by Ron Holmes
3D graph showing financial real estate growth.
Almost everyone is familiar with C Corporations, S Corporations, Limited Liability Companies, Limited Partnerships and Partnerships. In the real estate arena (in which I am heavily involved), real estate assets are typically held in either a Limited Liability Company (“LLC”) or a Limited Partnership (“LP”). We still recommend that income producing assets (e.g., a multifamily property) be held in in a LP, although not everyone shares our opinion. In any event, almost all lawyers recommend to their clients that real estate assets be held separately in either an LLC or LP to protect the individual owner(s) from third party liability and to insulate each asset from the debts and liabilities of the other assets. Of course, every entity (whether LLC or LP) that you form to hold a real estate asset requires accounting and tax return expense, as well as Secretary of State filings and fees. If you own or contemplate owning multiple real estate assets, the cost of creating and maintaining a separate LLC or LP for each asset can be burdensome and, in any event, simply challenging from a record keeping standpoint.
A possible solution to holding multiple real estate assets in multiple LLCs or LPs is the Series LLC, which is a LLC that is permitted to have one or more separate Series of assets with separate rights, powers or duties and which limit creditor rights to a particular Series. In other words, one LLC can own multiple assets without subjecting all of the assets to the debt or liability of one asset. This structure avoids the “putting your eggs in one basket” problem as the assets of each Series is protected from the debts and liabilities of the other Series. However, to gain that protection each particular Series must account for the assets associated with that Series separately from the other assets of the Series LLC or any other Series. Accordingly, the accounting function is not eliminated. However, the Secretary of State filing fee ($300) applies only to the Series LLC and not to each of the separate Series, which can effect a substantial savings for someone who owns multiple real estate assets.
The most important feature of the Series LLC is the limitation of liability for one Series against the debt or liability of another Series. The Series LLC is new to Texas and has been adopted in only thirteen jurisdictions. Accordingly, there is little judicial precedent confirming this limitation of liability. One way to eliminate the uncertainty of this new concept is to include in all contracts executed by the Series LLC or a separate Series in the Series LLC a provision limiting liability to a particular Series.
Another unknown is the treatment of Series LLCs for Federal Income tax purposes. There are proposed Treasury regulations which clarify the intent of the IRS to treat each Series as a separate entity for tax purposes. However, those proposed regulations have not been finalized and, therefore, one must pause for consideration when contemplating a Series LLC if for no reason other than the lack of clarity for Federal Income tax purposes.
Like all new concepts, the lack of legal precedent to guide us is a draw back to the Series LLC. Even so, the possible advantages of holding multiple real estate assets inside of one LLC and yet protect each asset from the debts and liabilities of the others may be reason enough for you to learn more about the Series LLC concept.