By Michael K. Elson, Attorney at Law.
Many clients ask whether a Limited Liability Company (LLC) or Living Trust better protects their assets. The LLC is designed to protect your personal assets from lawsuits, while the Living Trust preserves your estate from probate costs and inheritance taxes when you die.
The LLC — a liability barrier
The LLC functions as a legal entity similar to a corporation but with fewer formalities. Operating a business or holding investment properties through an LLC limits business liabilities to assets within the entity, insulating owners from personal liability and shielding residences, bank accounts, vehicles, and other investments from lawsuits.
LLC advantages for investment property owners
- Legal title of rental property is held by the LLC.
- Tenants' rent checks are payable to the LLC.
- When eviction is necessary, the LLC is the plaintiff.
- LLCs can utilize 1031 exchanges.
- Multimember LLCs are exempt from 3⅓% withholding on real estate sales.
- Single-member LLCs do not require a federal tax return.
- The deductible $800 annual state franchise tax is small compared to the benefits provided.
- Transfer of rental property to the LLC is exempt from reassessment if done correctly.
- The LLC provides lawsuit protection from tenants, managers, and workers.
The Living Trust — a probate avoidance vehicle
A Living Trust is a legal instrument that holds title to personal assets including bank accounts, real estate, stocks, and LLC membership interests. The Living Trust contains instructions for asset distribution after death. Because assets are transferred to the trust during the trustor's lifetime, probate is avoided entirely. After the trustor dies, successor trustees — usually adult children or relatives — simply distribute trust assets to designated beneficiaries.
Living Trust advantages
- Probate involves public court proceedings lasting two years or more; trusts are private and administered quickly.
- The individual(s) who establish the trust serve as trustees during their lifetime with full control and power to modify or revoke.
- For married couples, the trust can be designed to maximize estate tax exemptions — potentially saving heirs nearly a million dollars.
- The trust does not affect income taxes; tax filings remain the same throughout the trustor's life.
- The trust can hold LLC ownership interests, allowing the LLC and its assets to avoid probate.
- Living Trusts can be established for individuals or as joint trusts for married couples.
How they work together
In conclusion, the LLC and Living Trust work together to protect and preserve assets. They can be created at the same time or independently of one another, and both can be modified or dissolved at any time by the owner. Given their tremendous advantages, these legal instruments are frequently utilized by real estate investors for themselves and their heirs.
The cleanest setup is often the living trust as the owner of the LLC membership interest — giving you both liability shielding during life and probate avoidance at death.