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Introduction

A series limited liability company (LLC) – now available in Texas – is the preferred way to own multiple properties and businesses. The first thing real estate investors should know about the Texas series LLC is this: get one.  The traditional LLC should no longer be considered for real estate investment purposes except in very limited circumstances.  

This article should be read along with our companion article, Asset Protection in Texas.

What is an LLC and what does it do?

A limited liability company is a legal entity that combines the best of a corporation and a partnership. It has the benefit of an effective liability shield joined with informal management and pass-through taxation. Texas limited liability companies are governed by Title 3, Chapter 101 of the Texas Business Organizations Code (“BOC”). Traditional LLC’s have been around a long time.  The Texas series LLC was an innovation of the 81st Legislature and became available September 1, 2009. 

A series LLC can accomplish a variety of objectives. The main ones are (1) minimizing personal exposure of its members; (2) organizing and managing the members’ business; (3) tax benefits including one-time taxation of members’ profits; (4) credibility with the public; and (5) compartmentalizing assets and liabilities.  These compartments or “series” are, in effect, sub-companies.  The need to have multiple traditional LLC’s is therefore eliminated.

Asset Protection

A primary purpose of an LLC is to provide asset protection for its members.  For this reason, properties that could potentially generate a lawsuit or other liability, especially rental properties, should be held in the name of individual series of the LLC. Notes and other obligations should be executed by the LLC.  Personal guarantees should be scrupulously avoided.  

The basic suggested asset protection plan for Texas real estate investors is:

Although there is no such thing as a “bulletproof” plan to avoid personal liability or protect assets, the rule is this: the more fences a plaintiff and his attorney have to jump, and the more money they have to spend in order to get to you personally, the better protected you are. One way or another, plaintiffs have to pay their lawyers, and that means either cash or contingent fee - and few good lawyers will take a real estate fraud case on a contingent fee, particularly if they know they will have to penetrate a bona fide LLC before they can get to any real assets.

It is critical that your attorney draft the series LLC’s company agreement so that it discourages creditors from even attempting to seize your membership interest or the membership interest of a fellow member.  A membership interest in an LLC is not a protected asset under the homestead laws (even though it is exempt from a “charging order”) – so provisions should be included in the company agreement to the effect that any creditor succeeding to a membership interest by means of collection, assignment in satisfaction of a debt, or execution on a judgment will not be able to vote that interest; not be able to serve as a manager or officer; not be able to direct that assets of the company be sold; not be able to alter or reduce the company’s ability to do business;  and not be entitled to distributions unless all members unanimously agree. The objective is to make your membership interest (or the membership interest of any of your partners) essentially worthless to a creditor, so that the creditor passes it by in any attempt at collection.   

Company Identity

An LLC requires maintenance and respect for its independent status.  It may be your company, but it must still be treated at arms length for legal purposes. You must undertake certain actions to maintain its separate character, and it is vital that you do so if you wish to avoid personal liability for the actions of the company or its agents and employees.  The reason is the legal doctrine of “piercing the corporate veil.”  Unless the company pays its state and federal taxes, maintains a bank account, conducts regular meetings, keeps records, and the like, then in the event of a lawsuit, a court may disregard the company’s existence and proceed directly against the members/owners personally.  It will be alleged by the plaintiff’s attorney that the company is a sham and nothing but the personal “alter ego” of its owners, designed to shield them from the consequences of wrongful conduct. 

Omitting company “maintenance” is a common mistake.  Doing the initial paperwork to file the company and paying a filing fee, is not enough to maintain a liability shield.  It will not protect you from a clever plaintiff’s lawyer who is determined to get a judgment against you personally.  Remember, he or she will be looking for deep pockets and hard assets, wherever they can be found.

It has been reported that a new lawsuit is filed every 1.3 seconds.  Literally millions of lawsuits will be filed this year.  Many will award huge damages for such things as serving coffee that is too hot.  In this legal environment, asset protection is a serious matter.

Where to Form the Company

 For reasons of simplicity and economy it is recommended that most investors use a Texas LLC.  Recent improvements to the Texas Business Organizations Code make Texas an excellent choice. The new series LLC allows its owners to compartmentalize assets, members, and managers into separate “series” that are immune from the liabilities that may pertain to other LLC assets that are in a different series (eg., Series A, Series B, etc.).  Now that Texas has a series LLC, it is difficult to conceive of a good reason for investors to form any other type of company.  There is no downside to forming a series LLC vs. a traditional one.

Forming a company in Nevada, Delaware, or some other state no longer has the benefits it once did. Also, such “foreign” LLC’s are required to pay a stiff fee and maintain a registered agent with a physical address (ie., not a PO box) both in Texas and the state of origin.  For most Texas real estate investors, a Texas company is clearly the best choice.   

The Company Name and Other Formation Details

In setting up an LLC, one of the first things to consider is a company name – and whether or not it is available. Unfortunately, the easy names tend to be taken, so you will need to be creative.  Name availability information is available from the Texas Secretary of State at (512) 463-5555 (also www.sos.state.tx.us). 

When you have an available name, contact your attorney and tell him who the original members are going to be and what percentage of ownership each will have.  Generally, LLC’s have a managing member or co-managing members.  Who will be serving in these capacities?  You will also need to choose a registered agent with a physical address (not a PO Box) in Texas. The registered agent will receive official company mail from the Secretary of State, the Comptroller, and anyone who is putting the company on formal legal notice. He is also the person who is served with process if the company is sued.

Members

The owners of an LLC are referred to as “members” rather than shareholders or partners.  An LLC may be formed by one or more persons.  Members may be individuals, partnerships, other LLC’s, corporations, and/or any other type of legal entity. LLC’s generally operate through a “managing member” although officers may also be elected if the company agreement so provides. 

For maximum asset protection, the personal name of a company member should never appear on any deeds or leases, and a tenant should never write a check to a member personally.  Do business using the name of the LLC (or its assumed name – DBA - if you have obtained one) and use a dedicated operating account. Avoid any form of personal guaranty on legal documents. Property management should always be conducted by your LLC. These are simple but essential asset protection measures.

A note for married investors: Since Texas is a community property state, an owner’s membership is presumed to be community property, even if the spouse is not named as a member.

Moving Investment Property into the LLC

Any and all investment property acquired or currently held in a personal name should be moved into the LLC by means of general or special warranty deed without delay.  A series LLC can hold different properties and/or businesses in separate, insulated compartments. The properties can be located in Texas or any other state.  We have a companion article on this subject entitled Deeding Property to an LLC. 

Clients occasionally wonder if transferring property into an LLC is permitted if there is a “due on sale” clause in the lender’s deed of trust.  This is usually not a problem, since lenders seldom protest transferring real property into a personal company and, in any case, are far more concerned with loans that are in monetary default (see Due on Sale Clauses in Texas).

One factor that should be considered in deeding property into an LLC is whether or not the property is to be transferred with an assumption of the existing loan or “subject to” the existing loan (ie., the LLC does not take liability for the loan). This choice has accounting implications, ie., whether or not the company will in the future be carrying the loan on its books as a company debt. Most such transfers are “subject to.” An appropriate clause specifying assumption or “subject to” should be included in the deed.

The Homestead and Other Exempt Assets

It is neither necessary nor advisable to transfer a Texas homestead into an LLC since the homestead is already protected by the Property Code against forced sale or execution upon a judgment.  Homestead-exempt assets should be kept separate from investment assets.  We recommend a living trust to avoid probate on these assets. See our companion articles Living Trusts in Texas and Homestead Protections in Texas.

Use of DBA Certificates and Land Trusts

You may wish to file a “DBA” certificate in the counties in which you operate, showing the name under which you will be publicly doing business. This also promotes anonymity. For example, the name of your LLC as registered with the Texas Secretary of State might be “ABC, LLC.” The company’s DBA, however, might be “Wilshire Investments.”  Therefore, the face you show to the public should always be Wilshire Investments.  As a technical legality, Wilshire Investments cannot be sued since it is not a legal entity.  A claimant would have to research the DBA records to discover the true legal entity, which is of course ABC, LLC, and suit would then have to be filed against the company and service would be have to be made upon the company’s registered agent. 

It is also possible to create a land trust with the LLC as primary beneficiary. The trust holds legal title to some or all company property.  This introduces an element of anonymity - an important element in asset protection - that can make it more difficult for adversaries to identify the true owners.

Separating LLC From Personal Affairs

 An LLC is also a useful device for organizing your business, particularly in separating your business from personal affairs.  Failing to do this is a common mistake of novice investors and can create legal and accounting problems.  Running business income and expenses through your personal account may not be illegal, but it can complicate your defense if you are sued.  It will be alleged that you “commingled funds.”  Again, this may not always be contrary to law, but it will arouse the suspicion of the judge and jury and may result in your defense failing what trial lawyers call the “smell test.”  This sort of error can also result in your being held personally liable for damages.

You can open a company bank account as soon as you receive your Certificate of Filing from the Secretary of State’s office.  Most banks will open the account if your TIN has been applied for even if it has not yet been formally received.

State and Federal Taxes

An LLC differs from a conventional corporation in that it avoids “double taxation,” ie., taxation on corporate profits and then taxation again when dividends are paid to the owners.  Income passes through to the individual members of the LLC with only one taxable event.  In this way, an LLC is treated similar to a partnership for federal income tax purposes.  Your LLC will need to obtain a TIN (taxpayer identification number) using an SS-4 form (supplied with our company kit) or the TIN can be applied for online.  The TIN will be required to open a bank account for the LLC (although banks will often open the account if the application is pending).

Although Texas does not have a personal income tax, it does have a franchise tax (also called the margin tax) that is imposed on all “taxable entities.”   The statutory definition of a “taxable entity” can be found at Texas Tax Code Sec. 171.0002(b)(2), but it includes LLC’s.  The margin tax is basically a modified gross receipts tax, although some thresholds and deductions apply.  A franchise tax return must be filed annually. Go to the Texas Comptroller’s excellent website for more information: www.window.state.tx.us/taxes/. There is also a companion article on our website, Margin Tax in Texas.

LegalZoom-Style Internet Services

            Internet services allegedly provide “self-help legal services at your specific direction” and offer all sorts of documents, including LLC formation documents. This is internet huckstering. All LLC’s are not created equal, nor do they achieve equivalent degrees of asset protection.  At best, internet services provide a “plain vanilla” company with no bells or whistles. Here is what such services do not provide:
NO comprehensive advice on how to structure your business and investments so as to achieve an overall asset protection plan

NO serious knowledge of what a Texas Series LLC is (as opposed to the traditional LLC)

NO attorney to serve as organizer, initial member, and/or registered agent in order to maximize your anonymity

NO sophisticated company agreement that deters creditors from taking control of your company

NO advice on how to move property into the LLC after it is formed

NO advice on how to use the LLC in conjunction with a land trust

NO advice on how to set up and arrange the LLC’s finances, including setting up LLC accounts, injecting capital, and/or loaning money to the LLC

NO advice on how to maintain the LLC liability barrier to prevent a plaintiff from “piercing the corporate veil”

NO free follow-up questions after the LLC is formed

Additionally, the documents provided by such services are so simplistic as to be barely above the level of junk. This office spends a fair percentage of its time cleaning up the inadequacies in companies formed this way and offering asset protection advice that the client should have received from the beginning.   

Conclusion

Investors with multiple properties and/or businesses should consider forming a Texas series LLC.  It is recommended that you consult an attorney who will tailor his advice and documents to your individual investment and asset protection plan.  Questions relating to structuring an asset protection plan as well as follow-up questions on company formation are included in the legal fee charged by this office.  No internet service will do that.

For a summary of the core documents pertaining to LLC’s – the Certificate of Formation, the Minutes of the First Meeting of Members, the Company Agreement, and annual and special meetings - see our companion article on this site, LLC Documents in Texas. 

Attached to this article is a checklist that will help you assemble the information necessary to begin forming a Texas LLC.

Information in this article is proved for general educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences.  Consult your tax advisor as well. This firm does not represent you unless and until it is expressly retained in writing to do so.

THIS DOCUMENT IS NOT INTENDED TO BE USED, NOR CAN IT BE RELIED UPON, BY ANY TAXPAYER FOR THE PURPOSE OF AVOIDING PENALTIES IMPOSED UNDER UNITED STATE FEDERAL TAX LAWS. THIS DOCUMENT DOES NOT CONSTITUTE DOES NOT CONSTITUTE A TAX OPINION OR OTHER ADVICE TO WHICH CIRCULAR 230 IS RELATED.

Copyright © 2010 by David J. Willis.  All rights reserved worldwide. David J. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his web site, http://www.LoneStarLandLaw.com.