For decades, limited liability companies (LLCs) have been an effective way to protect personal assets from lease obligations. State governments provide this protection to encourage investment, strengthen the economy and benefit the community.
Fortunately, one of the primary functions of corporate and limited liability company law is to protect individual investors from personal liability and promote society and the general public interest. However, to receive this protection, one must run the business in strict compliance with the LLC statute. The following serious mistakes are often made by people who attempt to create an LLC on their own or who rely on cheap legal documentation services, paralegals, accountants, or attorneys who do not specialize in LLC formation. (Tax advisor services can be of great value, but they are generally not used for asset protection).
LLC Mistake #1
Waiting for a tenant to assert a personal injury or a lawsuit against you to create an LLC. If you don’t create an LLC before a tenant files a claim or lawsuit against you, creating an LLC offers no after-the-fact protection for your assets. I am amazed at the number of clients who call me in a panic to create an LLC when they have already been sued, and by that time, it is often already too late.
LLC Mistake #2
Non-compliant transfer of the leasehold interest to the LLC at the time of forming an LLC only protects its owner’s property if the leased land is transferred to and held by the LLC. This critical step must be accomplished through a Grant Deed or Quitclaim Deed and requires proper wording and certification by a notary public. Unfortunately, many people do not complete this transfer or attempt to complete this step themselves with the help of a paralegal or document preparation service.
Without the proper attention to detail, errors and omissions can easily lead to erroneous and unnecessary property tax reassessments. Voided reassessments caused by clients who previously attempted to transfer property without proper guidance can be very costly. Those who made this mistake regret the fact that they hired an experienced LLC attorney in the first place.
LLC Mistake #3
Failure to open an LLC bank account and conduct all LLC transactions through that account. Some of my new clients have previously formed an LLC but continued to do all LLC banking through their personal or DBA accounts. It is essential that all LLC income be deposited into the LLC account and all LLC expenses be paid from the LLC account. If LLC funds are not segregated from personal funds during litigation, the judge will declare the LLC void and allow creditors to attack and seize the personal property. Tenants must write a check to pay rent to the LLC and must deposit that check into the LLC’s account.
All LLC expenses, such as mortgage payments, insurance, taxes, and maintenance, must be paid from the LLC account. In an emergency, it may be possible to cover the LLC’s expenses with one’s funds and write a check to the LLC to reimburse the costs. However, this should only be for limited amounts. In addition, the LLC should have a credit/debit card so that small purchases can be made for the property. If you use a management company/rental agency to collect the rents on your behalf, the agency should pass on the rental income to the LLC and not to you personally.
LLC Error #4
Creating a corporation instead of an LLC for rental property. Many mistakenly make a corporation for a rental property to save money without seeking legal advice. This is not a good idea, as a corporation generally does not offer the same asset protection as an LLC for this type of business. In addition, a corporation requires additional procedures, such as more tax filings and mandatory meetings and minutes. Even if you want to be taxed as a corporation. You can choose to have the IRS treat your LLC as an S or C corporation. By submitting the appropriate forms.
Many clients have paid legal assistants and law firms to create LLCs and C corporations for their businesses. However, they have run into severe problems afterward and have sought legal advice after the fact. They were deeply disappointed when they realized they had to start over. And pay a lot for unnecessary or inaccurate documents and the franchise tax.
LLC Mistake #5
Do not transfer the LLC to a living trust. If you have a living trust. It is crucial to make sure that the LLC is transferred or owned by the trust. I have met many new clients who did not transfer their LLC to a family trust. If they had died before resolving this issue. The LLC and its assets would have passed through the probate court. Not directly to the heirs, as the trust provides. In this area, proper legal advice is also essential to protect your assets from litigation. And shield them from potentially unnecessary estates and estate taxes.
If you decide to create an LLC. It would be unwise not to ensure that it is appropriately formed and managed. However, it can seriously compromise the protection it provides if it is not used correctly.
Villie Walters Ramirez is a 32-year-old tax assistant at a tax firm who enjoys bookkeeping, accounting, and NY LLC formation services. She has a post-graduate degree in accounting, and she has a severe phobia of cats. She enjoys traveling A lot.