Holding Property In An LLC:

Things You Need To Know

By: Nathaniel Gilbert

Chances are, if you own property of any kind you have heard mention of the concept of holding that property in a Limited Liability Company (LLC). LLC’s are great entities for holding property, and

a vast majority of my client’s who own property want to put that property into an LLC. To put it simply, if you are considering buying a property that is not your primary residence, the advice of an attorney is going to be to put that property into an LLC. There are, of course, caveats and exceptions to this advice, and there are several other property holding vehicles such as Trusts or Corporations, but this article will focus on the Limited Liability Company as the default choice of most property investors.

But first, let’s get something clear: make no mistake, if you buy property other than your primary residence, you are a property investor. I have clients who humbly avoid using the words “real estate investor” because they are self-described farmers and ranchers, but

I try to remind them that the property is in all reality a significant investment and they need to treat it as such. We need to confront the issue of property ownership of all kinds from the perspective of savvy investors who wish to not only see return on their investment, but to protect that asset at all costs. Be a Farmer or Rancher first, with Real Estate Investor coming in a close second.

LIMITED LIABILITY: ISN’T THAT THE POINT?

Limited Liability Companies are popular because of the very name by which they are known. “Limited Liability” is where most folks stop reading, because it tells them all they think they need to know—“If I form this company, then I will not be liable ever again for anything.” Well, that’s not necessarily the case. In my practice, I encourage people to put the emphasis on the last word in the name of this all-

encompassing entity: “Company”. The company itself is what makes the limited liability part work in the first place.

If you form an LLC, and the last thing you ever do with that LLC is to file the Certificate of Formation with the Secretary of State, then you

may as well just skip it altogether. A name and certificate do not a company make. LLCs are companies that are required to be run like companies. The Limited Liability only applies to those companies that are, in all sense of the word, companies.

When someone decides to sue your entity for whatever reason, their attorney is going to include you personally. Your attorney’s first job will be to get you personally dismissed from said lawsuit under the theory that the plaintiff (the one bringing the lawsuit) only interacted with the company and the company assets and has no basis to sue you individually. The Plaintiff’s attorney will then attempt to “Pierce the Corporate Veil,” or, more simply, attempt to show the Court

that the LLC is not actually a company, but just an alter ego of you individually and that therefore you should receive NONE of the liability protection traditionally afforded by the LLC entity structure.

If the only documents you have are your Certificate of Formation after 10 years of running a business, do you think the Court would look at your company as legitimate? You must be able to show the Court that you were running a legitimate company: separate bank accounts for the company, corporate records showing Member interactions and voting, contracts and receipts showing your LLC engaging in business in the name of the company, and proper financing and capitalization of the company for the business it conducts. That’s a lot of fancy words for “paperwork” but is nonetheless an important aspect of company management and thus, asset protection.

Your new LLC is no different than any Fortune 500 Company. No, really, this is the way that you need to think about your company. Does the CEO of McDonalds look at the company bank account and think, “Huh, guess we need some more money so I’ll just transfer some from my personal account really quick.” Clearly not. Capital contributions (what it is called when Members of an LLC contribute personal funds or assets to a company) must be made in compliance with the requirements set out in the Company Operating Agreement. Usually, this means a vote of all the Members, unanimously approving the capital contributions, and this vote being memorialized in a Corporate Resolution that identifies those members, the amount of the contribution, and the date by which those contributions must be made. This paper trail showing the inner workings of the LLC is crucial to showing the formal operations of the company have been followed.

For instance, Bob and Agnes decide to buy the quarter to the north of their ranch and place the property in an LLC. Agnes files the Certificate of Formation, purchases the property and deeds it to the

LLC. Sounds great, right? Well, 10 years later, a farm hand is walking through that north quarter and when he is injured, decides he will sue Bob and Agnes and their LLC for damages. From here, there a couple of different ways this will go.

In the first scenario, Agnes has maintained diligent records for the LLC and the property. The property taxes and general cash flow from the property has been properly documented and kept with the corporate books, and the accounting is up to date and accurately reflects the expenses, income, and receipts for the company.

Agnes has, in this instance, done an incredible job of maintaining and running the company and observed all necessary corporate formalities. It will be exceedingly difficult to pierce the corporate veil of Agnes’ LLC and she has likely saved both her and Bob a great number of headaches.

In the second, and far less desirable scenario, Bob tells Agnes he will take care of the LLC paperwork and maintenance. But, like many farmers and ranchers, Bob has 10,000 other things on his mind at any given time and the LLC paperwork slips through the cracks.

When he is asked about the LLC paperwork, Bob opens his file cabinet in the barn to reveal only a few scattered receipts, and some handwritten notes on a manila folder. This may spell disaster for Bob and Agnes, as the LLC has not been treated as a formal company, and the whole structure could come tumbling down.

Now, all is not lost—If reading the last few paragraphs made your heart sink because you may be more of Bob than an Agnes: “Be not afraid, for I bring you good news.” LLCs and corporate structures can be easily brought current with the right motivation by those involved with the company. It is ideal to begin with this mindset, but hardly

the end of the world if you can otherwise get back on the right track before lightning strikes.

ASSET PROTECTION STRUCTURE

Asset protection means just that: you are setting out to protect those assets that are most important/most valuable to you. In LLC speak, it means that we are most likely going to be placing these assets into separate companies and structuring these companies in such a way as to ensure that all of our eggs are in separate baskets, the bulls are away from the heifers, the foxes are out of the henhouse, etc. etc.

Let’s look at how we can use the properly managed LLC that we set up in the early portion of this Article, to limit our liability.

Separation of business dealings and assets should be highly prioritized in the realm of asset protection. We want to not only separate our public facing operation from our key assets, but on a much more detailed level, our own unique business ventures and unique assets. From a simplicity standpoint, we look to separate the cattle operation from the company holding the property where we graze and work the cattle. Going even further down the rabbit hole, we want to separate the cattle operation and the farming

operation and the hunting lease operation, and we want to separate the grassland we run cattle on, the irrigation pivots we farm, and the river-bottom ground we hunt. Now, that sounds like a lot—and it

is! There is more than one right answer here, so let’s dive in and see where you might land.

The “Holding Company” owns the property, is named Grantee on the deed, and is for all intents and purposes, the bona fide, fee simple owner of the property. This asset holding company should

not engage in any business besides owning the land and meeting the obligations of a property owner, paying real estate taxes, appearing on deeds, and otherwise remain blissfully silent.

This is a good place to note that there is no such thing as a 100% judgement-proof way of structuring assets. Asset protection is about presenting as many shields as possible to defend your property and assets. Essentially, we are making it extremely difficult to sue you and your company, and the more complicated that we can make that through the use of separate companies, waivers, and other tricks of the trade, the less attractive you are to the potential plaintiff’s lawyer. There are certainly better ways than others, but if anyone, including your attorney, guarantees that your assets are protected from any and all liability in perpetuity because of their profound genius in structuring your company—run the other way as fast as you can.

The second LLC, the “Operating Company” is the one actually doing the interacting with the public and conducting of business in the stream of commerce. This company enters into contracts and leases for the operation of the farm or real estate investment business.

Everything from buying seed or cattle, to property maintenance, to the signs over the entrance, should be handled from the purview of and be fully in the name of, the operating company.

Now, because the Operating Company is conducting business, there is liability exposure. There’s no way to get around this very basic fact of doing business. However, we can rest a little easier knowing that the Operating Company is not holding our most valuable assets: the land. So, even in the case of something disastrous, we have done all that we are able to do to have those assets removed as far as possible from ground zero and not put them directly in harm’s way.

So do you need two LLCs? Or three or four? It depends. The litmus test I use for most clients who begin the process of asset protection is cash flow and exposure. Do you need a separate LLC to run the

hunting lease operation if you lease to a family in town that you know from church for $2,000 every year? Probably not (but it never hurts). Do you need a hunting lease operating company if you lease to an outfitter for $50,000 who then takes 100 people onto your property over the course of a season? Probably yes, right? Again, there won’t be any one answer for all situations, and having a frank discussion with your attorney about these factors is absolutely crucial.

The answer for most real estate investors, ranchers, farmers, and landowners who do much of anything with their land is going to be at minimum, two LLC’s. Some attorneys will recommend more, some will recommend just one, and the answer will heavily depend on your operations, liability exposure (are you raising daffodils or rodeo bulls; one long-term tenant or multiple shorter-term tenants, etc.), and your needs in general, so no one-size-fits-all answer exists. But generally speaking, a holding company to actually hold the land and an operations company to interact with the outside world should be your bare minimum consideration.

In conclusion, LLCs provide a great service to landowners and real estate investors. Using an LLC as the basis for your land ownership and management structure ensures a well-rounded approach to the business of owning and running the land.

At the end of the day, the use of Limited Liability Companies is a common enough practice, but proper management and structuring is decidedly rare. When you head down this path of asset protection, keep in mind that you will only get out of it what you put in, and that you are the most vital company asset.