How Many Properties Should You Put Into An LLC?
As investors grow their portfolio past a couple of properties, the question arises whether they should put their properties into one LLC versus holding them in a separate LLC s, for asset protection purposes. The answer to this question is not as simple as you might think. You may immediately think each property should have an LLC, but before you jump to a conclusion, we should examine all the issues that need to be considered.
What is an LLC, how and when is it used?
A limited liability company (LLC) is a business structure in the U.S. that protects its owners from personal responsibility for its debts or liabilities. Limited liability companies are entities that combine the characteristics of a corporation with those of a partnership or sole proprietorship. From a tax standpoint, LLCs are ‘pass through’ entities, which means that net profits or losses are passed through directly to each LLC member, reported on Schedule D of Form 1040, and taxed at the individual’s rate.
If you place a company or a property into an LLC you can receive litigation protection because it is seen as a separate entity from your other assets, your home or bank accounts for example. This is known as the corporate veil. The corporate veil provides liability protection for property and business owners. It specifically protects you from personal liability.
The laws regarding LLC’s are recent. The first such entity was formed by the Hamilton Brothers Oil Company in 1977 in Wyoming. They are regulated on a state-by-state basis. The formation of an LLC requires registration with the state it is operating in and articles of organization to be filed with that state. An LLC is easier to set up than a corporation and provides more flexibility and protection for its investors than a sole proprietorship.
To establish an LLC, you typically do the following.
a. Have your attorney prepare ( or you can buy online) an operating agreement that defines the LLC, the principals, members and decision makers and the purpose of the LLC. LLC’s can be single member or multiple member entities.
b. File for an EIN Number with the federal government
c. Chose the state you want to establish the entity in
d. Register with the secretary of state.
e. Pay annual fees to keep the entity active.
f. Establish a bank account for the LLC.
g. Have your attorney prepare ( or you can buy online) an operating agreement that defines the LLC, the principals, members and decision makers and the purpose of the LLC. LLC’s can be single member or multiple member entities.
It is not expensive to form an LLC.
It is not expensive to form an LLC but there are annual costs you need to consider.
a. Preparation of annual tax returns
b. Planning of annual meetings and tracing of minutes
c. Annual submissions to the secretary of state for active LLC’s
Is there a limit, how many properties you can put into a LLC?
There is no limit regarding the number of properties you put into an LLC, but if a claim arises, such as a grandma slips on the stairwell of your office building and breaks her coccyx and sues you for loss of consortium, she can sue all the properties placed into the LLC to find the assets that will pay her claim. (Yes, this really happened to one of my clients over 30 years ago).
As a long-term property investor, you need to consider the values of the properties you own, the equity positions, and the location of the properties, as you make the decisions to establish the number of LLC’s you want to form.
If you have a lot of equity, you have more risk; if the location is a dynamite location or a terrible location or in another state you may want separate LLC’s. Those that are suing you (Plaintiffs) will love a large LLC with lots of equity and many properties under its umbrella, if the properties are worth a lot of money. You may have insurance to protect you, but all insurance has limits ($1,000,000 or $2,000,000) and a good plaintiff attorney will sniff out where you are keeping your wealth.
The best thing to do is create a rule of thumb for yourself after consulting with your attorney and CPA on how you want to organize your assets. Recently on a refinance we were forced to
take a four property LLC and split it in half. The new lender did not want to share their ability to pursue our assets for a claim, if we stopped making the mortgage payments or were accused of committing fraud) with the existing lender on the other two assets in the LLC. They also preferred we separate and create a separate LLC ( a special purpose entity) decrease the risk that the entity's assets will be consolidated into the bankruptcy estate of an affiliated entity.
In this case we established a new LLC that was a separate entity and a Sub LLC to the first LLC to ensure that we did not create a taxable event as we transitioned the property from one lender to another.
In any case making the decision to separate LLC’s, especially as you grow your real estate empire, becomes a tactical decision. If for example, you have a portfolio of ten properties that are valued at $50,000,000 for an average of $5,000,000 that all have a fifty percent equity position (which is high), you may decide to form five LLCs of $10,000,000 each.
This of course creates challenges as you lend money back and forth (from LLC to LLC) and pool all your assets to assemble the downpayment for the purchase of your next real estate investment, but your assets are better protected from litigation. In this case one LLC is not enough. As investors age, they tend to get more conservative and may want every entity in a separate LLC for ease of accounting, refinance, sales, reinvestment and or donation to children or charities.
Tax / IRS Clarifications
States recognize LLCs but the IRS does not. For tax purposes LLC’s can be:
Single (1) member - which is the IRS default is a disregarded entity so no separate return to information flows through to investor 1040.
Multi-member LLC’s - these are seen by the IRS as a partnership. A 1065 with K1s is filed, which then flows through to the 1040 return. The IRS considers husband and wife to be two people for the purpose of counting owners of an LLC.
If a single member or multi member does not want the default they can make a special election to be treated as a c corporation or an s corporation.
An entity taxed as a C corporation, partnership or individual can own multiple single member LLCs, which are disregarded for tax.
The structure and elections dictate the filing requirements NOT the number of properties.
A living trust is considered a “disregarded entity” for tax purposes.
Is there a right answer?
There is no “one size fits all” answer to the size of assets to place into an LLC. Your needs and the size of your assets typically keep changing. This is a question you will want to decide with your attorney and CPA every couple of years.
If you are an active investor, you may find financial institutions will encourage you to establish a single member LLC. for each real estate transaction. The most conservative approach would be for each building tends to have its own LLC which is then owned by a parent LLC.
In any case, as your assets keep growing you need to revisit this decision on a regular basis.
Appendix
Cozza Law. "LLC for Rental Property: How Many Per Entity." Cozza Law, 28 Jan. 2020, https://www.cozzalaw.com/2020/01/28/llc-for-rental-property-how-many-per-entity/.
Investopedia. "Limited Liability Company (LLC)." Investopedia, n.d., https://www.investopedia.com/terms/l/llc.asp.
Kohler, Mark J. "How Many Properties Should I Put in My LLC?" Mark J. Kohler, n.d., https://markjkohler.com/how-many-properties-should-i-put-in-my-llc/.
LLC University. "Should I Form an LLC for Each Rental Property?" LLC University, n.d., https://www.llcuniversity.com/should-i-form-an-llc-for-each-rental-property/.
Stessa. "LLC Mortgage: How to Hold Rental Properties in an LLC." Stessa, n.d., https://www.stessa.com/blog/llc-mortgage/.
Ellen Day CPA, Portland - Interview
Clifford A. Hockley, CPM, CCIM, MBA
Cliff is a Certified Property Manager® (CPM) and a Certified Commercial Investment Member (CCIM). Cliff joined Bluestone and Hockley Real Estate Services 1986 and successfully merged that company with Criteria Properties in 2021.
He has extensive experience representing property owners in the sale and purchase of warehouse, office, and retail properties, as well as mobile home parks and residential properties. Cliff’s clients include financial institutions, government agencies, private investors and nonprofit organizations. He is a Senior Advisor for SVN | Bluestone.
Cliff holds an MBA from Willamette University and a BS in Political Science from Claremont McKenna College. He is a frequent contributor to industry newsletters and served as adjunct professor at Portland State University, where he taught real estate-related topics. Cliff is the author of two books, 21 Fables and Successful Real Estate Investing; Invest Wisely Avoid Costly Mistakes and Make Money, books that helps investors navigate the rough shoals of real estate ownership. He is the managing member of a real estate consulting practice, Cliff Hockley Consulting, LLC., designed to help investors and commercial brokerage owners successfully navigate their businesses. He can be reached at 503-267-1909 , Cliffhockley@gmail.com or Cliff.Hockley@SVN.com.
