Recently I began working with a client, Ted, to help him protect his real estate holdings. Ted is not unlike many investors I meet who receive counsel from their CPA or general practice attorney. Both of who believed insurance was the best and least expensive form of asset protection. Relying on this advice almost cost Ted his entire portfolio when an unscrupulous attorney brought a bogus mold claim on behalf of some tenants Ted was evicting. To Ted’s utter horror, his insurer informed him he was not covered for toxic mold claims. Although Ted ultimately prevailed in his lawsuit, he came to the realization he desperately needed structuring and better counsel.
Ted and I created a plan wherein we established 12 LLCs throughout five different states (Ted’s investments were spread out). Each LLC held one property and collectively all of these LLCs were owned by a Nevada holding LLC. Ted’s structure looked as follows:
This structure provided the following benefits for Ted:
- Each property is isolated from the other i.e., claims brought against the property in one LLC will not contaminate the properties in the other LLCs;
- Each property LLC is set up listing the Nevada LLC as its sole member i.e., Ted is not listed on any state filings thus preserving his privacy; and
- Each property LLC is disregarded for federal tax purposes i.e., the Nevada LLC is the only entity required to file a federal tax return.
- Nevada provides exceptional asset protection from Ted’s personal creditors i.e., charging order protections.
- With the benefits come some drawbacks and in Ted’s situation it is cost. 13 LLCs will require 13 annual state filings and 13 resident agent fees. For some this is minimal and is considered a cost of doing business and a cheap form of insurance when considering the alternative. I agree with this sentiment but I do look for ways to minimize costs when creating a structure. One way is to create a Series LLC provided your holdings are located in one of a handful of states that currently recognize this unique form of limited liability company.The Series LLC Introduction
A Series LLC is, in essence, an LLC (“Master”) that can be subdivided into separate units (”Series”) with separate rights, powers, or duties with respect to specific property or obligations of the LLC, or with respect to profits and losses associated with specific property or obligations. The primary attraction to this form of LLC is that the debts and other liabilities of a separate series will be enforceable against that series. This is similar in form to what I created for Ted minus the numerous annual fees and expenses. For example, a Series LLC typically has only one annual filing fee, one resident agent fee, and reduced ongoing legal fees for future property acquisitions. Unlike Ted’s structure where we will create a new LLC for each purchase, in a Series LLC Ted can easily complete the documents on his own by filling in a few blanks on a standardized two-page form and a new Series is ready to take title.
Here is a list of key benefits and requirements:
- Each Series has its own owners (members) and may be managed separately from the master LLC and other Series;
- Each Series must maintain separate books and records;
- As with a regularly formed LLC, the owners (members) of each Series are not financially responsible for the Series’ debts and obligations;
- A Series may conduct part of the business of the master LLC, or may conduct a wholly different business;
- Each Series has its own assets and liabilities. The members of each Series are treated under the laws of the state where the master LLC is formed as owning an interest in only that Series, and have no rights as members of one Series in the assets or income of any other Series; and
- Each Series is liable only for its own debts and obligations. In general, creditors of one Series may only make claims against the assets of that Series.
You might be wondering why Ted opted for the “support your favorite attorney charity program” and set up 13 separate LLCs when he could have opted for the cost savings Series alternative. Believe me, we discussed this option but Ted was already getting the cold shoulder from lady luck, and he was not comfortable venturing into unchartered waters. The Series LLC has not yet been fully vetted by the legal system.
A lack of case law should give any prudent investor pause because a judge is operating in the blind when first presented with this new form of entity. This is further compounded when the litigation arises in a state that has not yet adopted this form of LLC. (Currently, only Alabama, Delaware, Illinois, Iowa, Kansas, Missouri, Montana, Nevada, Utah, Oklahoma, Tennessee, and Texas have Series LLC statutes. It is also worth mentioning Minnesota, Wisconsin, and North Dakota offer an LLC called a Series LLC, but it is confusingly different from the other Series LLC states. These “not fully committed to the relationship” type states only allow for different interests of ownership of the LLC but don’t provide asset protection for each separate Series.)
When Should You Consider Using a Series LLC
A lack of legal precedent should only be a deterrent for those who are considering using a Series LLC is a state outside of the 12 I listed above. In Ted’s situation, only 2 of his properties were located in a Series LLC state hence us going a different route. However, if you have substantial holdings in a state like Nevada or Texas, then most definitely this form should be considered.
If you are considering using this entity form, then I strongly suggest you do not attempt to set up this entity without the assistance of a professional. The initial formation and the creation of the master LLC agreement and first Series is far too complex for the uninitiated. I have found many attorneys who discuss this entity form do not even understand the basics themselves and often refer to the master LLC as a “parent LLC” which is not the case and should not be confused as such. It is especially important for real estate investors considering this form of entity to know how to take title in a specific Series.
Consider Ted’s situation. If we set Ted up a Series LLC and created 12 separate Series to hold his various properties e.g., Red Rock, LLC – 732 Broadway Series A, Red Rock, LLC – 3225 McLeod Series B, Ect..(A sample form can be found here), Ted could not simply deed his various properties into each separate Series as if these were separate LLCs. Unlike the situation where a separate LLC is created and has a verifiable and legal existence, a Series does not for title holding purposes. If Ted attempted to deed his property into a specific Series, he would create a title defect for himself. A title defect occurs because title companies typically require a certificate of good standing for an LLC, whether it is a traditional LLC or a Series LLC. The problem arises in attempting to secure this certificate from the Secretary of State. The Secretary of State will only issue a certificate of good standing for the master LLC and not the specific Series. The reason being is the Series is not filed with the state only the master, thus the Secretary of State has no way of verifying its existence. Remember, Series are created privately, without the necessity for public notice or a state filing, no official method exists for establishing that a Series (as opposed to the company at large) is in “good standing.”
Some commentators have suggested deeding the property into the name of the master LLC and then adding a parenthetical notation at the bottom of the deed stating that this property will be held as a Separate Series with the following language:
_________________ is held in the _______________ Series, a separate Series of the ______________ Series, LLC. Pursuant to Section ______________________ of the _______________________ Limited Liability Company Act the debts, liabilities, and obligations incurred, contracted for or otherwise existing with respect to such Series of the Company shall be enforceable against the assets of such Series only and not against the assets of the Company generally or any other Series thereof, and none of the debts, liabilities, obligations and expenses incurred, contracted for or otherwise existing with respect to the LLC generally or any other Series thereof shall be enforceable against the assets of such Series.
I am not comfortable with this approach because the master LLC is listed on the deed as the Grantee. If you have 12 properties, then a simple records search would show all 12 in the name of the master LLC. Only by a careful inspection of the deed might one discover what the grantor hoped to accomplish.
A better approach would be to file a DBA for each Series. In fact, some states, like Texas, actually require that an assumed name certificate be filed indicating that the company is doing business by and through one of its Series – e.g., “Red Rock, LLC – 732 Series A.” These filing must be done at the county level because the Secretary of State typically rejects DBA filings for individual Series (e.g., ” Red Rock, LLC – 732 Series A) because technically a Series is not a stand-alone legal entity. The DBA is important if you want to open a bank account in the name of the Series but not necessarily for deeding property. For property transfers, the quickest and most efficient mechanism for working with a Series LLC is to use a land trust.
Whenever I recommend the use of a Series LLC, I will always explain to the client he must become comfortable with the use of land trusts because of the title issues discussed above. In Ted’s fictional Series LLC scenario, he would create 12 land trusts, one for each property, and transfer title to the respective trust. (Note: I recommend naming the trust the same as its corresponding Series to avoid confusion.) After title is vested in the name of the trust, Ted will assign his beneficial interest to the appropriate Series.
In the past, I have counseled against the use of Series LLC for numerous reasons, some of which I touched upon in this post. However, I think this entity has received enough exposure that warrants an investor giving it serious consideration in certain situations.