Real Estate LLC & Asset Protection
July 25, 2011
Real estate can be the source of substantial liabilities. Under certain circumstances, however, many of those liabilities can be eliminated by properly structuring ownership of real estate in a limited liability entity like a limited liability company (LLC).
The significant cost of acquiring real estate often requires owners to borrow money purchase real estate. Because of the significant fluctuations in real estate values over the past decade, especially here in Arizona, many property owners now owe more money on loans associated with their real estate than the real estate is worth.
Although Arizona law generally prohibits lenders from suing homeowners to collect deficiencies associated with the disposition of primary residences, lenders can obtain deficiency judgments against real estate owners in other circumstances. However, if the real estate is owned by an LLC as opposed to a person, and the owner of the LLC (called an LLC member) has not personally guaranteed the loan or acted wrongfully, the lender cannot seek recourse against the LLC member for a deficiency, only the LLC itself.
In the United States, people are required to act reasonably (non-negligently) relative to their age and capacity. If a person does not act reasonably, he/she can be liable for damages associated with his/her breach of that duty. However, a person who owns real estate can, in certain situations, protect his/her personal assets from negligence claims arising from the ownership of the real estate. This is done by titling ownership of real estate in the name of an LLC or other limited liability entity.
For example, if a tenant of rental property slips and falls in a pool of standing water at the rental property because a sprinkler was not properly installed, that owner of the rental property might be liable for those injuries. If the property is owned by a person, then the tenant can pursue the personal assets of the owner. If an LLC owns the property, however, only the LLC will be liable for damages (unless an LLC member personally created the danger through an act of negligence like incorrectly installing the sprinkler head that caused the pool standing of water), but the tenant would not be able to pursue the LLC member's assets to satisfy a judgment entered against the LLC.
Limited Liability Company (LLC)
During the past 30 years, the LLC has risen from realtive obscurity in Wyoming to wide-spread acceptance and usage in every state as an entity of choice for many businesses and for many asset protection plans. This is in large part because of the flexibility and lack of formational and operational formalities required by LLC statutes as compared to corporation statutes. There is, however, another possibly more important reason: charging order protection for LLC members.
In contrast to corporations, which generally permit judgment creditors of a shareholder, except in Nevada, to foreclose upon a judgment debtor's property interest in a corporation, which is represented by shares, and exercise the rights associated with those shares, creditors of LLCs in many states, e.g. Arizona, are expressly prohibited from seeking foreclose of an LLC member's property interest in the LLC and are not permitted to exercise management or control over the LLC. Courts in some states, however, have permitted a foreclosure-like remedy, i.e. Florida (Olmstead) & Colorado, by disregarding single-member LLCs and imposing personal liability upon an LLC member in situations where the member was utilizing the LLC for unlawful purposes. However, Florida's legislature recently enacted a statute that only allows creditors to pursue charging orders against multiple-member LLC interests.
This brief overview of some important considerations associated with real estate LLCs and asset protection is by no means comprehensive. Always seek the advice of a competent professional when making important financial and/or legal decisions.