How to Protect Your Assets:
Living Trust vs. LLC
By Michael K. Elson, Attorney at Law
Many of my clients ask me whether the Limited Liability Company (LLC) or the Living Trust will better protect their assets. The answer is that 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, and prevents court control of your assets if you become incapacitated.
The LLC is a legal entity, much like a corporation, but with fewer formalities and receives favorable federal tax treatment as either a partnership or sole proprietorship. Operating your business venture or holding title to investment properties through an LLC limits the liabilities of those businesses to the assets held within the LLC. Consequently, the business owners are insulated from personal liability; your residence, bank accounts, vehicles and other investments are shielded from lawsuits.
LLCs are favored by investment property owners for a number of reasons:
- 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 the 3 1/3 withholding on sale of real estate
- Singlemember LLCs do not require a federal tax return
- The deductible $800 annual state franchise tax on LLCs is small compared to the huge benefit it provides
- Transfer of rental property to the LLC is exempt from reassessment if done correctly
- The LLC provides its owners lawsuit protection from tenants, managers, and workers, and helps alleviate insurance exclusions such as mold and lead paint
The Living Trust is a legal instrument that holds title to a person’s personal assets, including bank accounts, real estate, stocks, LLC membership interests, etc. The Living Trust contains your instructions for the distribution of your assets after you die. Because a person’s assets are transferred to their Living Trust during their lifetime, probate is avoided entirely. After the person who established the Living Trust (the Trustor) dies, the successor trustee(s), who are usually the adult children or relatives of the Trustor, simply distribute the trust assets to the designated beneficiaries. Because the Living Trust eliminates probate and, under a variety of circumstances, can greatly reduce estate taxes, it may be possible to pass on a much greater portion of your assets to your heirs. The Living Trust, unlike an LLC, however, is not designed to protect personal assets from exposure to lawsuit liability.
Living Trusts are favorable because:
- Probate entails public court proceedings which can last two years or more; whereas trusts are private and can be administered very quickly which your heirs will greatly appreciate
- The individual(s) who set up the trust are the trustee(s) during their lifetime and have full control over the trust assets, including the power to easily change or revoke the trust
- The trust for a married couple can be designed to maximize the estate tax exemption, which can result in a savings to the heirs of almost one million dollars in estate taxes
- The trust does not cause a change in income taxes; tax filings remain exactly the same throughout the life of the Trustor
- The trust can hold ownership interest of an LLC, so that the LLC and its assets will avoid probate
- Living Trusts can be established for individuals, or as a joint trust for married couples, bringing all of your assets together under one plan
In conclusion, the LLC and Living Trust work together to protect and preserve your 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 the tremendous advantages of these legal instruments, they are frequently utilized by real estate investors for the benefit of themselves and their heirs.