LLCs give us asset protection through the laws of each state, that say creditors may not generally attach or seize a debtor’s assets where those assets are held in an LLC (as long as the LLC has nothing to do with the debt or lawsuit at hand). So in a situation where you’re being sued personally for something, or you’ve got a business that is in trouble, it’s an effective way to keep your home and other personal assets out of the way of those claims.
SMLLCs also became popular as personal asset protection entities several years ago. Basically you retitle your home or personal into an SMLLC, which you keep maintained. If anyone sues you personally, the LLC protection kicks in for your personal assets. There isn’t a tax return obligation because you aren’t paying yourself to live in your own house – so there’s no income or expenses moving through the LLC. That means no tax return is required.
Even better is that the IRS came out with a revenue ruling back in 2003 that allows you to keep all of the tax deductions associated with home ownership, like mortgage interest deduction.
Plus, if you’re operating rental real estate through a SMLLC, the SMLLC can report income or loss on your personal tax return, on either Schedule C or E, depending on the income flowing through it. Bottom line, a SMLLC should be cheap, effective asset protection.
It was a pretty solid asset protection strategy until a bankruptcy court in Colorado ruled that a debtor couldn’t protect personal assets in an LLC from a personal bankruptcy. Then came another ruling, where the IRS was able to break through the legal protection and hit up a business owner for unpaid business taxes. Now we’ve just seen a Florida case where a court ruled the government (in this case the FTC) could reach into several SMLLCs that were owned by a couple convicted of operating a credit card scam that had defrauded thousands. And of course, it won’t protect you from a mortgage holder, if you buy a property and then transfer it into an LLC.
So is there any reason to continue with SMLLCs? I think you could make an argument that there is.
None of these cases have involved a third party – someone who falls down on the property and tries to sue the owner, or someon who’s taking a run at you for some reason, because it looks like you’ve got a nice asset portfolio and can afford to defend or pay off a frivolous claim.
However, it’s definitely an area to proceed in cautiously. You’ve got to understand the limitations of an SMLLC, and weigh that against what your plans for the LLC are. It’s also something to talk to a local attorney about. Local attorneys will have the inside story on how their courts are upholding (or not) SMLLCs and in what circumstances.