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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   December 2015

Business or Personal?

Limited liability companies offer tax and legal advantages, and help protect private assets

Business or Personal?

Establishing a limited liability company, or LLC, can be an effective and tax-efficient way to protect personal assets from business liabilities. But the advantages can fall apart when an LLC is haphazardly organized or carelessly operated, or when owners start thinking of the business as a personal bank account.

Creating a limited liability company is a good way to wall off personal assets from your company’s liabilities and can offer protection for those assets in the event of a judgment against your business. LLCs, as they are commonly called, are an increasingly popular business structure that combines the simplicity of pass-through taxation — characteristic of a partnership or sole proprietorship — with the limited liability of a corporation.


The number of LLCs in this country has surged in recent years — fueled by the real estate boom as well as changing corporation laws. The entity is relatively new: Wyoming approved the first LLC legislation in 1977, and about a decade later the Internal Revenue Service said LLCs in that state could be treated as partnerships. Since then, every state in the union has approved LLC legislation, and the business structure is fast replacing the joint venture and limited partnership as a preferred investment and development vehicle.

If properly structured, LLCs are especially effective at shielding owners from personal liability that may arise from business dealings. For this reason, sole proprietorships and partnerships often convert to LLCs as business grows, and they have more assets to protect. Common uses for LLCs include the following:

  • Operating single-purpose bankruptcy-remote entities;
  • Holding real estate for parent entities;
  • Planning for transfer-tax purposes;
  • Creating development entities to acquire, construct and sell a development (with the LLC often being dissolved when a property is sold);
  • Establishing husband-and-wife businesses. (In a community property state, if the LLC owners are married, the LLCs can be taxed as a partnership or a disregarded entity.)

Not surprisingly, the use of LLCs is especially prevalent among investors and commercial real estate professionals, who frequently use them to hold title to investment properties. Astute commercial real estate professionals — as well as the mortgage originators who work with them — should be familiar with the key benefits of a well-structured LLC and understand how to “bulletproof” an LLC in order to limit a company’s exposure to liability.

Common mistakes

Owners and investors should be especially on guard to operate their LLCs properly as the real estate  market heats up. When the velocity of transactions  increases, some people stop paying attention to  important details. That can lead to a multitude of  mistakes in setting up and operating LLCs. These miscues can invite legal challenges from creditors in an attempt to pierce the veil of liability-protection offered by LLCs — resulting in personal liability for members (as the owners of an LLC are called).

Veil piercing essentially means disregarding the artificial personality of an LLC and exposing individual members to liability. The result is that an LLC debt becomes a debt of the member. Reverse veil piercing is using the LLC’s assets to satisfy a member’s debt.

Real estate professionals should pay close attention to detail
and be a bit more formal than they otherwise might be.

One of the worst errors an operator of an LLC can make is using the company as a personal piggy bank by paying for personal expenses or the expenses of other companies with corporate funds. Such payments can be made properly, of course, by making a distribution from the company — which naturally has tax and other consequences — and avoiding what are known as alter-ego issues.

Another common and serious mistake is commingling funds and other assets. Many real estate investors and developers use multiple single-purpose LLCs to structure their businesses. Even with the most beautifully structured LLCs, if you throw all your money in one big pot — rather than keeping assets separate — you will expose the members to potential liability. Separate bank accounts and accounting codes for each entity you operate will greatly reduce this risk.

Courts also frown on failures to adequately capitalize a corporate entity. There is no bright-line rule for adequate capitalization. But when you determine the amount of initial capital required to set up and operate an LLC, it is helpful to detail in writing the assumptions you made in setting the initial capital amount. This will allow you later to prove the reasonableness of your assumptions (and will aid your memory as well).

Some other common operating mistakes include not clearly differentiating the records of separate entities, concealing and misrepresenting the identity of the ownership of an LLC, diverting assets to the detriment of creditors, failing to keep minutes or adequate  corporate records, establishing identical equitable ownership in the two entities, and diverting corporate funds or assets to unauthorized uses.

Miscue prevention

Problems that surface in relation to LLCs are usually the result of the speed of business and sometimes the mistaken belief that  the process of separating entities is merely a matter of form over substance. In order to prevent the types of mistakes that can prove costly in a court battle, real estate professionals should pay close attention to detail and be a bit more formal than they otherwise might be.

This means documenting financial transactions — including keeping careful records of loans between entities, particularly when managing multiple LLCs. If you can’t draft a formal promissory note for a loan between entities, for instance, at least make certain there is an accounting entry that shows a loan being made on the books of the lending entity and being received on the books of the borrowing entity.

Another easy fix is to always be clear which company is communicating with another party. Make certain that you are using the appropriate letterhead, e-mail address and signature blocks. If an LLC requires annual meetings, hold them. 

In addition to the common mistakes, and the sloppiness that comes with haste, another big source of LLC difficulties is reliance on websites that offer inexpensive assistance in setting up limited liability entities. Remember, you generally get what you pay for.

•  •  •

The benefits of setting up well-structured LLCs are many, including lawsuit and asset protection, tax savings and greater ease of raising capital. The operative term here, however, is well-structured. If an LLC is poorly put together or haphazardly run, many problems can ensue. You will always have people shooting at you, but the more careful and meticulous you are when setting up and operating an LLC, the easier it will be to defend yourself.


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