Also in this Issue:
-Limited Liability Companies:
An Introduction and General Overview
-Estate Planning with Family Partnerships
and LLCs
-LLCs: Assessing the Tax Pros and
Cons
REAL ESTATE INVESTMENT USING LLCs: NOT ALWAYS A NO-BRAINER
by Jonathan Rivin rivin@ddrs.com
In the four years since California authorized LLCs, they have rapidly become the entity most often selected for real estate investment transactions. The primary reasons are discussed above in this newsletter-all owners have the limited liability of corporate shareholders but receive pass-through income tax treatment of partnerships. S corporations have both of these attributes, too, but are relatively inflexible in the structuring of the business relationship among the owners and distributions of appreciated property are taxable events. Limited partnerships are more flexible, but often require forming a corporate general partner resulting in additional expense and administrative burdens. Thus, most California lawyers and their clients choose the LLC structure for most real estate deals.
There are some circumstances, however, in which the LLC should not necessarily be the entity of choice from the point of view of an investor, particularly an investor who will not actively manage the business. These circumstances are described briefly below.
Personal Liability. Ironically, the personal liability of some investors may actually be greater as LLC members than as limited partners! Some creditors who might have been satisfied with recourse to a general partner of a limited partnership will require debt guarantees from LLC members, even though they would not otherwise have been approached to guarantee partnership debt if they had been limited partners. Furthermore, a passive investor who is an LLC member may be liable for the LLC's obligations in the unlikely event the "corporate veil" is pierced for failure to be adequately capitalized, to keep proper books, to make required filings or to pay taxes. Limited partners do not face these potential exposures.
Fiduciary Obligations. In member-managed LLCs, the members may have fiduciary obligations to their co-members which are broader than those limited partners would owe to each other. California's LLC Act provides that managers have the fiduciary duties of a general partner, including prohibitions against competition and usurping business opportunities. Limited partners generally are not thought to have such duties to each other.
Distributions and Taxes. Improper distributions to LLC members are more likely to be required to be returned or used to satisfy LLC obligations than similar distributions to limited partners. Indeed, causes of action against a dissolved LLC may be enforced against any assets distributed even though distribution was not wrongful when made. Moreover, the LLC member has personal liability, comparable to that of a corporate officer, for willful failure to pay taxes due from the LLC.
Conclusion. For the individual investor with bargaining power, requiring a real estate investment to be structured as a limited partnership rather than an LLC may result in less potential personal liability and a decrease in obligations and duties. With a properly drafted limited partnership agreement, this investor should be able to obtain broader liability protection as a limited partner than as an LLC member, while at the same time maintaining sufficient control to oversee his or her investment properly.
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