Let me preface this by saying that I’m not a CPA or attorney. In fact, I’m struggling with some of these questions myself.
First, my opinion is that a LLC potentially offers better asset protection than an S Corp for situations where you are holding property. Execution of a judgment against you when you are the shareholder of a corporation could easily result in losing control of the property. In an LLC execution of a judgment is by charging order in general. The charging order gives the creditor the right to any income distributions, but not the right to the property. Accordingly, it may be possible to cease distributions, leaving the creditor with no distributions until the dissolution of the LLC but leaving them with a tax liability for the undistributed income. My statements are general, not specific, and you should have these statements reviewed by legal counsel. Further, there may be tax considerations which are unique to you that would make an LLC or a S corp preferable for you personally. My general feeling is that an LLC is a better vehicle than an S Corp for holding property.
In general I would say that it’s safer from an asset protection point of view to have properties in an individual LLC rather than to have all your properties in one larger LLC. However one of the factors that you also need to consider are the cost factors associated with forming and maintaining an LLC. There’s probably a limit as to how many LLC’s would be desirable from a cost standpoint, notwithstanding the benefits from an asset protection viewpoint. This is a question you will need to answer for yourself.
Between you and me, I think the issues surrounding what is “best” are quite complicated. There’s a cost to form the LLC, perhaps an ongoing cost to maintain it at the state level, perhaps additional paperwork concerns, insurance issues, tax considerations, lender issues, etc. Sometimes the advice you see concerns only the asset protection aspects?.not all the other aspects involved in the decision.
But if I were going to hold property, an LLC would be my choice. I would probably combine properties in an LLC, but not all properties. I’d separate some property in some fashion.
I am currently a shareholder/principal in a property management firm. We do only third party fee mgt right now. We are planning to purchase small apt buildings this year for our own portfolio.
Questions:
Do we purchase as the property mgt corp (S-Corp), or do we form a new LLC for each purchase? Should the property mgt co. be the member of the LLC or should the individual shareholders?
Also, if we use outside investors, how do we set out the % of ownership of all the members if it is an LLC?
I also have some questions about structuring paybacks and equity for investors that I’ll ask in another post.
My personal preference would probably be to set up an LLC, with each of the principals as members. I would make your property management company the manager of the LLC. This strikes me as a much cleaner set-up. This way problems in one entity would not influence the other entity.
Re: Best Structure for Holding Rental Properties - Posted by JHyre in Ohio
Posted by JHyre in Ohio on March 17, 1999 at 10:49:49:
“Do we purchase as the property mgt corp (S-Corp), or do we form a new LLC for each purchase?”
LLC’s are cheap in Ohio, so big dogs use one for each major property. Because there are no employees, S-corp has few/no advantages over LLC, while LLC P&L allocations are more flexible.
“Should the property mgt co. be the member of the LLC or should the individual shareholders?”
Doesn’t seem to matter in your situation. I would make sure that Manager (General Partner equivalent) is trustworthy for use as creditor deterrent (e.g.- charging orders). Remember, if S-corp is Member, it cannot allocate its P&L- all of it passes through strictly in proportion to ownership.
“Also, if we use outside investors, how do we set out the % of ownership of all the members if it is an LLC?”
Depends on your goals. LLC’s are very flexible in this regard, so you have lots of room to maneuver.
“I also have some questions about structuring paybacks and equity for investors that I’ll ask in another post.”
I will defer to other greater minds on that- I’m short on time and gotta go make a living!
By the way, did you find a good partnership agreement? I had none suitable for sending. I bought the Nolo book suggested by JP for $35. It was excellent and well worth the money.
The property mgt co can be the mgr of the LLC even if it is not a member?
So this would mean, on the properties we’re going to buy and hold, that we set up a separate LLC for each with the members being the individuals who have invested. And hire the prop mgt co to be the mgr of the LLC as well as the property.
The prop mgt co, I assume, would get an additional fee for being the manager of the LLC?
John: Thanks so much for your comprehensive reply.
Actually, our S Corp has 3 employees, the principals. the properties we’re looking at are large enough that they will probably have a super, which will be employee of the ownership entity of the property. We’re trying to limit employees of the mgt company if we can.
Manager…creditor deterrent…can you explain? Could the S-Corp mgt company be the manager if we choose to make it a member? Whatever we choose, one of the principals of the mgt co will be the manager and we have been in business together for over 5 years, now each other longer than that.
S-Corp cannot allocate its P&L and LLC can…what do you mean?
% of ownership in LLC…so I get to spell it out in the LLC charter in whatever manner I choose? And if I do this, I can distribute income and/or profit based on that %?
I bought the Nolo book on partnerships along with a book on forming LLC’s. Haven’t had a chance to get into them yet. But I’m sure it will save plenty. I’ll draw up the agreememt and have the attorney review it.
Should save on those legal fees!
Re: Best Structure for Holding Rental Properties - Posted by JHyre in Ohio
Posted by JHyre in Ohio on March 18, 1999 at 11:20:03:
I have seen the structure JPiper suggests in REITs and MLP’s. It’s clean and functional. Beware of one thing: In structuring the asset protection plan (e.g.- fending off charging orders) the S-corp becomes critical because it is the Manager. Thus WHO owns the S-corp is critical- make sure you do not leave the back door open for creditors by owning enough of the S-corp that your future creditors can use it to pump cash out of the LLCs. If you want asset protection for yourself AND own most of the S-corp which in turn is the Manager of the LLC’s that you have a direct membership interest in, it won’t happen.
Re: “increasing economic interest”- what I mean is don’t be Manager and Member- it’s unnecessarily cumbersome. You can have Manager with x% capital and/or profits interest. You pick x…no need to create a separate membership interest just to change % of ownership.
Yes, your property management company can be the manager, and does not have to be a member of the LLC. Matter of fact, this may well carry some asset protection advantages as it applies to the LLC.
Yes, you could set up separate LLC’s for each property, or you could put all the properties in one LLC. If the cost is not prohibitive a separate LLC would make sense in my opinion. You could hire the property management company to be the manager of each LLC.
Yes, you can pay a fee for management to the property management company.
By the way, Bill Bronchick puts out an excellent course on the subject of LLC’s. It included forms, operating agreements etc at what I feel is a modest price.
Re: Best Structure for Holding Rental Properties - Posted by JHyre in Ohio
Posted by JHyre in Ohio on March 17, 1999 at 12:23:03:
“Manager…creditor deterrent…can you explain?”
Long explanation- I think Bill Bronchick’s website (legalwiz.com) has an article expaining how family limited partnerships or LLC’s can be used to keep assets safe from creditors. If not, I’ll make a post- I’m short on time today.
“Could the S-Corp mgt company be the manager if we choose to make it a member?”
Probably. Depends on State law. I see little point though- why not just increase % of ownership as Manager to reflect economics instead of creating seperate Member interest?
“S-Corp cannot allocate its P&L and LLC can…what do you mean?”
P&L = Profits & Losses. LLC can customize P&L (e.g.- Bob gets 50% ordinary income, 20% capital gains & 80% losses) subject to certain “economic substance” tests. S-corp passes EVERYTHING through in proportion to ownership- no flexibility.
“% of ownership in LLC…so I get to spell it out in the LLC charter in whatever manner I choose?”
Yes.
“And if I do this, I can distribute income and/or profit based on that %?”
John: All this is so foreign to me! I hope I don’t sound too stupid! (Just stupid enough - VBG).
Charging Orders?
Our S-Corp is the property mgt company and is owned by three principals. 1/3 each. Would this be a good arrnagement? Otherwise, I suppose we could set up a separate S-Corp for this purpose, but how would the ownership have to be different?
“Increasing Economic Interest” So…manager should not be a member, but can have % of ownership in the LLC and/or % of profit?
John: I’ve checked out Bronchik’s site. I’ll have to go back and see the stuff about the LLC’s.
OK, I know I’m pretty dense today , but increase % of ownership as manager to reflect economics instead of creating separate member interest.
What does this mean? We planned on having our mgt co be the mgt agent of each property we manage and collect a % of the gross collections as a fee. Do you mean, in addition to this, that the manager of the LLC gets a fee, or more of a % because they are the manager? And, if so, can the mgt firm be hired as the manager of the LLC (even if they are not a member) as well as the property?
I knew P&L, but didn’t know that an LLC can get that creative in deciding what the income, etc. gets allocated to. I guess my accountant would love that!