As an attorney, I’m programmed to mitigate risk. That’s the core of my job.
My other primary responsibility is to position my business clients for success. The goal is to advance two pillars simultaneously: positioning the business to be financially successful while reducing risk.
This premise (i.e. the two pillars) begins with the type of entity. Accordingly, I have lots of strategies on entity preference.
The majority of my real estate investor clients utilize LLCs. I can draft an LLC operating agreement to accommodate just about anything that a member/owner requires (so long as it is lawful and ethical!).
With LLCs, there are minimal corporate formalities. Outside of filing the articles of organization and drafting an operating agreement, the only primary responsibility for a LLC is submitting an annual report. There are many additional benefits, including tax advantages.
In regards to LLCs and real estate investors, the most common piece of advice I give is to have a separate LLC for each real estate business. If an investor holds properties long-term as rentals, then a specific LLC should be devoted to this. So, keep your rentals in one LLC; this LLC does not partner on other projects or conduct other services (e.g. Contractor work). All the LLC does is hold property.
If you have a short-term portfolio (read: fix and flips) then put those in another LLC. If you’re a home repairperson or property manager then that service is performed in a different entity. The crux here is that you limit the exposure (i.e. The liability) of each LLC. Each separate and distinct business operates under its own LLC. In theory, a plaintiff can only go after what is in the LLC/ the value in the LLC. So, if you get sued as a contractor then the plaintiff can’t get ahold of your rentals because it’s a separate and distinct business.
It’s common that investors comingle different assets and different businesses in one LLC. Yet, consider this very real hypothetical: you incur liability on a short-term investment property due to an on-site injury. LLC “A” owns this particular property. LLC “A” also owns your rentals. Your rentals could now be subject to the liability associated with the injury that occurred at your flip property. This hypothetical can easily be avoided. The take away: rentals are different than flips; they are a different business. Keep them separate; keep them in separate LLCs. Doing so will help you reduce risk while positioning your business to be profitable!
Attorney Craig Morgan is a member of Metrolina Real Estate Investors Association, www.MetrolinaREIA.com, which provides education, networking, and mentoring to investors in the Greater Charlotte area. He can be reached at Craig@providencelawcarolina.com, (www.providencelawcarolina.com).