By Scott Letourneau
Many of our real estate investor clients form an LLC to hold and manage their real estate in order to protect their other assets from liabilities or lawsuits that might result from their real estate investment. If the LLC is formed and managed correctly and there is a claim or lawsuit relating to the real estate, then generally only the assets owned by the LLC, and not the investor’s other personal assets, will be subject to the claim or lawsuit.
Many of our clients, considering today’s market, are upside down (the mortgage is higher than the value of the property) and still consider protecting their real estate investments. The reason being, if you own 2-3 properties outside of your residence, you are a target for a lawsuit, even if you have no equity. There are many who have lost everything financially and will be looking for alternatives, and lawsuits can be a financial game plan. Even with no equity, you may have an insurance policy they can collect from. That is a big part of the problem. I will point out that your home (or principal residence) is handled differently.
With that being said, here are the strategies and key points to consider when transferring real estate to an LLC to protect it.
Keep in mind, almost always, when you purchase a rental property for example, you will be closing escrow in your name personally with a personal guarantee. After the close of escrow is usually when you would transfer it to the LLC via quitclaim or warranty deed.
Here are some issues to be aware of when you do that.
Four Key points to be aware of when you own real estate and are considering forming an LLC to transfer the property into the LLC (called quitclaim or warranty deed). Typically, a title company would do this for you.
Due on Sales Clause: Your mortgage company can accelerate your loan if you change title. Meaning you purchased the property in your own name now you are transferring it to an LLC (a different name) the mortgage company can technically call the mortgage and you have to pay off the mortgage.
This really never happens as long as you continue to make the mortgage payment from the LLC and the owners are the same. Meaning you and your wife owned it before and now you and your wife are the members of the LLC. Plus most mortgage companies resell their mortgages.
Transfer tax-the county assessor may charge you a transfer tax for transferring title of the property (from you to the LLC).
Usually there is an exception if you (or you and your spouse) own 100% of the property before and answer the transfer there is NO tax. If you change title and add a new owner to the LLC that MAY trigger a tax. If you are not getting the response you want from the county assessor you can use this approach; The best way to test this is to ask, “is there a transfer tax if you transfer it to our living trust?” When the country assessor says, no that is an exception. Now you can say, “now that we have established that there are exceptions, are there other ones?
3. Reassessment for property tax purposes-if someone has held onto the property for many years by transferring it, that may trigger a reassessment for property taxes.
You should know from their local county if that is the case. Many times areas automatically reassess every few years and this is not a real concern. Exception is California (Prop 13) where the values have been frozen for many years and transferring property could trigger a huge reassessment for property tax purposes.
4. Insurance issues: When you go from owning a property in your own name to transferring it into an LLC, the insurance company may charge a higher insurance rate (with more coverage) for you as a landlord because they now look at you as a business. Sometimes the increase may be minor like $100 per year. The key is to make sure you communicate to your insurance company so if you have a claim in the future you do not give them a reason to not write you a check!
Meaning, if the insurance policy was made out to you because you owned the property and now transferred to an LLC but the insurance policy is not in the LLC is that a problem from the insurance companies point of view?
That is what you must find out!
The next step is to determine how many entities for your properties. The key is not to put all your “real estate eggs” into one basket. Meaning do not just form one LLC to hold five properties that represents 90% of your net worth.
If the LLC is sued directly by a tenant and you lose and your insurance company does not pick up the tab, you may lose 100% of your equity in that one LLC! That also does not mean you need five separate LLC’s for each property. The factors you want to take into consideration are the following:
The fair market value of each property.
The equity in each property.
The percentage of net worth the real estate as a whole represents.
The liability of each property.
Example; if you have two rental properties in Northern Wisconsin that are only $50,000 each and you only have $10,000 of equity and this is only 30% of your net worth, then one LLC is probably fine for both properties. Again, everyone’s risk tolerance is different. If that was 90% of your net worth you may want two LLC’s in Wisconsin.
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