Investing in U.S. real estate is still one of the best investment opportunities that are loaded with tax advantages. The key is to make sure your real estate is protected, beyond just having insurance.
When investing in U.S. real estate it is important to make sure you protect your investments properly. The challenge is real estate has a few technical issues that need to be addressed if you are going to use LLCs for protection.
Here are important real estate strategies to protect your investments:
- Never own U.S. real estate in your own name, personally (long-term), unless your primary residence. If you have a mortgage, you will have to typically close escrow in your own name personally, then quitclaim or warranty deed it to an entity (typically an LLC).
- Do not put all your “real estate eggs” in one basket. If you have four triplexes worth $500K each, that is $2-million of real estate, and if the properties are free and clear (no mortgage) by putting the real estate into one LLC, you are exposing all the equity to a lawsuit by any one of the properties.
- You may need 2-3 entities to protect your real estate investments.
- An LLC (limited liability company) makes the most sense as an entity to protect U.S. real estate (not a Corporation, because of double taxation). The LLC would either be a two-member LLC taxed as a partnership or a single-member LLC taxed as a disregarded entity.
- If you live in California, for example, and you own property in Florida, if you form a Florida LLC to own that property, California will require that the Florida LLC register to also do business in California. You have nexus (or a business presence) where you are doing the work (checking your bank balances, transactions) and where the physical property is located.
- You will need a separate bank account in the name of the LLC.
- You will need a separate EIN number for each LLC.
Overall, investing in U.S. real estate is a great opportunity. The key is to work with a company like NCP, experts who can provide you with the steps, resources, and tax and legal support tools to make this a turnkey experience for you!
Q: How do I protect my real estate investments?
A: 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 an 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.
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 for protecting real estate when transferring it to an LLC.
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. You would typically transfer it to the LLC after the close of escrow, via quitclaim or warranty deed.
Here are important real estate issues to be aware of before transferring to an LLC.
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 the title. When you purchase the property in your own name and then transfer it to an LLC (a different name), the mortgage company can technically call it a mortgage and make you pay off the mortgage.
This rarely 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 the 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 after the transfer. In that case, there is NO tax. If you change the 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 we transfer it to our living trust?”
When the country assessor says, “No, that is an exception,” you can say, “now that we have established that there are exceptions, are there other ones? See this list of transfer tax exceptions for properties in Nevada.
- Reassessment for property tax purposes-if someone has held onto the property for many years, transferring it that may trigger a reassessment for property taxes.
The local county will tell you if that is the case. Many times, areas automatically reassess every few years and this is not a real concern.
The 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.
- 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 close to 2/3rd higher so it makes sense to shop around with insurance providers. The key is to make sure you communicate to your insurance company, so if you do have a future claim, you do not give them a reason to refuse to write you a check! If the insurance policy was made out to you because you owned the property, and now you have transferred it to an LLC, but the insurance policy is not in the LLC’s name, is that a problem from the insurance company’s 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 represent 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 number of properties you own
- The equity in each property
- The percentage of overall net worth the real estate represents.
- Your risk tolerance. Usually, older couples have less risk tolerance vs someone in their 30’s. You likely don’t want to lose all your equity and start over
Example: if you have two rental properties in Northern Wisconsin that are only $75,000 each, with $10,000 of equity, but this only represents 30% of your net worth, then one LLC is probably fine for both properties. If you have three properties in California with $500K in equity in each and the $1.5 million presents 90% of your net worth, two if not three LLC may make sense (even with the $800 per year franchise tax fee per LLC). Again, everyone’s risk tolerance is different.
Finally, if you need funding from the equity in your own properties, usually you will need to transfer the property back to your name or living trust, refinance, and after transfer back to the LLC for protection.
Is it easier at the end of the day to load up on insurance and not do anything, yes, but at the end of the day, the more you have and you want to keep it, the more complex the steps and structure? The goal is to work with a team to simply your plan for you.