LLC Mistakes – How to Avoid Them

For decades, the Limited Liability Company (LLC) has been an effective tool to shield your personal assets from apartment rental property liability. The State governments extend this protection to encourage investment, which, in turn, bolsters the economy and benefits society. LLC services

Fortunately, one of the important functions of our corporation and LLC laws are to insulate individual investors from personal liability, so that society and the general public good can be advanced. However, to obtain this shield of protection, business must be conducted in strict accordance with the LLC statutes. Below are some of the serious mistakes individuals often make when they attempt to set up their own LLC, or when they enlist the help of a discount legal document service, paralegal, accountant, or even a lawyer who does not specialize in LLC formation. (While the services of a tax accountant are of tremendous value, they are not typically performed from an asset protection standpoint).

LLC Mistake #1. Waiting to form an LLC until after a tenant has claimed an injury or initiated legal action against you. Unless the LLC is in place before a tenant makes a claim or takes legal action, you will receive zero protection for your personal assets should you form the LLC after the fact. It never ceases to amaze me how many clients call in panic, wanting to rush through the formation of an LLC after they have already been sued. At that point, it’s often too late.

LLC Mistake #2. Failing to properly transfer the rental property into the LLC at the time the LLC is created. An LLC provides asset protection for its owners only if the underlying rental property is transferred into and held by the LLC. This important step must be performed through the use of a Grant Deed or Quitclaim Deed, which must be properly worded and legally notarized. There are unfortunately many individuals who did not make the transfer or attempted this step on their own, through the use of a paralegal or document preparation service. If not done properly, down to the smallest detail, mistakes or omissions can easily lead to an accidental and unnecessary property tax reassessment. It can be very expensive to reverse a reassessment that was triggered by the client, who previously attempted to transfer their property without proper guidance. In hindsight, the makers of these mistakes wish they had hired an experienced LLC attorney from the onset.

LLC Mistake #3. Failing to open an LLC bank account and conduct all LLC business from this account. Some of my new clients previously formed an LLC, but continued to conduct all LLC banking transactions though their personal or DBA account. It is absolutely critical that all income generated by the LLC be deposited into the LLC account, and all LLC expenses paid from the LLC account. In the event of a lawsuit, the failure to keep LLC monies separate from personal funds will cause a judge to invalidate the LLC, thus allowing creditors to attack and seize your personal assets. Tenants must make their rent checks payable to the LLC and those checks must be deposited into the LLC account.

All LLC expenses, including, but not limited to, mortgage payments, insurance, taxes and maintenance, must be paid from the LLC account. In an emergency, it is possible to occasionally cover an LLC expense through the use of your personal funds, and subsequently write an LLC check reimbursing yourself. However, this should be kept to an absolute minimum. Further, your LLC should have a credit/debit card to facilitate small purchases for the property. If you utilize a management company/rental agency that collects rent under their name, the agency must forward the rental income to the LLC, not to you personally.

LLC Mistake #4. Forming a corporation for your rental property, rather than creating an LLC. In an attempt to save money, but without proper legal guidance, many individuals mistakenly form a corporation for their rental property. This is bad idea because a corporation generally does not provide as much asset protection as an LLC for this type of business. Also, corporations require more tax filings, as well as additional formalities, such as mandatory meetings and corporate minutes. Even if you subsequently wish to be taxed as a corporation, you can elect to have the IRS treat your LLC as an S or C-Corporation through the filing of the appropriate forms.

I have had many clients who paid a paralegal or legal document service to form an LLC or corporation for their business. Only later did they encounter serious problems and seek legal help, after the fact. Deep frustration sets in when they realize they paid significant money for useless or incorrect documents, as well as franchise taxes, and needed to start over from scratch.