Generally, each real estate investment should be owned by a separate entity. If multiple properties are owned in one entity, a financial problem for one property—such as judgments by vendors or by trip-and-fall plaintiffs—will affect all properties. Think of this strategy as not putting all your eggs in one basket. If each property is in a separate entity, only the troubled property will be at risk and only its owner will be liable. Furthermore, many lenders will require that the borrowing entity own only the property which secures the loan.
The choice of entity is an important one. The first step should be consulting an accountant and attorney you trust before deciding which type of entity to use. Each case is unique and may have different tax and legal consequences. Usually, accountants and attorneys recommend limited liability companies. In properly organized and operated limited liability companies, the owners, called members, have no liability for the obligations of the company. The IRS has ruled that a limited liability company is taxed as a partnership, i.e., a pass-through entity where the entity is not subject to income tax. In the last 20 years, all 50 states have passed statutes creating limited liability companies.
Properly formed and maintained corporations will protect shareholders from the liabilities of the corporation, but they carry the potential for double taxation, i.e., taxing the entity and the owners. Partnerships allow the tax consequences to pass directly to the partners with no tax at the partnership level, but all general partners are liable for the obligations of the partnership. S corporations enjoy pass-through tax treatment and shareholders are not liable for the obligations of the company, but the Subchapter S rules of the Internal Revenue Code are restrictive.
Limited liability company laws permit the members to enter into an operating agreement, but this is not required. However, no limited liability company with more than one member should ever neglect to have an operating agreement from the company’s very inception. The operating agreement should address such issues as management, control, distributions including any priorities, whether there is a buyout at the death, disability or termination of employment of a member, allowable competition versus non-competition, and other important matters.
Of all these entities, limited liability companies offer the most flexible structuring of control and operations. Under the laws of Illinois and most other jurisdictions, limited liability companies can be managed by managers (like a board of directors) or by the members. In a member-managed limited liability company, the operating agreement can give the members as much or as little say in the operations and important decisions of the company as the deal dictates. The statutes themselves do not authorize capital calls on members, but the operating agreement can set the terms for capital calls and the consequences for failure to meet a capital call, usually dilution or expulsion.
Regardless of the type of entity you choose, as the shareholder or member, you will be personally liable for anything you guarantee, and the holder of the guaranty could reach all your assets, which would include ownership in all the entities.
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