With the residential market continuing its surge, a number of people are turning to real estate as a way to diversify their investment portfolio. We are seeing more and more clients with a variety of legal issues related to the acquisition and development of rental properties.
One of the main questions that we hear is whether there is an overall benefit to using a limited liability company to hold an investment property. While LLCs can be a great way to limit any personal liability, it is important to consider a few different issues before taking that step.
Many real estate investors are drawn to using LLCs because they are easy to use, and they limit the exposure of any personal assets from claims related to the property. Unlike corporations, limited liability companies are fairly straightforward in their structure and allow for maximum flexibility for business and tax planning purposes. However, similar to corporations, LLCs provide their owners with a great deal of protection from various claims arising for the development and leasing of the property. As a result, holding this high-risk asset in a separate LLC can be ideal for individuals who want the benefit of simplicity while still providing that added layer of protection.
While there are certainly benefits in acquiring your investment property with an LLC or subsequently transferring into one, it is important to understand some of the less attractive aspects of that strategy.. First, you should consider how this method of ownership will affect your financing. When acquiring an investment property in an LLC outright, you may not qualify for the most favorable loan terms as compared to acquiring it in your individual names. As a result, you may be asking yourself why not acquire the property in your individual name and then subsequently transfer the asset into a newly formed LLC.
A subsequent transfer would likely violate the terms of your loan documents, allowing the bank to call the loan once they discover the change in ownership. As a result, it’s important to either consider loan terms available to LLCs, or obtain the consent of your lender before subsequently transferring your investment property into a holding company.
In addition to concerns over violating any due-on-sale clause, there are some other issues that you should consider before transferring an investment property into a newly formed entity. First, you will want to make sure that the transfer does not invalidate any insurance coverage on the property. If the existing policy is in the individual’s name, it’s important to communicate the change to the insurance advisor so that the policy can either be updated or a new one put in place.
Additionally, you will want to confirm that the deed transferring the property into the LLC will not be subject to state and county transfer and recordation tax. As a general rule, this tax applies to any deed recorded in local land records and is based on either the consideration or the unpaid principal balance.
However, state law provides certain exemptions from this tax for specific transfers. As a result, its always a good idea to consult with an attorney in order to structure the transfer in a way that one of those exemptions will apply and the deed will not be subject to those excessive taxes and fees. This attention to due diligence by an owner prior to transferring or acquiring investment property into an LLC, its important to have a sense of the initial and ongoing costs associated with forming and maintaining an entity with the State of Maryland. As with most filings, the State Department of Assessments and Taxation charges an initial filing for the organizational documents necessary to register the business with the State. Additionally, keeping your LLC in good standing will require an annual cost associated with filing a personal property return for the business.
In conclusion, we encourage our clients to consider all of the various issues when deciding how to own and operate an investment property. Utilizing a holding company is undoubtedly an effective way to limit your personal liability when you become more active in the real estate market. However, many investors do find that adequate protection can be secured through additional insurance coverage on the property and the business.
In any event, it is important to consult with an attorney to ensure that the proper steps are taken that will minimize your costs while securing the protection that you need to maximize the return on your investment.
Here at Liff, Walsh & Simmons, my colleagues and I have helped many business owners determine their best course of action in choosing a legal structure and tax classification. If you have questions about a particular employment law issue or would like more information, email me at jmcgowan@liffwalsh.com or call me direct at (443) 569-7389.
About Liff, Walsh & Simmons
Liff, Walsh & Simmons is a business law firm. We provide expert, responsive legal services to middle-market businesses, their owners, operators, and investors across the mid-Atlantic region. Our attorneys are subject matter specialists in business counseling, contracts and transactions, commercial and civil litigation, real estate, employment, banking and finance, real estate, land use, zoning, and estate planning and administration.
