Why a Series LLC may work for you. #TaxPlanning
So many investors and entrepreneurs like
to use the Limited Liability Company (LLC) format for entity planning. I
refer to LLCs as a Swiss Army Knife because it is so flexible and adaptable to
so many situations. Corporations are still a viable and proper choice for many,
especially with the flexibility provided by Sub S elections. The Series LLC now
deserves special consideration as way to reduce entity costs, both initially
and over the long run. Here's why.
What is a Series LLC? Its an LLC that
allows you to form multiple series entities via one entity; protect the equity
of one series entity against the liabilities of another series entity; and have
a different set of owners for each series entity. This is a Swiss Army knife on
steroids!
Let’s review the most common reasoning
behind choosing such a structure. We’ll assume an individual real estate
investor, married with 2 children, living in Texas. He owns 3 properties.
Property 1 is a small 6-unit apartment complex that is debt free, with an
equity of $1 million dollars. Property 2 is a rent house that is worth $250,000
with a mortgage of $100,000. Property 3 is beach house used exclusively for
rental with a value of $500,000 and a mortgage of $450,000.
Previously the properties may be owned by one
corporation or LLC, with a sub S election made to pass through the rental income
to his individual return. A forward-thinking investor may choose to form 3 separate
entities to protect the equity in each property from potential liability arising
from the other properties. He may choose to form a parent entity, or family
limited partnership own the entities. For our discussion we will assume that he
uses a parent entity to own the three corporations that owns each corporation,
that in turn owns each individual property.
Our investor will have to form four entities.
That’s four filing fees, four registered agent fees, four franchise returns,
four federal income tax returns, four bank accounts, etc., etc.
With a Series LLC he forms one entity, we’ll
call that Mothership, LLC. The Certificate of formation discloses three series –
Property 1 LLC, a separate series of Mothership, LLC; Property 2 LLC, a separate
series of Mothership, LLC; and Property 3 LLC, a separate series of Mothership,
LLC.
He has one entity, one filing fee, one
registered agent, one franchise return, and one federal income tax return. The
series LLCs are designated as disregarded entities, so their income is rolled
up into Mothership, LLC. It doesn’t reduce your taxes. It does reduce your entity
maintenance costs.
The great side benefit is that you can
have different owners for each series LLC. This allows our investor to be
equalizing the ownership among his children considering other assets passed on
to the kids. So maybe he conveys Property 1 LLC 50%-50% to the kids. Property 2
is passed 100% to kid #2 as kid #1 has received another asset worth an equal
amount. Maybe Property 3 is passed to a trust for the benefit of his grandchildren.
The Series LLC’s unmatched flexibility,
from a liability and ownership perspective to the ongoing maintenance costs
savings makes it a very attractive entity consideration for investors.
So, what’s the downside? Banking is still
problematic. You only have one Certificate of Formation to show for the
Mothership and each series LLC. Some banks make be reluctant to accept the one
certificate in order to open an account. You may have to go above the retail
banker to get this done. This is not a criticism of retail bankers; however, this
is may be beyond their ken.
You will need to maintain separate bank
accounts for each series LLC in order to comply with the Texas statute. This is
something you may been doing anyway in order to file separate tax returns. Keeping
separate accounts may be the heaviest burden presented by the Series statute.
The other major burden is the lack of familiarity
by the business community and the public in general with the way a Series LLC
operates. The enabling statue is still relatively new, and people don’t know
what it means or tend to lump this into the parent-subsidiary form of entity.
It is not. We use the term Mothership, not parent. The Mothership does not own
the series LLCs. Each is its own entity. The distinction is that the Mothership
obtains its right to operate via the enabling statute. Each series LLC obtains
is its right to operate from the Mothership only, again, even though the
Mothership does not own the series LLC.
Keep in mind that not all states have
series LLC enabling language and its unclear currently that a Texas series LLC
has standing in a non- series LLC state to own property. Even with this limited
applicability, Series LLCs are worthy of your consideration for investors that
own more than one property.
Questions or comments? We’d love to hear
from you.
