What Entity Is Right For Real Estate? Single or Multiple LLCs.

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When it comes to real estate investment, LLCs are the preferred entity by most investors, attorneys and accountants. Here is a short introduction to why LLCs are preferred and some ways to utilize the LLC in your real estate investment endeavors.

Real Estate Ownership--A Risky Business
Holding a piece of commercial or residential property that you're renting, is very risky from the perspective of lawsuits. There are many potential sources of legal liability for the owner. From common slip and falls, to environmental contamination, landlords and owners are exposed to legal judgments. Landlords have been successfully sued by victims of crimes--such as robberies, rape, and even murder--that occur on their property on the theory that the landlord provided inadequate security.

Therefore, it is crucial that you do not own investment real property in your own name. The only real property you should hold in your own name is your primary residence. You need to have an entity with limited liability hold your property.

What Entity Is Right For Real Estate?
For many reasons, few investors hold investment real estate in C corporations. Double taxation of dividends and the inability to have "paper losses" from depreciation flow through to owners are two of the most important reasons.

Before LLCs gained popularity in the 90s, limited partnerships and partnerships were the entities of choice for real estate investment. Limited partners were protected from personal liability while also being able to take passed through tax losses (subject to IRS rules--you'll need an accountant or attorney to sort out the issues of at-risk limitations and so on) from the property. The biggest downfall with limited partnerships was that someone had to be the general partner and expose themselves to unlimited personal liability.

LLCs don't require a general partner. All LLC owners--called members--have complete limited liability protection. LLCs avoid the double taxation of corporations, and have complete limited liability for all members. For holding investment real estate, the LLC is the best of all worlds when it comes to business entities.

Multiple Entities For Multiple Properties
Now that you're convinced you should use an LLC to hold your real estate, the next question is how many properties per LLC should you have. Should you create one LLC and hold all your property under it, or should you create a new LLC for each property?

There are several reasons why you should consider having multiple LLCs--one for each property.First, having multiple entities prevents "spillover" liability from one property to another. Suppose you have two properties worth $500,000 and they're held in the same LLC. If a tenant is injured at property 1, and wins a $750,000 judgment, he will be able to put a lien on BOTH properties for the entire $750,000. Even though property 2 had nothing to do with the plaintiff's injury, the plaintiff would still be able to attack that property.

On the other hand, if each property had its own LLC, then your creditor could only put a lien on the property where she was injured (assuming that they cannot pierce the corporate veil).
Many banks and lenders require separate LLCs for each property. They want the property they're lending against to be "bankruptcy remote". What this means is that the lender doesn't want a problem at a separate property to jeopardize their security interest in the property that they're lending on. If they are lending money to you to buy the building on 123 Main Street, they only want exposure to risks from 123 Main Street, and not from a bunch of other properties that you own elsewhere. Therefore, lenders often insist on a new entity for the property they are lending on.

Multiple LLCs For A Single Property
You can also use multiple LLCs for a single property. In this case, you would have one LLC own title to the property, while a separate LLC managed the property--i.e. handled repairs, collected rent, paid taxes, etc. For example, if you owned the building at 123 Main Street, you could form an LLC called 123 Main Street Partners, LLC and a second entity to manage the property called Main Street Management, LLC.

You should discuss the use of multiple entities for real estate investment with your attorney or accountant. The use of multiple entities can have tax consequences that are favorable or unfavorable depending on the details of the arrangement--and only an attorney or accountant working with you can arrange the details properly.