Using Limited Liability Companies or Partnerships to Protect Assets

 In Asset Protection

Photo by Graphic Node on Unsplash

Corporations date back to the Dutch East India Company as a structure for investors to share the rewards and risks of business ventures without risking anything beyond their actual investment. In addition to being a way to raise money and centralize management of businesses, corporations limit liability since claims against the corporation for debts and injuries do not flow back to the shareholders. Only the corporate holdings are at risk, not the other property of its owners.

This is distinguished from a sole proprietorship. If, for instance, you own a rental property in your own name, fail to shovel the walk after a snowstorm and someone falls and hurts himself, he can sue you personally for his injuries and seek recovery against all of your assets, not just the rental property. If, however, the property were held in a corporation, the injured party could only seek recovery against the corporate assets, presumably just the building itself and a bank account maintained for operating expenses.

New Forms of Corporate Ownership

Since corporations are formal entities and somewhat cumbersome and expensive to manage, recent decades have seen a proliferation of other limited liability business forms, each with its own acronym and features, including limited liability partnerships (LLPs), professional corporations (PCs), and limited liability corporations (LLCs). While each entity is a bit different and they differ from state-to-state, all these corporate forms have the following in common:

  1. They permit multiple owners.
  2. One or more owners may be named to manage the business.
  3. Liability for corporate actions extends only to the entity’s assets, not those of its owners.

To determine which form of business best fits your needs, you will need to consult with a local corporate attorney.

Each Boat in its Own Corporation

Often landlords who own multiple buildings have them each owned by a separate corporation or partnership. That way, if anyone sues due to an injury occurring at one building, the other properties will not be at risk. Other business may follow the same strategy:

When I was in law school, I spent a summer working at a large New York City law firm that had a specialty in bankruptcy. I was assigned to work on the bankruptcy of a shipping company that owned several old freighters that sailed up and down the east coasts of North and South America. It turned out that each ship was owned by a separate corporate entity, meaning that we had to prepare separate filings for each ship. Unfortunately in terms of our workload, this was before the days of word processing, so we couldn’t simply copy and paste. One of the biggest immediate problems for the company was that one ship full of ripe bananas was just off the port of Galveston. The company couldn’t afford to pay the dock fees and was also concerned that if the ships did come into port they would be seized by its creditors. As the week went on, the bananas began to rot. In addition, there was concern that it and other ships would run out of fuel to run their bilge pumps, potentially resulting in their sinking. As part of the bankruptcy process, the company was permitted to use its cash on hand to keep the ships afloat rather than pay it to creditors. (Of course, they were also permitted to pay their attorneys.)

Follow the Rules or Risk Losing the Protection

One caveat to be aware of if you choose to use any of these corporate forms for purposes of limiting liability: You will need to follow all of the formalities required by law, whether that includes annual filings with the state, notices to shareholders, or annual meetings. Otherwise, you could lose the benefit of the protections provided by the limited liability structure. If your corporate entity is sued, the plaintiff may seek to “pierce the corporate veil” by showing that despite the incorporation, you treated the business as if it were a sole proprietorship. If the plaintiff is successful, all of your property could be at risk. As an example, if you were to place rental property in a corporation or partnership, make sure that the tenants make their checks out to the company, not to you personally. And make sure that you deposit the checks into an account in the corporation or partnership’s name, not your own bank account. Run all of the expenses through the business account and file a separate income tax return for the business each year.

Related Articles:

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Showing 2 comments
  • greta mccaughrin

    Owner of several rental properties wishes to protect each via an LLC. Does each property have to be re-titled in LLC name, insurance, and mortgages redone in LLC name?

    • Harry Margolis

      Yes. The idea of limited liability corporations (LLCs) is to encourage investment in businesses without the risk of incurring unlimited liability. This is also true of all corporations and limited liability partnerships (LLPs).
      When you buy stock in a corporation, you do not take on the corporation’s liabilities; you only risk your investment. This is what happened when Silicon Valley Bank went bankrupt. The shareholders lost their investment, but they didn’t have to cough up more money to reimburse the customers whose accounts were at risk (or the federal government that ultimately guaranteed the customers’ accounts).
      When you own real estate, you are personally liable for anything that may happen related to the property. So, if someone falls and is hurt on the property, you might get sued and if you are found to have been negligent you would have to pay the damages, which may be more than the value of the real estate, especially if there’s little equity due to mortgages. Your insurance should cover both the costs of litigation and any resulting damages, but there’s some risk that they would exceed the level of the insurance.
      You can protect against that risk by transferring the property into a limited liability entity such as an LLC. For that to work, the LLC must become the owner of the property, which means re-titling it and updating the mortgage and the insurance. Once you have taken this step, only the property in the LLC would be at risk if anyone were hurt on the property.
      Since it sounds like you own more than one property, you might want a separate LLC for each. That way, if someone were hurt on one of the properties, the other properties would not be subject to claim. To mix metaphors, each boat would rest on its own bottom.
      For this strategy to work, you will need to make sure that you follow whatever requirements your state has for maintaining LLCs. This will probably mean an annual report and fee to the office of the secretary of state. In addition, each LLC will need to obtain a separate tax ID number and file its own 1041 tax return each year.
      You will have to assess whether the protections offered by the LLCs are sufficient to justify these added costs and administrative duties.

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