As of April 1, 1997, all fifty states have adopted the Limited Liability Company or “LLC.” The LLC is relatively new to the U.S., and most states have adopted LLC laws only within the past few years. Essentially, the LLC is a cross between a corporation and a partnership, with all of the bells and whistles of both.
The IRS Has Cleared the Way
Most conservative attorneys and CPAs (including myself) shied away from LLCs because it was not clear how the IRS would classify such an entity. However, the new IRS rulings make it clear that an LLC will be treated as a partnership, so long as it has at least two members. A single-member LLC will be “disregarded” for tax purposes. This means a single member LLC is still valid under state law (and thus affords lawsuit protection), but no additional tax reporting is necessary at the federal level.
The LLC, like a corporation, provides “lawsuit protection” for its owners. The owners (called “members”) of an LLC are not personally liable for debts or liabilities of the company. Thus, an LLC which holds real estate will protect its owners from personal liability for lawsuits. In addition, a foreclosure against the company will not create personal liability for the members (unless, of course, the members signed personally on the loan).
Favorable Tax Treatment
Like a partnership, the LLC provides “pass-through” tax treatment. This means that the company is not taxed on its profits; all profits of the company “pass-through” to its members. A regular corporation (called a “C” corporation) is taxed at the corporate level. The shareholders are taxed again on the income they receive from the company.
For many years, the “Family” Limited Partnership was the preferred vehicle for estate planning and creditor protection. The popularity of the FLP was that a creditor could not take partnership property or attach a partner's interest. This limited remedy would force a creditor to settle with a partner for pennies on the dollar.
The problem with limited partnerships for holding real estate is that the general partner has personal liability. This problem was often solved by using a general partner which is a corporation. This, of course, creates added expense and paperwork. An LLC afford its members the same creditor protection as a limited partnership, but no member has personal liability.
Another interesting feature of an LLC is that the IRS does not consider a single member LLC to exist for tax purposes. Thus, the single member still has lawsuit protection in state court, but the member continues to report his rental income and expenses on schedule “e” of his personal income tax return.
An example of this simple, yet effective protection is shown below:
In this scenario, Larry Landlord does not need to file separate tax returns for each of his three LLCs. However, if a tenant in his apartment building is injured, he will not be personally liable, nor will he risk losing his other rentals in a lawsuit.
As you can see, the LLC can provide excellent protection for landlords, with little paperwork hassle.
Estate Planning Features
The LLC can provide a vehicle for passing wealth to younger family members without having to re-title the real estate. Once real estate is transferred into an LLC, the members' interest is converted to personal property, which is represented by their LLC “shares.” These shares can be transferred incrementally to children as tax-free gifts ($10,000 worth per year). The process for transferring LLC shares is very simple compared to filing a new deed each year. The parents can still retain control of the property during their lifetime by acting as “managers” for the company.
As you can see from this brief discussion, LLCs can play an important role in your overall asset protection, estate planning and tax strategies.