Question: My accountant says that I should form a parent LLC that will own subsidiary LLCs to reduce the administration headaches and expenses. Should I have a parent LLC own three other LLCs that each own a rental property?
Answer: It depends on your risk tolerance.
A lot of people ask me what I think about the parent – subsidiary entity structure. This structure exists when one LLC (the parent LLC) owns one or more other LLCs (subsidiary LLCs).
Most people understand that maximum asset protection requires that you put one real estate property or one business in an LLC that owns no other property or operates no other businesses. We all know what happens if you put all your eggs in one basket and drop the basket – you lose all your eggs. The primary reason to put real estate properties and businesses in separate limited liability companies is so that a financial problem with one does not affect the value of any other properties or business.
There are several disadvantages with owning multiple entities. They are more expensive to create and operate. The administrative burdens such as bookkeeping and tax returns are multiplied. You need a separate bank account for each entity. Multiple entities are more work and cost more than a single entity.
Some people create a parent – subsidiary entity structure to reduce the burdens of owning and operating multiple limited liability companies. The parent – subsidiary structure exists when multiple entities (the “subsidiaries”) are owned by a single entity (the “parent”). Many accountants recommend the parent – subsidiary structure to reduce administrative burdens and costs. Some people create this structure when they own a lot of LLCs that have rental real estate properties and want to have a parent LLC that is a property management company.
The problem with the parent – subsidiary structure is that you are taking your carefully and expensively created separate entities that you formed to maximize asset protection and putting them all in one basket. If a creditor sues the parent and gets a judgment against the parent, the creditor can reach all of the parent’s non-LLC assets, but if the subsidiary LLCs are Arizona LLCs the creditor can only serve a charging order on every subsidiary entity. The charging order would require the subsidiary LLCs to make all future distributions of money or property to the creditor instead of to the parent LLC.
You may think the risk of having a claim brought against the parent is low, but it may not be. For example, if you are driving to meet a prospective tenant who wants to rent a home owned by LLC #1 and you run a red light and kill or injure somebody, you and the parent and LLC #1 will be sued and you and the two LLCs will be liable. If the judgment exceeds the parent’s insurance coverage, the creditor will take everything the parent owns until the judgment is satisfied.
If you are contemplating the parent – subsidiary entity structure, you will have to decide, which is more important: (i) maximizing asset protection, or (ii) minimizing administrative burdens or expenses.
P.S. If you do have a parent – subsidiary structure, make sure that your insurance coverage is adequate.