When it comes to asset protection, I always tell my students and clients that segregating dangerous assets from each other is a sound strategy to limit overall risk exposure. Best practice dictates that each asset should have its own entity. For many people this could translate into to a multitude of business entities.
For example, just yesterday I spoke to an individual who owns over 30 properties. If this investor desired complete asset segregation he should create 30 separate Limited Liability Companies. This would surely translate into an annual cost of over $6,000 in state fees. Now depending on your risk tolerance level, $6,000 may be considered cheap insurance given that the cost breaks down to only $200 per property. For many, this is a bargain given today’s hostile business environment and personally, I would agree. However, some investors who live in a state with high annual business fees, such a structure may not be financially practical. Thus, the desired asset protection plan is sacrificed in favor of grouping several properties into to a handful of LLCs.
Is this to say one investor is smarter or savvier than the other? No, it just comes down to each individual’s risk tolerance level and money. Now this brings me to the point of my article. I have been receiving more than usual interest in a relatively new variation of the LLC referred to as the Series LLC. A Series LLC could be viewed as a possible solution to the cash conscious investor’s dilemma and the “I am entity overwhelmed” investor.
The Series LLC is similar to having multiple LLCs for different properties. However, the structure is simplified by allowing one LLC to operate numerous other subsidiary LLCs, each of which runs a “single-asset” business. For the real estate investor, this means that each subsidiary LLC owns one property, protecting it from the liability of the other properties. The Series LLC could possibly simplify things greatly: fewer forms, fewer reports, and a much easier time managing multiple properties than if you had to form a new, independent LLC for each property and not to mention potentially only one annual business fee.
One strike against adopting the Series LLC is the lack of legal precedent. Only a handful of states, Delaware, Illinois, Iowa, Nevada, Oklahoma, Tennessee, Texas, and Utah have adopted statutes recognizing this form of business entity. As such, it is new and untested as an asset protection tool. In point of fact, to my knowledge, the series LLC has only been tested in one case. In that case, GxG Management LLC v. Young Brothers & Co., No. 05-162-B-K, 2007 U.S. Dist. LEXIS 12337 (D. Me. Feb. 21, 2007), the Court struggled with the series concept and in the end viewed the entity as one LLC.
Second, there is a lot of uncertainty in the federal government about how the Series LLC should be taxed. On October 13, 2010 the IRS issued proposed regulations that if adopted will remove much of the uncertainty over the tax treatment of series LLCs however, this remains to be seen.
Third, some states, notably California, have taken the position that each series will be treated as a separate LLC when it comes to annual franchise fees – this will not help the cash conscious investor.
Fourth, if an investor owns property in different states will the parent entity be required to file in each state as a foreign LLC in order to take title to property in one series? If so, will that bring every series under the control of the filing jurisdiction even though separate series own property in other states?
Finally, general business principles require that each series must be treated as a separate legal entity which necessitates separate bank accounts, agreements, letterhead, etc. – this does not help the “I am entity overwhelmed” investor.
Therefore, creating a Series LLC for real estate and asset protection purposes is still largely uncharted territory and one should proceed with extreme caution. The Series LLC has there are guidelines for formation, but very little governing business operations, taxation, or legal liability. I learned long ago that predicting how governing bodies will view a particular strategy or structure is impossible and the risk of getting it wrong is better left to others who have client’s that are willing to put up the money to wage the fight of acceptance. Many a client has learned the hard way that it is sometimes better to take planning slow and evolve with the law rather than try and chart its course.
I wish you all the best with your business and investing.