All Forum Posts by: Scott Smith

You would need to operate the LLC by the guidelines that are laid out by the state you operate in. But that doesn't mean it needs to hold a massive balance. You would need it to hold enough money to fulfill it's business for a period of time, generally several months. But if that LLC is sued you will be facing smaller risk that having the LLC that holds your entire property exposed. The LLC would essentially function as the property manager for the property (properties.) Large corporations do this all the time by using the popularly termed shell companies to operate their more risky endeavors.

The idea is to create additional layers of defense again lawsuits. However, if you are not abiding by the law they can still dig through these entities to the assets beneath them pretty quickly, which is why it's important for investors to commit to good business practice as a first step toward a solid asset protection strategy. I often try break it down into the 5 Pillars of Asset Protection when explaining it to investors - helps place the initial strategies of asset protection into a better framework.

In regards to Series LLCs and states that recognize them or not, the issue comes down to each specific state recognizing the "internal liability shield." Not if they have a Series LLC to create in that state or not--an investor in any state can form a Series LLC in a different state if he or she wants one. Every state has an internal liability shield for LLCs and that is what is analyzed in every state: the LLC Internal liability shield of the state you're being sued in.

There is a misconception that the Series LLC is a new entity. It is not. It was first created in 1996 in Delaware, over two decades ago. While the Traditional LLC is more established, it is not much “older.” The Traditional LLC first became available in Wyoming in 1977, but most other states did not follow suit until the 1990s. The next state was Delaware, which enacted LLC legislation in 1995, followed by California in 1994/5. It was not until 1996 that all states had an LLC option. The same year, the Series LLC was statutorily created. So it’s interesting how people quickly fall in love with the Traditional LLC thinking it’s been around forever. But the reality is that after the creation of the LLC in most states, the Series LLC immediately came into the game. Just one year after California codified the traditional LLC.

I hope this quick timeline of the Series LLC’s history helps dispel the misconception of the “novelty” of the Series LLC.  The fact that there isn't much case law provides more security than having a large body of case law behind it, in my opinion - it shows that the laws surrounding the entity are clearly stated and people aren't willing to try attack the structure. They've had over two decades to try and crack it, with great incentive to do so since most investors using the Series LLCs have a lot of wealth inside them. I have more case law to support the claims and history of the SLLC, too, so if you want a more detailed breakdown I can provide it.

Most of what I have on hand are specific to the deals I create for them. There are many available online that are created to be very general/broad, so if you plan on going the DIY route I would say finding one of those might suit you best - I am pretty used to adjusting them significantly, so the drafts I have aren't generally applicable without adding to them.

Hey Molly,

The only time you would be at risk of triggering the due-on-sale clause would be if you purchased the property under your personal name and then transferred it directly into the LLC. You can still make a transfer like this using a Land Trust by following this article, if you want. But simply opening an additional personal bank account will not provide you any legal protection - you would need to form an entity that limits your liability.

You will find it difficult to secure agreeable financing for an LLC. Getting financing for a new LLC may prove nearly impossible--particularly if there is no equity in the company. Financing terms for LLCs, even those with established equity, are typically far more costly than getting financing in your own name. But there is a way around this problem.

The first step is to get your financing in your personal name then use a land trust to execute any transfers into your LLC or Series LLC asset-holding company. Land trusts are viewed as estate planning tools [or an Inter Vivos Trust] and will not trigger the due-on-sale clause thanks to the St. Germain Act. They simply don't set off the same "alarm bells" at the bank that transfers to LLCs do. This has to do with the fact that land trusts are private documents, while most states require LLC membership to be reported on the public record with the Secretary of state. You can read more about this method of using land trusts to avoid due-on-sale issues from my previous BP article on the subject.

I have used this method personally and have seen many other investors do the same. None have even gotten a letter from the bank, to date. Barring a dramatic change in law, I would expect this method to help real estate investors avoid the "LLC lending problem" for the foreseeable future. Even if my entire analysis were wrong (it's not, I'm just playing out the worst-case-scenario for the excessively cautious), the very worst thing that could happen is that the property would revert back to your name. The bank won't force you to pay the entire loan in full without some time to "remedy" the situation. But even that is a worst-case scenario that I've literally never seen play out. Nor do I expect to. Land trusts have many asset protection benefits and can be a powerful addition to your asset protection plan anyway--yet this use is still not as widely known as it should be.

The rule of thumb is always to use the strongest entity which has the lowest costs - the main issue is the foreign filing fees. As @Michael Lewis Lee mentioned, it is judged by the state in which is was formed - this article touches on a few states that hold different benefits to forming an LLC in them. The best strategy I have seen to working around the foreign filing fees involved would be to create a land trust to hold the asset, then assign the LLC as it's beneficiary. This way it would be the Land Trust conducting the business of the property while still maintaining the liability protection you desire.

In the end there are an infinite number of ways to cut the pie. To identify the best way would probably involve you talking things out with an experienced attorney. I am partial toward Texas LLCs since they have strong laws reinforcing the LLC and no annual fees - and you can tie in that handy Land Trust to also remove your name from public records.

You're not the first investor to have difficulty securing agreeable financing for an LLC. Getting financing for a new LLC may prove nearly impossible--particularly if there is no equity in the company. Financing terms for LLCs, even those with established equity, are typically far more costly than getting financing in your own name. But there is a way around this problem.

The first step is to get your financing in your personal name then use a land trust to execute any transfers into your LLC or Series LLC asset-holding company. Land trusts are viewed as estate planning tools [or an Inter Vivos Trust] and will not trigger the due-on-sale clause thanks to the St. Germain Act. They simply don’t set off the same “alarm bells” at the bank that transfers to LLCs do. This has to do with the fact that land trusts are private documents, while most states require LLC membership to be reported on the public record with the Secretary of state. You can read more about this method of using land trusts to avoid due-on-sale issues from my previous BP article on the subject.

I have used this method personally and have seen many other investors do the same. None have even gotten a letter from the bank, to date. Barring a dramatic change in law, I would expect this method to help real estate investors avoid the “LLC lending problem” for the foreseeable future. Even if my entire analysis were wrong (it’s not, I’m just playing out the worst-case-scenario for the excessively cautious), the very worst thing that could happen is that the property would revert back to your name. The bank won’t force you to pay the entire loan in full without some time to “remedy” the situation. But even that is a worst-case scenario that I’ve literally never seen play out. Nor do I expect to. Land trusts have many asset protection benefits and can be a powerful addition to your asset protection plan anyway--yet this use is still not as widely known as it should be.

I know many investors in the Chicago area who use this method, so that wouldn't be an issue.

I don't know how your current LLC owns those properties or how you are connected, so instead of trying to give you a specific answer I will simply outline a good model to follow along with a comparison.

By placing the properties you own in the LLC you are creating a separation of liability between the LLCs and your personal assets (or potentially other LLCs you might operate.) So currently it sounds like you have your investments in a single traditional LLC. If there is a lawsuit against any of those investment properties that exceeds [or is excluded from] your insurance policy than a settlement/judgement can impact all of the investments you own inside of that LLC. 

The benefit of establishing an additional LLC to carry out the operations of your assets is that it can carry the majority of the high-liability operations (paying contractors, property management, collecting rent, interacting with guests/renters,) but you wouldn't end up placing any actual assets in it other than the money it requires to carry out those operations. If there is a lawsuit against the operations LLC, you would only be exposed by the balance that you hold in it's bank account. This requires good bookkeeping and the proper formation, but is not that big of a hassle once to have it established.

One of the strongest strategies I have seen for this is to set up a Series LLC to hold your assets, since it can actually legally separate each property into their own "child series" within the "parent" Series LLC. Then you would establish a traditional LLC as your operational LLC. In this scenario you only have to submit documentation to form two entities while still being able to protect each individual property you have as if it was in it's own LLC. Each "child series" you set up for the individual investment properties is a private document so you don't even need to form it with the state.

I wandered a bit, but I wanted to just lay out a couple of scenarios. I really don't know what your situation looks like, so this isn't advice. If you want to clarify your structure a bit more and ask additional questions you can just TAG me or reply and I will swing back to update this. Best of luck to you moving forward, it sounds like you are doing well! 

Hey Jordan,

A lot of this is stuff you want to pave the way for before it ever happens since it can get really messy if a partner decides to drop out down the road. Ideally when you are working with a partner you will want the property to be held in an LLC or some form of liability protection tool to start with. The two really major benefits would be asset protection for all involved and the ability to establish an Operating Agreement which can clarify scenarios like what you listed above.

Asset Protection: if you just hold the property into a general partnership, then any legal issues the property has can "spill" over into either you or your partner(s) personal assets. On top of that, if either you or your business partner have any issues that exceed or are excluded from taxes (say a car accident while intoxicated or texting,) then a legal action can impact the investment through a bad judgement or settlement. The LLC would create a stop gap between the investment property and either of the investor's personal assets.

Operating Agreement: this is where the LLC can really shine. When you set up an LLC you want to come up with an operating agreement that outlines how the investment will be run, who is in charge of what responsibilities, ways for people to "back out" without hurting the deal and what to do if the investment is either hyper successful or a total flop. If you can explore these possibilities before they happen it is quite simple to make a contingency and get on the same page. But lets say you have a bad year or two with no contingency, then suddenly a partner wants to sell and move on... That gets really difficult and strains/breaks many partnerships. But it can be pretty easily avoided with a good OA. Check out this article for some questions that should be addressed on that agreement.

Realistically they are on the note with you, so I would place the responsibility on them (as much as possible) to help find a solution. The ideal would be to find a replacement investing partner who you can trust to essentially buy them out of the deal - but there will be costs involved in this transaction and you would want to know the individual. In reality there would be a few ways to handle a situation like what you said above. I only enter into partnerships with people I trust, and so if I were in your situation I would generally feel  comfortable asking them to find a good solution to resolve the issue and work with them to find it - such as finding a new partner to buy them out. For partners I am not so trusting with... I would probably try find some local investors promptly and built those relationships for advice and a potential replacement.

Just some thoughts! Hope it all works out - feel free to reply if you have more questions.

Hey @Roxanne Ibrahim

Great question! While you don't need to hold each investment in it's own liability limiting company, but it is a much stronger way to protect yourself. If you own all your properties in your personal name, then any law suit that exceeds or is excluded by your insurance can impact all your other investments and personal assets. The LLC will separate the assets you place in it from yourself, so if there is a lawsuit against one of the LLC properties that exceeds or is excluded from your insurance then the litigants can only have access to the other assets in that specific LLC. The benefit of having each asset is that if you have any legal issues with any of your properties, then it will be contained to that single property and will not impact the rest of your business or personal life as significantly.

The cost involved is that you will need to introduce additional entities, which takes time and money, as well as learn to operate them correctly to avoid any bookkeeping issues. There are entities which are built to scale with investors - such as the Series LLC - so once you get a system down it is just a small cost to add additional assets to your asset protection plan. Just depends on how protected you want to be and what level of risk you are willing to take.

We discussed it in the BiggerPockets Podcast episode 109, so feel free to refer to that also. Shoot me a reply if you have any more questions.