A couple of weeks ago we began an examination of how the limited liability company or LLC is often sold with misleading information and bad legal advice. One specific mistake we discussed was the misuse of the LLC as a way to hold your personal vehicles. This week we look at the LLC and how doctors can use it to hold and protect real estate, and when they can’t.
The LLC is a great vehicle to segregate a specific piece of investment real estate or appropriately scaled real estate portfolio. The idea is to segregate the real estate asset(s) from you and your personal and professional liability by putting it into a separate legal entity that is not subject to the unrelated liability of the LLC’s owner. The protection is also meant to work the other way, protecting you from the liability that a real estate asset can generate itself, such as with a rental home, office building, or commercial property where you have a high standard of care for your tenants and their guests and invitees. In this way any liability generated on the premises is limited to the LLC as the property owner, and hopefully just to the assets of the LLC itself and not you, the owner.
In order for the LLC to act as a separate legal entity you must observe the formalities of the entity as a separate business with separate banking, accounting and legal formalities in place that comply with the rules of the jurisdiction in which it operates. It’s also important to note that the protection is not absolute or fail safe; there is no such thing as a guarantee in the law. Wanton, willful, or negligent acts and omissions like failing to address a known safety hazard, especially if committed by the owner, can result in the “piercing of the corporate veil” where liability is attributed to the owner directly.
Finally, the issue of “scale” referred to above is really a question of how many eggs are in one basket. One of the common fatal flaws of physician’s asset protection referred to in a previous article is having too many separate pieces of property with high equity in a single LLC. When any individual LLC gets “top heavy” it jeopardizes not only the subject property where the liability occurs but also all other assets owned by that LLC, i.e. you can lose your cabin if there is an exposure at the office condo owned by the same LLC.
When it does not work
There is a substantial amount of what I consider to be malpractice being committed nationally by estate planners and other attorneys who are using LLCs to shield their clients’ personal residences. I’d have included the non-attorney promoters and LLC mills that physicians seem to love so much, but one who is not licensed or professional, like most of these radio-advertising LLC mills, can’t commit malpractice if they were not licensed professionals in the first place.
Among the worst offenses is the increased (11th hour) use of an LLC for personal residence purchases or shelters with promises of privacy and asset protection and, in the very worst cases, Family Limited partnerships. It is being done wholesale by the DIY LLC guys on the radio and the internet and in “seminar” settings that target doctors as well.
This bad move will not be effective if challenged and will often:
1. Negate homestead protection provided by state law;
2. Cost the homeowner their mortgage interest deductions and capital gains benefits;
3. Typically lack any legitimate defensible business purpose;
4. Almost never be accompanied by a lease agreement where the family pays commercially reasonable rent to the LLC for the use of the home;
5. Lack formalities like separate bank accounts and operating agreements;
6. Trigger “due on sale” clauses or cause the property to be reassessed when the deed work is done in a clumsy way.
This discussion merely scratches the surface of the uses and details inherent to effective LLC usage and hopefully spurs you to ask good questions or examine any issues at play with your own LLC structures.
Remember that every situation, asset, and jurisdiction is unique and any legal advice or strategy you consider most not only be a legally sound idea, but a fit for you in particular. “You’ve got an LLC, what could possibly happen?” is a little less accurate than they’d have you believe.