Using Series LLCs for Real Estate Investment
Using Series LLCs for Real Estate Investment
February 16, 2018
One of the more interesting developments in the world of business law over the last few years is the introduction of the Series LLC.
For the uninitiated, a Series LLC is a variation of a traditional limited liability company ("LLC") which elects to have legally-separated subdivisions called "series." Each series is treated in much the same way that individual LLCs are treated, but the individual series are not independently registered with the state. This allows for a company to spool up and shut down series quickly and under much less formal circumstances while still keeping the benefit of legal protection across asset classes.
The best part of series LLCs is that they provide segmentation between one side of your business and another. You can group and segregate high-risk assets away from low-risk assets. This allows your business to continue to operate without a hitch even through the loss of a high-risk asset.
This is especially attractive in real estate investment, because you can place each individual property into a separate series within a single LLC. This means that your investment will only have a single LLC registered with the state, subjecting you to only a single set of state registrations and taxes, but you could have dozens of series holding dozens of properties at no additional charge. If anyone were to get a judgment against a single series, it would only affect the assets in that series, and would not taint the assests in any other series.
Not everything is perfect with series LLCs, and the most common problems with series LLCs is their youth, their complexity, and the tax treatment.
The first problem with series LLCs is that they are relatively new. As of this writing, only 17 states and Puerto Rico have adopted series LLC laws. In Alabama, for instance, series LLCs have only been allowed since 2015, and almost no lawsuits have been filed to date challenging the interpretation of Alabama state law in regards to series LLCs. This means that there is still a significant question about the enforceability of the various series LLC provisions. This also means that if your series LLC is operating in a state that does not recognize series LLCs, you may not get the benefit of this series segmentation of liability. Therefore, if you own properties in more than one state, you might not get the same protections in a non-series LLC state as you would in a series LLC state.
The second problem with series LLCs is their relative complexity. Most states, including Alabama, provide significant deference to the LLC's internal operating documents, such as a Operating Agreement or Limited Liability Company Agreement, in determining how the series will behave. This means that poorly drafted internal documents can result in significant liabilities, including the potential piercing of the corporate veil. This could result in personal liabilities even though you are operating an LLC. This means that retaining a competent attorney to draft the series LLC documents is of even more importance than it is in a standard LLC.
The final issue with series LLCs is the tax treatment. Currently, IRS Private Letter Ruling 200803004 governs the federal tax guidance regarding series LLCs. Specifically, this letter states that each separate series of an LLC is to be treated as a separate tax entity, which can continue to claim all deductions and exemptions that any other applicable LLC might be able to claim. However, this creates difficulty in multi-member series LLCs because each individual series that operates as a partnership could potentially be responsible for filing a separate tax return, which would greatly increase the expense of operating a series LLC, making it unattractive for many as an investment vehicle. While the IRS guidance is not final, and while there is lobbying currently being conducted to shift the current policy, nothing has changed in almost 10 years, so it is not certain when the IRS will supplement this guidance, if at all.
Unlike many attorneys, I still remain an advocate of series LLCs. I do not believe that they are a silver bullet that are going to solve all of your investment strategy woes, but I think that they can be especially attractive for single-owner investment companies. I also believe that, with slight tweaking, they can adequately fulfill the needs of multi-member LLC investment groups and partnerships. That said, a series LLC is not a DIY project. I have seen experienced attorneys critically bungle series LLC formation documents, which means that the average non-attorney is almost guaranteed to make mistakes that will likely result in corporate veil piercing, exposing your personal assets to risk. Setting up a series LLC should not be done without the assistance of competent legal counsel.