| Possibly THE most frequently asked question of me is | | | | money in the long run. It may even save the property |
| "What is the best business entity to use for real-estate | | | | itself if a claimant was to successfully sue the LLC |
| investments?" My recommendation to most people is | | | | and win. If the LLC had no insurance coverage in place |
| that a limited liability company (an "LLC") is the best | | | | a court may order the property sold to pay the |
| entity for this type of use. Here's why: | | | | claimant's judgment. |
| -- Excellent liability protection for managers and | | | | However, if a lawsuit is brought against you personally, |
| members | | | | and a claimant attempts to seize assets you hold |
| -- Flow-through tax treatment on LLC profits and | | | | through an LLC, the rules are a little different. |
| losses | | | | Charging Orders. |
| -- Ability to transfer properties in and out of an LLC | | | | A charging order works in the same fashion as a lien |
| with minimal tax consequences | | | | -- it is an obligation to pay money placed over assets. |
| -- Personal Asset Protection through the Charging | | | | The charging order does not convey any voting rights, |
| Order procedure (for Nevada LLCs) | | | | any ability to control the decisions of the LLC or the |
| Liability Protection. | | | | ability for a creditor to force the LLC to make profit |
| An LLC is similar to a C-corporation ("C-corp") or a | | | | distributions. The charging order merely grants the |
| Sub-Chapter S corporation ("S-corp") in that it exists | | | | creditor the right to receive a portion of the LLC's |
| as a separate corporate entity. It provides full liability | | | | profits until the judgment is completely paid. And, in a |
| protection to its officers and directors (called | | | | fairly ironic twist, the monies received by a judgment |
| "Managers") and its shareholders (called "Members"). | | | | creditor through a charging order will be treated as |
| As either a Manager or a Member, you are liable only | | | | income and taxed. |
| for the money you have invested into the LLC and | | | | Under Nevada law, a charging order is the sole legal |
| cannot be found personally liable for any debts | | | | method for creditors suing you personally to attack |
| incurred by the LLC. Consider the risks associated with | | | | your assets held in an LLC. So for example, if you are |
| owning real estate, especially rental properties. Tenant | | | | a Nevada resident and have a day trading account, a |
| injuries. Trespassers injured while on vacant land. | | | | boat and a duplex held in an LLC and are sued |
| Unauthorized dumping or storing of hazardous waste. | | | | personally, a creditor would not be able to seize your |
| All of these could pose a serious risk to your financial | | | | assets. They would instead have to obtain a charging |
| well-being if you held the property in your name | | | | order over your membership interests in the LLC, |
| directly, even with insurance. Owning property in your | | | | entitling them to receive a portion of income earned by |
| own name means that in the event you are sued and | | | | that LLC. If the LLC didn't earn any income, then there |
| found guilty, anything your insurance policy does not | | | | would be no profits to be distributed. |
| cover will come out of your own pocket. Putting an | | | | Unfortunately, the charging order laws in other states |
| LLC entity between you and this personal liability | | | | may not be as strong as Nevada. For those of you |
| means that your personal assets will stay protected. | | | | who don't live in Nevada, or who hold property in |
| Flow-Through Tax Treatment. | | | | another state that does not offer strong charging |
| Unlike a C-corp, an LLC does not pay income taxes. It | | | | order laws, we suggest using two LLCs. The first LLC |
| is a "flow-through" entity, meaning that, like an S-corp, | | | | is formed in the state where your property is located |
| the tax on the profits (as well as the write-offs on any | | | | and holds title. The second LLC is formed in Nevada |
| losses) are passed through to the Members and taxed | | | | and is a passive holding company, holding all of the |
| on their individual personal tax returns. | | | | interests of the first LLC. You in turn hold interests of |
| The flow-through tax treatment becomes important | | | | the Nevada LLC. What will happen in the event of a |
| when you decide to sell a property, or convert it to | | | | lawsuit brought against you personally is that no matter |
| personal use. Here's a quick example of what happens | | | | in what state a lawsuit is brought, a creditor will |
| to a $400,000 profit on real estate after taxes. For this | | | | eventually have to come to Nevada to attempt to |
| example we are assuming that your personal tax rate | | | | seize the assets, and will then run up against the |
| on the monies received would be 39.1%, the top tax | | | | charging order procedure. It costs a little more to set |
| bracket: | | | | up and maintain, but if you are truly trying to make |
| C CORPORATION: | | | | yourself as small a target as possible, it is a fairly |
| Gross Profit: $400,000 | | | | cost-effective solution. |
| Less: Corporate Tax: -136,000 | | | | One final point to consider while on the subject of |
| Subtotal: $264,000 | | | | charging orders is to limit the number or dollar value of |
| Paid to You as a Dividend:$264,000 | | | | properties held in an LLC. If you have several |
| Less: Tax You Pay on Dividend: -103,224 | | | | properties held in an LLC and you depend on the |
| Net Profit to You: $160,775 | | | | income stream, then a charging order placed against |
| LLC | | | | that LLC could cause a major disruption to your |
| Gross Profit: $400,000 | | | | earnings. |
| Paid to You: $400,000 | | | | Do I ever NOT recommend using an LLC for |
| Less: Tax You Pay on Profit: -156,400 | | | | real-estate holdings? Occasionally. For example, |
| Net Profit to You: $243,600 | | | | California assesses an additional franchise tax fee for |
| Ease of Sale. | | | | LLCs with earnings over $250,000 per year. So, if your |
| LLC's have an extra advantage over an S-corp (or a | | | | LLC is holding very high income-earning properties, you |
| C-corp) where you want to convert a property to | | | | could wind up paying extra taxes. To avoid that, we |
| personal use, or trade it (called a "like-kind exchange" | | | | may recommend that you use a Limited Partnership, |
| and subject to special rules) for another home of | | | | as it does not have the extra franchise fee levied on |
| similar value. If held in an S-corp the conversion or | | | | its earnings. However, if you operate your Limited |
| trade of property would be considered a sale with the | | | | Partnership with a corporate General Partner, then you |
| accompanying tax consequences. Held in an LLC, | | | | have the filing and operating costs for two entities in |
| there are no tax consequences to converting or | | | | California, rather than one, not to mention two |
| trading the property. | | | | franchise tax fees. |
| Asset Protection. | | | | Another example could be a situation where the entity |
| When using an LLC to hold real estate, it is very | | | | is going to be used for estate planning purposes to |
| important that you also obtain comprehensive property | | | | pass your wealth through to the next generation, and |
| insurance coverage. In the event of a lawsuit brought | | | | you perhaps foresee trouble on the horizon with your |
| against the LLC by a tenant injured on the premises, | | | | children wanting control once they have gained a |
| or, believe it or not, even by a trespasser on your land, | | | | majority interest. |
| good and comprehensive insurance can save you | | | | |