We have lots of clients who come to us after dealing with promoters and would-be practitioners who have recommended elaborate (and usually expensive) entity structures for their businesses. This “up-sell” approach tends to happen whether the business sells cheeseburgers or invests in buy-and-hold rental properties.
One of the structures that is almost always included in these intricate structures (especially when real estate is involved) is something called a “holding company.” Simply put, a holding company is a business entity that exists solely to own other business entities. In our practice, we see this most often in the form of a holding company LLC, which owns one or more additional LLC’s, each of which, in turn, owns a single rental property.
At first glance, this structure may seem like overkill, and in many situations it is. Owning a rental property in the name of a single properly established, maintained, and operated LLC will provide the LLC owner with limited liability for the potential debts and obligations associated with that property.
In several states (but certainly still less than half), this simple structure also does a great deal to protect the rental property from the debts and obligations of the LLC owner. In these states, if an LLC owner has some sort of judgment against him or her, the sole remedy available that judgment creditor has to get at the LLC owner’s interest in the LLC that owns the rental (and the rental itself) is something called a “Charging Order.” Let’s call these states “Charging Order States.”
The Charging Order lets the judgment creditor step into the LLC owner’s shoes if and when the LLC makes a distribution of profit – but it doesn’t let that judgment creditor do much else. For that, and several other reasons, the Charging Order is a particularly weak remedy that many judgment creditors will simply decide not to pursue (or that they may be willing to walk away from for pennies on the dollar).
So, given the protections offered by a single LLC, when can a holding company, set up in a Charging Order State, actually make sense in the context of rental real estate? Here are a few:
1) You work in a profession that tends to get sued a lot (think doctors and engineers), and your rentals (and their associated LLC(s)) are located in a non-Charging Order State. In this situation, the holding company can be an effective barrier between the people who might sue you for malpractice and your rental property assets.
2) Even though you don’t work in a “high risk” profession, you are a bit of an asset protection junkie, so for you, because your rentals (and their associated LLC(s)) are located in a non-Charging Order State, the additional cost and paperwork of having another entity is worth the additional protection from personal creditors. Here, the holding company may have less practical effect than in number one above, but it will serve as that same barrier if you get tied up in a lawsuit you end up losing.
3) You are a bit of an asset protection junkie, and you like the idea having two layers of limited liability protection between the liabilities associated with your rental property and your personal assets. In this situation, if a plaintiff in a lawsuit is for some reason able to pierce the corporate veil of the entity that owns the rental and get at the owner, they will find yet another corporate entity whose veil will also have to be pierced before they can access your personal assets to satisfy a judgment.
You’ve worked hard to accumulate the assets you have, and it makes sense to take steps to protect them. Don’t be fooled by those who say “you have to” do X, Y or Z. There is no one-size-fits-all-approach. The art and science of asset protection involves one cost/benefit analysis after another. Make sure you are seeking and following the advice of a knowledgeable professional who has your best interests at heart.
