Use of SMLLC to Hold Real Estate of a Public Charity

Many public charities accept various forms of appreciated assets, including real estate. By accepting real estate, the charity creates a major concern that any potential liabilities from the real estate may expose the charity’s other assets. Ownership of real property will subject the charity to all the liabilities of an owner, such as injuries arising from conditions on the property or the liability for environmental hazards. It is not prudent for a charity to accept a gift of real estate unless it can protect itself against such liabilities. The charity would require a thorough environmental inspection. In addition, to protect the other assets, the charity may consider the formation of a separate entity to hold the real estate. In some cases charities have formed Sec. 501(c)(2) and Sec. 501 (c)(25) title-holding companies. Under Sec. 501(c) (2), an exemption is granted to a corporation organized for the exclusive purpose of holding title to property and turning over the entire income it collects from the property (less expenses) to an exempt organization. Expenses include reasonable reserves for expected expenses and depreciation (Rev. Rul. 66-102). Each of the two types of title-holding companies is frequently organized as a shield against liability. Some charities form supporting organizations to hold real estate. A discussion of supporting organizations is beyond the scope of this item. However, the supporting organization regulations are complex and are enough to scare off many charities. One way to achieve a charity’s objectives is by using a single member limited liability company (SMLLC) to achieve the objectives of the charity. This approach differs from the traditional approaches. While it is simple and effective, it is still a new and relatively untested solution. Under this strategy, a charity will form a SMLLC for each parcel of real estate received by the charity, with the real estate placed in the LLC. Under Regs. Sec. 301.7701-3, an eligible entity with only a single owner can elect to be classified as a corporation or it can be disregarded as an entity separate from its owner (i.e., treated as a tax nothing). The charity would elect to treat the SMLLCs as a tax nothing. No Federal tax returns will be required by the lower-tiered LLCs. Rather, the results of the operations will be reported on the charity’s Form 990, Return of Organization Exempt from Income Tax. This structure avoids exposure of the assets of one project to the liabilities of another. The assets of the charity should not be exposed to the liabilities of each LLC. It is presumed that the real estate will go directly into the LLC to avoid the charity taking ownership of the property even for a minute. However, as a SMLLC is a tax nothing, the transfer of the real estate for tax purposes should be viewed as going directly to the charity and, therefore, resulting in a charitable deduction to the donor. This appears to be consistent with the fact that all tax results are reported on the charity’s tax return. An alternative approach would have the donor establish a SMLLC prior to the contribution to the charity. The donor first contributes the real estate to the LLC and then gives the LLC interest (not the real estate) to the charity. The donor should be entitled to the full charitable deduction, because the LLC interest was contributed to a Sec. 501(c) (3) organization. In this case, the donor has assumed the responsibility and cost of establishing the LLC, including any local transfer taxes. A SMLLC could provide some practical solutions to accepting real estate within a charity. Unlike a supporting organization that must file with the Service each time a new organization is established, a SMLLC has no such filing requirement. Moreover, it does not have the complexities of a supporting organization.