We have seen that Uncle Nils has all his investment real estate in limited liability companies (LLCs). He even has one LLC with just cash, waiting to be invested in the next project. Why do people use LLCs?
One big reason is limiting liability. If Nils owned his properties outright, just in his own name and not in an entity, any lawsuit coming out of one of them could threaten all his holdings. So if there were a disastrous loss in just one real estate venture, say an injury or an economic meltdown, someone might get a huge judgment against Nils as owner, and seize any of his assets, not limited to the project in which the loss was incurred. And there are serious potential liabilities in owning real estate; see for instance some of the mold cases in recent years. If on the other hand the property is in an LLC, only the holdings of the LLC would be at risk. A limited partnership has a similar effect, at least for those who are limited partners rather than general partners. In Nils's state of Washington, limited partnership law has recently been updated to offer the same protection to all partners as the LLC, its newer cousin.
A second reason for LLCs is centralization of management where more than one owner is involved. If Nils owns a property with two or three others, it's important to define who is responsible for overseeing any construction, maintenance, insurance, and other business activity. If three people are just plain co-owners without a partnership or LLC agreement, then management remains undefined. In most of Nils's LLCs, nephew Lars is designated as the Manager and his responsibilities and compensation are described, as is the inability of other owners to interfere with Lars's management. Also important is to name successor Managers, in case something should happen to Lars.
Third, LLCs are convenient arrangements for making gifts. Once he places a property in an LLC, Uncle Nils can, on whatever timetable he chooses, share ownership with other family members. It works much better to give LLC interests than fractional interests in direct real estate ownership, for the reasons given above. With an LLC, the new owners have limited liability, and also limited opportunity to participate in decisions. This wouldn't be the case with shared direct ownership. So Nils can give small LLC interests to greatnieces and greatnephews without jeopardizing nephew Lars's control. And Nils has done that with most of his projects. In reporting the gifts he has followed certain valuation principles that bring us to the big debate, the big deal about family partnerships and family LLCs.