When considering their real estate portfolios, every investor should be asking themselves one very important question: have I chosen the best method to hold title in and to my real property assets? And to answer that query, investors should be aware of all their options, including the Series LLC.
Sure, some investors may find it acceptable to own property in their names individually, with the caveat, of course, that they have “adequate” insurance coverage. I generally disagree and recommend instead that properties always be held by a business entity (read: a corporation or a legal liability company (LLC)).
Like a corporation, an LLC protects investors from personal liability for certain debts, liabilities, judgments and other financial and legal obligations. LLCs are commonly used in favor of corporations for a variety of reasons: they’re easy to set up, reasonably priced, have positive and straightforward tax implications and LLC members (investors) can dictate the terms by which their entities function by customizing their operating agreements.
By and large, LLCs are a great choice for ownership of real estate investment properties. But that’s not where this story ends. Investors have another—albeit related—entity structure to contemplate: the lesser known and certainly lesser utilized Series LLC (SLLC).
What is an SLLC?
The SLLC is a relatively new entity structure that first came into vogue in Delaware in 1996. Well, perhaps “vogue” is too strong a word—the SLCC is still only available in 16 states and the District of Columbia. While each qualifying jurisdiction treats SLLCs a bit differently, maintaining varying formal legal requirements, an SLLC universally contemplates the creation of a master LLC (sometimes referred to as a parent LLC) with separate child LLCs beneath it. That being said, the SLCC can be a nice option for investors owning multiple properties.
As an entity structure, the SLCC is comparable to a corporation with subsidiaries. To that end, if the SLCC is formed and operated correctly, each child LLC beneath the master LLC is only liable for its own debts, judgments and other obligations. As otherwise stated, a child LLC has no legal duty to satisfy the debts, judgments or other obligations of the master or sibling LLCs.
Forming an SLLC
Forming an SLLC is typically simple and straightforward. Articles of organization of the master LLC are filed with the secretary of state or similar agency in the jurisdiction in which the investor’s property is located, and then, depending on the state, the investor formally designates child LLCs. In the alternative (and again, depending upon domicile), the master LLC’s operating agreement is amended to account for the formation of each child LLC.
In most jurisdictions, each LLC in the series (master and child) requires its own federal employer identification number (EIN), bank account, record keeping and operating agreement. Moreover, it’s imperative that investors keep separate records and operate each LLC (once more, master and child) as individual entities. Funds shouldn’t be commingled between child LLCs and transactions between them that aren’t objectively arm’s length should be avoided at all cost. This way, investors can maintain liability protection between and among the various LLCs in the series.
The pros and cons of the SLLC
There are some clear advantages to forming an SLLC. For one, they’re a relative breeze to set up and arguably require less administrative time, expense and effort than do separate LLCs.
As discussed above, investors can limit liability across real estate portfolios. For example, if a tenant files a slip and fall lawsuit for an injury occurring at an investment property located at 123 Main Street—and the entity structure has been properly set up so that title in and to 123 Main Street is held by its own child LLC—then any recovery obtained by the tenant is collectible only against the Series 123 Main Street LLC, and not against the investor personally or against the master LLC or any other related child LLCs owning other investment properties.
In some states, the SLLC structure offers investors much lower administrative expenses because each child LLC can be formed with zero or limited cost beyond the initial articles of organization for the master LLC. On the other hand, in my home state of Illinois (where the SLLC “bang for your buck” is less than other less regulated states), the filing fee for a normal LLC is $150; whereas the SLLC parent filing fee is $400, while designation of each child is another $50. Thus, it is clear that using the SLLC entity structure rather than individual LLCs can be significantly less expensive for investors owning several investment properties. This is particularly true in states having no formal filing requirements (and thus no additional cost) for adding child LLCs.
Despite these benefits, there are challenges and disadvantages to SLLCs when compared to creating separate LLCs. Because SLLCs are still somewhat new to the scene, their tax treatment and reporting requirements remain unclear. Similarly, many tax and legal professionals are unfamiliar with the specific requirements and ramifications of the SLLC structure, adding to the lack of clarity and risk involved.
Each child LLC that falls underneath a master LLC must have a separate registered agent, a separate bank account, separate accounting controls and bookkeeping practices, and a separate operating agreement, all of which limits the administrative efficiencies of the SLLC structure.
Because many states still don’t allow the formation of SLLCs, there’s uncertainty about how they’d be treated in cross-border disputes or lawsuits. There’s also uncertainty about the impact of bankruptcy proceedings on SLLCs.
In states like Illinois, where the real estate investor must complete a separate formal registration of each child LLC (which renders them extremely similar to separate LLCs), there’s little advantage to the SLLC structure beyond cost savings.
Despite any perceived disadvantages as just listed, the SLLC may well be the right vehicle for investors owning a large number of properties. At the same time, those wanting to avoid any uncertainty associated with SLLCs (or investors who don’t have a significant inventory of real property) will likely find the standard, tried and true LLC to be the better choice. Whatever the case may be, real estate investors are encouraged to consult with legal and financial counsel, determine if SLLC are available to them and consider the novel entity structure as a viable option.
About the author
Bryan Johnson is a partner at Michelman & Robinson, LLP, a national law firm with offices in Los Angeles, Orange County (California), San Francisco, Chicago and New York City. He’s a powerhouse litigator who also routinely represents real estate developers and investors in all aspects of their businesses. Bryan can be contacted at [email protected] or by phone at (312) 706-7762.