LLCs, Series LLCs and Real Estate, Oh My!
The majority of businesses in the United States today are structured as some variety of pass-through entity, ranging from Sole Proprietorships and S-Corporations to Partnerships and Limited Liability Corporations (LLCs). According to one estimate, those four structures account for over 90% of businesses.
Wyoming was the first state to draft LLC legislation in 1977. By 1996, all 50 states had enacted similar legislation permitting this business structure.
The series LLC is the new kid on the block in terms of business entities. The first state to permit series LLCs was Delaware in 1996. In the subsequent 23 years only 16 other states have adopted similar legislation.
States Permitting Series LLCs
- District of Columbia
- North Dakota
By contrast, less than 20 years after Wyoming started the LLC ball rolling, all 50 states were on board. If the LLC is the young adult of business entities, the series LLC is still teething.
What’s the Difference?
A traditional LLC is a single stand-alone entity. The series LLC is a variation on a theme. As illustrated, a series LLC consists of a master LLC and separate subunits (or series). Think of each series as a cell within the greater whole.
Fascinating, Now Why Should I Care?
The real estate investor is exposed to a multitude of risks. Some risks can’t entirely be avoided or transferred, such as vacancy rates and economic downturns.
One of the largest risks though, involves lawsuits. What if a tenant injures themselves on your property? Without proper planning, a single lawsuit can very efficiently destroy the investment and the investor. Both the LLC and series LLC are different tools in the toolbox of risk management and business planning.
The Traditional Approach
An excellent and time-tested planning method is to create unique LLCs for each real estate holding. This has the virtue of making each property an island unto itself.
If the tenant of Property A decides to sue, the potential loss to the investor only extends to the assets of that one LLC. The lawsuit can’t reach properties B, C, D, and so forth. Other holdings continue on their merry way, generating income without interruption.
Pros of a Series LLC
The costs to organize and maintain a series LLC can be less than for multiple entities, and a series LLC might require fewer organizational documents. Thus, as new properties are purchased, an investor might find it easier and quicker to add a new series than to organize an entirely new entity.
For example, in Kansas, the state fee for a single LLC is $160. Using the traditional approach, an investor with 10 properties pays $1,600 in total for 10 separate LLCs. By contrast, a series LLC requires a single $250 filing fee for the Master LLC and another $100/series for a grand total of $1,250.
In Texas, the state fee for a single LLC is $300. Our hypothetical investor with 10 properties is confronted with the choice of spending $3,000 ($300 x 10 individual LLCs) or $800 (One $300 filing fee + $50/series).
To create a series LLC, a master LLC is formed and each individual real estate holding becomes a separate sub-unit (series). As a result, if the series LLC satisfies the statutory formation requirements, debts and liabilities of one series, such as a lawsuit, are enforceable only against that specific series. Theoretically.
Series LLC Risks
The series LLC is an alluring concept. Who wouldn’t want relative ease of formation, lower costs and separation of liability? As always, there’s more to the story.
Because the series LLC is a newcomer, it’s not clear whether liability protection will be upheld in non-series LLC states. For example, what if our investor in Texas establishes a series LLC but owns rental property in Colorado, a non-series State? It is by no means certain that Colorado will recognize the series structure for asset protection purposes. It may choose to recognize the master LLC, but Colorado is not required to recognize the series structure for separation of assets and liabilities.
Additionally, the series LLC has not been well tested in bankruptcy proceedings. Courts have characterized LLCs as corporations under the Bankruptcy Code that are generally eligible to file a Chapter 7 or Chapter 11 case. The primary difficulty with series LLCs stems from differing treatment of the structure under state law.
On one hand, the state views the master LLC and the multiple series as one entity. Yet for asset ownership and liability allocation, state law treats the master LLC and each series as separate and distinct. What happens then, to the individual series if the master LLC files for bankruptcy and vice versa? The courts have yet to fully answer these questions.
Finally, it isn’t always true that costs to form a series LLC will be lower. In Tennessee, identical filing fees and franchise taxes are due regardless of whether an LLC or series LLC is formed.
What’s the Bottom Line?
The series LLC is an elegant concept. It could easily represent a new stage in the evolution of the traditional LLC.
However, an investor must follow all the mandates under state law. They must meticulously and clearly designate the allocation of assets and liabilities and ideally, keep the properties owned by each individual series within the state lines. This offers the best chance that if the worst happens, courts uphold the liability protections theoretically afforded by the series LLC.
Still, because of the uncertainties surrounding it, the series LLC isn’t for the risk averse. Creating individual LLCs for each property represents a typically higher cost to be sure but more conservative method. The uniform adoption of LLC statutes across the 50 states means more consistent liability and bankruptcy protection.
Ultimately, as is often the case in the financial planning world, there are few clear-cut answers. Sometimes a lower cost approach is better. Other times, you get what you pay for. Good planning requires that we achieve the greatest reduction of risk weighed in the context of the larger financial picture.
George James, CFP®
- Series LLCs, Wise or Risky Strategy – CT Corp Walters Kluwer 2015
- Series LLCs in Interstate Commerce – American Bar Association 2018
- Series LLCs, The Next Generation of Passthrough Entities – Forbes 2015
- Series LLCs, What Happens When One Series Fails, Key Considerations and Issues – American Bar Association 2017
- Series LLCs, Pros and Cons of a Growing Trend – Journal of Accountancy 2009
- Tax Aspects of Series LLCs – American Bar Association 2018
- State Code References:
- AL Code § 10A-5A-11.01 (2014)
- 6 Del. Code Ann. §18-215 (Revised legislation going into effect on August 1, 2019)
- District of Columbia
- DC Code Ann. §29-802.06
- (805 ILCS 180/37-40)
- Iowa Code Ann. §490A.305
- S.A. 17-76,143 (2012)
- Rev.Stat §347.186.1
- Montana Ann. Code 2017 §35-8-304 et seq
- Rev. Stat. §86.296
- North Dakota
- D. Cent. Code §10-32
- 18 OK Stat § 18-2005 (2014)
- Texas Business Organizations Code §§101.601 – 101.622
- Utah Revised Limited Liability Company Act § 48-2c-606
- Stat. Ann. §183.0504
- Chapter 29 Article 1 – 17‑29‑211 (Effective July 1, 2018)
This commentary is provided for general information purposes only and should not be construed as investment, tax or legal advice. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.