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LLC’s… One Solution For Real Estate UH OH’S!!!

February 1, 2012 Douglas Davis

[image_frame style=”framed_shadow” align=”left” title=”Chair on Dock”]/wp-content/uploads/2012/02/Rocking-Chair-at-Beach.jpg[/image_frame][dropcap4 variation=”red”]I[/dropcap4]t’s not uncommon for friends or business partners to get together and purchase a piece of investment property or even a vacation home with the idea of establishing a flow of rental income while also enjoying the appreciating value of the asset and deductibility of certain expenses.  Although the merits of that kind of investment have become more problematic as a result of the deep recession, many people are still making these purchases by pooling their resources, intellectual capital, and their abilities.

Most of us in this situation expend a lot of time and effort focusing on obtaining the right piece of property and weighing the financial commitment and reward.   We also tend to be optimistic, and forget to address the many things outside of our control that change the nature of the investment and the legal relationship with our partners.  For instance, ask yourself … what if:

  1. One of my partners divorces and their spouse ends up with an ownership interest in the property?
  2. One of my partners dies and their spouse inherits the property and then remarries?  Worse yet, one of their minor children ends up with an ownership interest?
  3. One of my partners experiences financial difficulty and is unable to continue contributing to the upkeep and expense of the property?
  4. One of my partner’s creditors attaches their interest in the property and tries to force a sale?
  5. One of my partners insists on selling their interest in the property and files a partition action in court?
  6. One of my partners dies, leaving his or her interest in the property to someone who is a total stranger?

These are a few of the problems we see on a regular basis.  Fortunately, there are a number of possible solutions.   One thing to consider would be that the partners establish a Limited Liability Company (LLC) to purchase the investment property, and  couple it with a well drafted Operating Agreement.  For example, the Operating Agreement could:

  1. include transfer restrictions specifically designating to whom a transfer of an interest can be automatically made, to whom a transfer may be made upon the vote of the members, and to whom transfers cannot be made;
  2. specifically set guidelines governing the amount that each member is to contribute toward the upkeep and expense of the property every year, and set forth specific consequences and remedies if payment cannot be made (i.e. loss of use and eventual relinquishment of membership interest);
  3. provide that a creditor could only obtain a charging order against that member’s interest and could not vote or require a sale of the interest or property.  The creditor could also be required to become responsible for the member’s share of the upkeep and expenses and lose the charging order if not paid.  There could also be a provision that compelled the sale of the interest to the remaining members at a reduced value;
  4. specifically set out how a member would be dealt with if they want to sell their interest, or in the event of their death.  The sale could be restricted so that only the remaining members would have the opportunity to purchase the interest based upon a particular formula valuation and methodology.   The agreement could also provide for payment over time in an installment sale;
  5. specifically provide for logistical concerns involving the use and occupancy or the allocation of responsibilities among the members.

With a well drafted professional plan unique to your situation, the unanticipated circumstances that all of us encounter during life can be dealt with in advance and the UH OH’s of an investment opportunity can be significantly reduced.