If you own a rental property, you can transfer it to a limited liability company (LLC). You may already have an LLC or need to start one, but either way, there are benefits and drawbacks to putting a rental property into an LLC.
It’s also a process that needs to be done correctly to avoid legal issues. Lucky for you, this guide details all you need to know to successfully transfer your rental property to your LLC and the best reasons for doing so.
Benefits of an LLC for Real Estate Investments
The liability protection provided by an LLC protects you from personal liability if disputes arise over the property itself or if someone is injured on the property.
The LLC can also protect the property to an extent, as a creditor or lawsuit party cannot force the sale of the property to recover their funds. They can, however, place a lien on the property.
A corporation is also an option for your real estate business, but an LLC offers a tax advantage. LLCs are pass-through entities, which means the LLC itself is not taxed. Instead, income passes through the company to the owners or members, who then include that income on their tax returns.
On the other hand, a corporation is subject to corporate taxes, and dividends paid to shareholders are also taxed, referred to as double taxation.
Drawbacks of an LLC for Real Estate Investments
When you buy properties under your LLC, they will be in the LLC’s name and become assets of the business. However, financing properties in the name of an LLC is not always easy, and some types of loans, such as FHA loans, are only available to individuals.
Also, sometimes lenders charge higher interest rates for properties owned by a business. Finally, if you need to transfer the ownership of a property either from the LLC to you or from you to the LLC, it may trigger a due-on-sale clause in the loan, requiring additional financing.
Transferring Rental Property to an LLC
First, a transfer could trigger the loan’s due-on-sale clause if you have a mortgage on the rental property because you’ll essentially be selling your home to the LLC.
This means the LLC would likely have to pay the balance due on the mortgage loan – and presumably take out a new loan. It’s often challenging to get a loan for an LLC, so you first need to contact your lender to see if your LLC can qualify for the financing.
If you can get financing in the LLCs name, it will be a purchase transaction from you to the LLC when you close on the loan. This requires a deed transfer. The title company will handle the closing and transfer paperwork.
If you don’t have a mortgage on the property, you’ll need to transfer the deed yourself, but it’s best to do so with the assistance of an attorney.
There are two types of deeds – a quitclaim deed and a warranty deed. When you purchased the property, you most likely received a warranty deed.
A warranty deed ensures that the title to the property is free and clear of any other claims. With a quitclaim deed, you transfer the property without any warranty.
You should have your attorney prepare a warranty deed, as having a clear title will make it easier for you to sell the property if you ever need to.
The Operating Agreement
Hopefully, your LLC has an operating agreement in place, particularly if your LLC has more than one member. However, if you do have one, it will need to be amended with some provisions about the rental property or properties.
If you don’t have an operating agreement, you should draft one immediately, preferably with an attorney’s help.
Most states do not require an operating agreement, but it’s a very important document. It defines the ownership percentages of members and how profits and losses are distributed. Those are the most important elements of the operating agreement, but it should also include the following:
- Each member’s rights and responsibilities
- Management structure and roles
- Voting rights of each member
- Rules for meetings and voting
- What happens when a member sells their interest, becomes disabled, or dies
Since your LLC will now own at least one rental property, it’s also important to include provisions on how purchases and sales will be decided, who’s responsible for purchases, and how the value of the properties will be allocated to members.
If you already have an operating agreement, these provisions should be included in your amendment.
Your lease on the property will need to be amended to reflect that the LLC is now the owner of the property and the landlord. Of course, you can still manage the property as you normally would, but your lease must be in the correct name.
If you don’t change the lease, you could risk the personal liability protection offered by your LLC.
Placing your rental property under an LLC has several benefits, particularly personal liability protection. It’s a good idea to have an attorney’s help when transferring rental properties to your LLC to ensure all your bases are covered.
You’ll want to protect your property and assets, so your rental property business is poised for success.