Should your investment real estate be in an LLC?

October 3, 2013, by

bank closure.jpgExecutive summary: Yes.

Lars's Uncle Nils is a very rich guy who owns several investment properties. Technically he doesn't own the properties; he owns limited liability companies (LLCs) that own the properties. Why?

Think inside and outside liabilities. Let's say there was an explosion in one of Nils's apartment buildings, that was found to be caused by negligence (say the failure to attend to a heating system he had reason to believe was shaky). Let's say there were death claims coming out of the incident, that exceeded the amount of Nils's insurance. If he owned the apartments outright, all his assets would be exposed. If instead they were in an LLC that was operated properly, the loss would likely be limited to that single investment. This is protection from inside liabilities.

Let's say instead that Nils was the director of a bank that failed (not an unlikely example, in light of recent occurrences), and the FDIC came after Nils for a huge amount. If the FDIC got a big judgment against Nils and he owned the same apartments in his own name, the judgment would immediately be a lien on the real estate that could be foreclosed. If instead the real estate were in an LLC, the FDIC would have greater difficulty enforcing its judgment, at least against this asset. Nils could argue that only a "charging order" could be granted against his LLC interest, entitling the FDIC to any cash distributions made by the LLC, but not to seizing the real estate itself. This is protection from outside liabilities.

So yes, LLCs are good. There is one limited way in which they are not. If the apartments were in California and Nils owned them outright, they would be treated as out-of-state assets in the calculation of the Washington (State) estate tax. If instead they were held in an LLC, his interest would be deemed to reside with him here in Washington. So he would have to make the difficult decision between an LLC for asset protection, and direct ownership to lessen taxes. This is unfortunate.