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A New Twist On Real Estate LLCs

Ginny…I read with interest what you wrote about putting rental properties in LLCs. What can you tell me about the new series LLCs for real estate investors? It appears they can be formed only in certain states, but would they be recognized in all states? — Rob V., Asheville, NC

Rob…The “series LLC” is a new, untested concept. Oversimplified, it is a “master” limited liability company, composed of two or more limited liability companies.

I have always recommended that real estate investors put their property into an LLC. But if you own two properties, each should be titled in the name of a separate LLC. Why? Because if a tenant in one of your properties decides to sue you — and you do not have adequate insurance coverage, or if the lawsuit is based on a matter that is excluded from your coverage — you could lose all of the assets in that LLC. So if you have two properties in the same LLC, both properties could be sold to satisfy any judgment against you.

On the other hand, if you have only one property in the LLC, the court — and the creditors — cannot go after those other properties. Of course, if you do not carefully follow all of the LLC rules (i.e., commingle funds, or sign legal documents in your name and not as “manager” or “member” of the LLC), then you potentially are exposing all of your assets.

Enter the series LLC. The concept began in Delaware, and to my knowledge, only seven other states currently allow the creation of such a legal entity. Those states are Illinois, Iowa, Nevada, Oklahoma, Tennessee, Utah and Texas.

In a series LLC, although each separate LLC (often referred to as “cells”) can have separate assets, different members and managers, the series (or master) pays only one filing fee and files only one income tax return.

While this column cannot provide a complete summary of the pros and cons to this concept, you can get a lot more information on the Internet by searching for “series LLCs.” But the most important questions are:

1. Will a state that does not authorize the series allow an entity that is legally formed in another state to be recognized and authorized to do business in that state? Recently, California has said “yes.” However, California is still going to require filing fees and taxes to be paid by each of the various cells in that master.

2. Is it absolutely certain that the assets of each cell are individually protected in the event of a lawsuit against one of the individual LLCs? Recently, the American Bar Association issued a report questioning the viability of this entity. One of the ABA’s concerns is whether the so-called “internal liability shield” would be recognized in those states that have not formally authorized series LLCs.

This is a new animal, and while intriguing, leaves a lot of questions unanswered. If you are an investor, discuss your situation with your attorney and your financial advisors before going down this uncertain path.