Entity Structure — Setting up Entities as a Series LLCNov 10, 2020
Legislation plays a key role in the entity structure of real estate holdings. Entity structure tends to be both complex and dynamic—changing regularly from state to state and over time. That's why it's so important that you seek out legal and tax professionals in your market area that specialize in real estate. Our advice should be seen more as insightful tips that you can take to your advisors in an effort to optimize how you set up your entities.
It's shocking how often clients take this subject lightly or not at all. Or even when they do get serious, calling that one random attorney you happen to know can lead to horrible advice if they don't actually know what they're talking about. This is similar to a man with a brain tumor going to his wife’s OBGYN and asking him for advice. It simply doesn’t work this way. You need to get a specialist and do the right thing for your entities. That way you can be put in a position to preserve and build wealth—limiting liability in the process.
The Most Common Entity Structure?
For real estate investors, the most common structure is to get a conventional residential qualified loan, then leave the title to the property directly in your name. THIS IS TERRIBLE. Why? As an investor, you'd be leaving yourself and your family assets completely exposed to any issues that may arise from the tenants during the lease (or after depending on the statute of limitations).
Being completely liable means that every single asset (cash, other real estate, businesses, personal belongings, savings, etc.) is liable to be sued for damages in the event of a lawsuit. A common response to this is, “Well I have insurance.”. Good luck. Insurance doesn’t always cover liability from being sued nor protects your other personal belongings.
There is a much better way.
Typically what we see is “Joe Buyer” will go in and create an LLC. He often thinks that the LLC alone will solve all of his real estate asset problems. It’s a start, but is not the entire solution.
There are several crucial steps to ensure that tenants cannot “pierce the corporate veil”. A quick definition moment: To “pierce the corporate veil” means that if you have something in the name of a business, but you don’t keep that business actively licensed, and don’t practice the rules of operating the business, then you have acted personally—so the veil that protects you personally from the liabilities of the business becomes broken and you are now liable.
Here are several steps to protect yourself from liability in the way you hold real estate:
- Set up an LLC (several types and options here)
- Set up a business bank account per LLC
- Never co-mingle funds that come in from the property or are paid for the properties expenses. Keep clean accounting.
- Ensure your leases state the name of the business entity as the landlord unless you are having a property management company act as landlord, then their name will be the landlord.
- If you are using a property manager, ensure that your entity name is the name on the property management agreement.
The above will help a lot with the process, but it brings up a couple of questions that need to be addressed:
- What if I own more than one property?
- What if I have a partner in a property?
- What happens to my loan if I change names on title?
What if I own more than one property? Think of this like the reason you got an LLC in the first place for just one property. You were trying to keep a veil between you personally and the asset. When you have more than one property, you must create liability between assets if they are both titled in the same entity name.
To accomplish this, you must obtain a “Series LLC”, which allows you to own multiple properties under the same entity umbrella. Essentially, this maintains a vertical barrier between the parent LLC and you as the owner, and horizontal veils between each property. This type of LLC only applies to legally in certain states—so do some due-diligence and ensure that this type of LLC has the proclaimed protections in the local state you invest in.
Another important step when setting up your Series LLC is to ensure your financials are clean from one property to another. When setting up banking accounts, the most protective measure you can take is to open up a bank account for your Series Name.
For example, if I set up “ABC Real Estate, LLC” and I owned two properties, one with the address 456 and another with an address of 789, I would have two Series LLC names under the parent of ABC Real Estate, LLC. One would be named ABC Real Estate, LLC Series 456 and the other ABC Real Estate, LLC Series 789. Then I would open up two business banking accounts under each respective name and I would NEVER co-mingle the funds so they can operate independently. This would preserve the integrity of business intent.
In states that do not recognize a Series LLC entity for the prior mentioned purposes—you are stuck with simply setting up independent LLC entities for each property. The same principles of banking still apply.
The attorney’s we’ve spoken with always recommend having a Holding Company LLC to hold the assets and an Operations Company LLC to run the property holdings. This also adds one more layer between you and your LLC that owns each property and receives payments to hold the cash assets of the operating company with a veil between the holding company and the operating company.