What is a limited liability company
and how can it be used in my real
estate investing operations?
By JJ Childers
Since we
began discussions through the InvestorWealth "Ask Our Attorney"
program, we've gone through an overview of the objectives that we must
accomplish in effectively protecting our assets. Now, it's time to begin
the task of delving into the individual entities and gaining a better
understanding of each. In this answer, we will be taking a look at what
I believe to be one of the best entities available for real estate operations,
the limited liability company. Let's take a look at what it is that
we need to know about this entity.
First of
all, an LLC is what is known as a "hybrid" entity. It is a
hybrid between a partnership and a Corporation in that it combines the
"pass-through" tax treatment of a partnership with the limited
liability accorded to corporate shareholders. This can be a great benefit
for those involved in real estate because it helps us to avoid the potential
problem of double taxation that can be associated with C corporations.
(We'll be discussing this in a later segment.)
Like limited
partnerships and corporations, an LLC is recognized as a separate legal
entity from its "members." This separate nature is very important
as it is what gives us the asset protection, the estate planning, and
the tax reduction benefits from the entity. It is also what makes it
such a great tool for real estate activities. You see, ordinarily, only
the LLC is responsible for the company's debts thus shielding the members
from individual liability. However, there are some exceptions where
individual members may be held liable:
Guarantor
Liability: Where an LLC member has personally guaranteed the
obligations of the LLC, he or she will be liable. For example, where
an LLC is relatively new and has no credit history, a prospective landlord
about to lease office space to the LLC will most likely require a personal
guarantee from the LLC members before executing such a lease. Additionally,
when purchasing a property, it is highly unlikely that a bank will lend
money to a new LLC that has not had a chance to build up any sort of
credit history without a personal guarantee from the individuals making
up the LLC. This is not a problem from an asset protection standpoint,
it merely obligates the individual to repay the mortgage which is something
I'm sure you knew you were going to have to do anyway.
Alter
Ego Liability: This is similar to the judicial doctrine applied
to corporations where a court may hold the individual shareholders liable
if the business entity is determined to be merely the "Alter Ego"
of its shareholders. A member of an LLC may also be held liable for
the LLC's debts if the court imposes its "alter ego liability"
doctrine to the LLC. I like to think of this in a very simple manner.
As I was growing up, my parents oftentimes told me, "If you want
to be treated like an adult, you'll have to act like an adult."
Now their words are coming back to me in a legal context, "If you
want to be treated like a limited liability company, you'll have to
act like a limited liability company."
One important
thing to remember, however, is that although a corporation's failure
to hold shareholder or director meetings may subject the corporation
to alter ego liability, this is not always the case for LLCs. An LLC's
failure to hold meetings of members or managers is not usually considered
grounds for imposing the "alter ego" doctrine. This is especially
the case where the LLC's Articles of Organization or Operating Agreement
do not expressly require such meetings. My students and clients rarely
encounter this issue as they understand that meetings are a great chance
to get away in a tax-deductible manner.
Management
and control: There are two types of management available to
LLCs. One is management by membership and the other is management by
a manager. There are various reasons for choosing each different type.
One important reason for establishing management by a manager is that
it gives a great opportunity for income-splitting in order to reduce
your overall income tax obligation. This is something that we spend
a great deal of time on in our Wealth Structuring Institute seminars.
If you would like to learn more about how you could attend one of these
seminars, please contact us at info@secretmillionaire.com.
It's important to remember that management and control of an LLC is
vested with its members unless the articles of organization provide
otherwise.
Voting
Interest: Ordinarily, voting interest directly corresponds
to interest in profits, unless the articles of organization or operating
agreement provide otherwise. This is another reason why it's important
to have your LLC drafted by a qualified attorney who can help you identify
the key legal, as well as tax, issues associated with properly structuring
the various aspects of your LLC.
Transferability:
One area of entity ownership that people fail to pay enough attention
to is the potential transfer of that ownership interest down the road.
No one can become a member of an LLC (either by transfer of an existing
membership or the issuance of a new one) without the consent of members
having a majority in interest (excluding the person acquiring the membership
interest) unless the articles of organization provide otherwise. This
is yet another example of how important the actual LLC documents are.
Duration:
While many states now allow an LLC to have a perpetual existence similar
to a C corporation, LLCs were traditionally required to specify the
date on which the LLC's existence would terminate. In most cases, unless
otherwise provided in the articles of organization or a written operating
agreement, an LLC is dissolved at the death, withdrawal, resignation,
expulsion, or bankruptcy of a member (unless within 90 days a majority
in both the profits and capital interests vote to continue the LLC),
depending upon what's outlined in the articles of organization.
Formalities:
One of the reasons that people like LLCs so much is that they have simple
formality requirements compared to other entities such as C corporations.
The LLC's existence begins upon the filing of the Articles of Organization
with the Secretary of State. The articles must be on the form prescribed
by the Secretary of State. Some of the required information on the form
is the latest date at which the LLC is to dissolve and a statement as
to whether the LLC will be managed by one manager, more than one manager,
or the members.
Operating
Agreement: To validly complete the formation of the LLC, members
must enter into an Operating Agreement. This Operating Agreement may
come into existence either before or after the filing of the Articles
of Organization and may be either oral or in writing. As you can probably
guess, I would always, always, always recommend that you have everything
in writing, especially if dealing with other people. This is another
lesson I learned from my parents as I was growing up: it's
better to have it and not need it than to need it and not have it.
While this
information may have been more than you ever thought you'd ever want
to know about limited liability companies, it should prove to be very
helpful as you begin utilizing this powerful tool in your real estate
operations.
Action Step
Over the
next week or two, visit your Secretary of State's website for the state
in which you live to identify the various requirements, filing information,
and fees associated with establishing a limited liability company. In
researching the numerous methods for establishing this entity, you will
notice a great disparity in the pricing. The reason for this is typically
that you get what you pay for. Don't expect to get much in the way of
support from most of the companies who merely establish the entities.
By making a greater investment in properly structuring your entities,
you can end up saving and making a lot more money through your real
estate investments over the long haul. If you're looking to do things
right and utilize a professional as part of your master mind team, feel
free to contact us at info@secretmillionaire.com
to find out how we can help. Until next time, remember to always
cover your assets!
About JJ Childers
JJ Childers
is a licensed attorney and active real estate investor and developer.
As an attorney,
he deals primarily with the areas of asset protection, estate planning,
and tax reduction. Simply put, he assists people with overcoming the
obstacles of lawsuits, income taxes, and death taxes. He travels the
country extensively sharing his strategies with other real estate investors
as well those involved in various types of small businesses. Through
his innovative and dynamic strategies, he has literally helped thousands
of people save millions of dollars in taxes.
Even better,
he has the knowledge and experience to apply these strategies to real
estate investors in particular. He teaches these strategies to help
real estate investors build in more profits to their real estate deals
and to properly protect those profits. The unique combination of being
both an attorney and real estate investor make him a hot commodity with
real estate investors throughout the country.
