personal decision. Whether I think it's necessary or not doesn't matter, and really doesn't matter if the s*&% hits the fan.
I meant what I said though...it's really possible that I just don't have enough exposure yet. Maybe my day of reckoning will come. I don't want others reading this thread to take any course of action just because I did. Maybe I'm just lucky. My point is that many folks on BP are freaked out by liability and spend all kinds of time and money forming entities for "asset protection" when they have very little exposure relatively speaking.
That said, I do have entities. Not for asset protection, but to segregate investor's capital amongst various groups of people and various RE strategies. This is a legitimate business purpose for having the entity and is the very foundation behind the thesis of entities protecting the personal assets of the members behind an LLC. It's about business, not escape from misdeeds and sometimes folks newer to the industry confuse the two.
As to your questions: I own a number of properties in my name, less than 50 units. Why? Because they are mine. I could form an LLC and maybe someday I will but since I have no real business purpose for doing so I have not. The rest of the units are in a variety of entities for the reasons stated above.
In the tenant lawsuits, the first one was related to a property in my personal portfolio, the second was in an LP which is governed by an LLC which is governed by another LLC. That complex structure is due to investor / strategy segregation.
In addition to tenant lawsuits, I've been sued several other times for frivolous stuff, each time related to a property within an entity. The entity didn't protect me. What protected me is that I didn't do anything wrong and I won each suit. The reality, however, is that I lost because I still had to pay to defend myself. Total tally is over $200K in defense costs, most of that related to one case. In another case, my insurance company actually paid to defend me. And it was about darn time!!!
Here's an answer to the OP:
Every LLC has (should have) an operating agreement. The operating agreement should state who the members (owners) are. The parent LLC can be the member of the child lower level LLCs.
If your child LLCs already have operating agreements, you just draw up a resolution stating that the members have changed (needs to be signed by the previous and subsequent members).
One can imagine a similar move for an investor who wanted to consolidate ownership of his LLC's into a Living Trust or other estate planning vehicle. To make clear that the trust owns the LLCs, one would draw up a resolution for each child LLC naming the Living Trust as the Member.
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