How to Transfer Your Rental Investment Property to an LLC
Transferring your rental property to an LLC is one of the major considerations for Fayetteville, NC property investors. The biggest concern of all, minus the tax benefits, is whether or not the LLC will protect you from personal liability.
Personal liability for your rental property comes in two forms: contractual and tort liability.
Properly forming and LLC, and proper business practices relating the the LLC for your rental property, has the ability to protect you from personal liability in both situations.
You must, however, follow the steps for the proper transfer of your rental property to an LLC to be afforded with all of the protections of the LLC.
Seven Steps to Transfer Your Property to an LLC
1. Contact Your Lender
2. Form the LLC
3. Obtain a Tax ID Number and Open Your Bank Account
4. Obtain the Necessary Deed Forms
5. Sign and Record the Deed
6. Amend Your Lease
Step 1 How To Transfer Your Rental Investment Property to an LLC: Contact Your Lender.
Contacting your lender serves a very necessary purpose when transferring your rental investment property to an LLC. If you fail to notify your lender, they could make you pay the full amount of your loan within 30 days.
Most lenders include in the loan agreement, that the transfer or sale of the property triggers full payment of the remaining loan balance.
This is usually referred to as “calling the note due.”
Even though you may own 100 percent of the LLC, when you transfer your property to an LLC, you are potentially triggering the clause.
While there are some who say “the bank won’t care as long as the loan is being paid,” there have been many instances when financial institutions have in fact called a note due.
And to be honest, do you want to be the test dummy to see if the “do it sayers,” are in fact right?
We wouldn’t.
The good news is that some banks will allow you to transfer your rental investment property to an LLC if you remain financially liable, or a guarantor of the loan. Fannie Mae is one of them.
This means that you can’t just walk away and not be financially liable for the loan.
We know this may not be your ultimate goal, but it is a good step towards legally transferring your rental property to an LLC.
You can take the steps necessary to remove your personal guarantee down the road, but we aren’t going to discuss that right now.
While you may not be afforded the umbrella protection, by transferring your rental property, with the banks permission, you will still have personal liability protections under your LLC. You just won’t have contractual protections as it pertains to the bank note.
It is important to note that, even if you flew under the radar, and transferred your property to an LLC without the bank’s knowledge, you may negate the personal liability protections of an LLC.
Why you ask?
Because, when a court examines everything, including your LLC’s formation documents, operating agreement, bank accounts, and other documents, the fact that your LLC is guaranteed by you personally, will give strong weight to the fact that you are operating the LLC as an alter ego.
Although this isn’t the sole determining factor, and is one of many.
When you have an above the board agreement with the bank, and all you are is a guarantor, while you are still financially responsible, it is possible the court can still rule that there is a separation, and thus, the LLC not you are liable, for personal tort liability.
In other words, you are operating like a business, and not trying to be shady.
Step 2 How To Transfer Your Rental Investment Property to an LLC: Form the LLC.
The next step to transfer your rental investment property to an LLC is to actually form the LLC. Although you may have already done this step.
Forming the LLC varies by state, so you should check with your separate state to see what the requirements are.
The usual practice, however, is to go online, and fill out the required form and information including, the name of your LLC, an address and other contact information, select a registered agent (this can be you or another party), and pay the filing fee.
The process for this step is rather simple, and does not necessarily have to involve the use of an attorney, but it is up to you if you decide to use one.
Another key component of the LLC is the operating agreement. The operating agreement provides the basics of who the managers and members are of the LLC, how the LLC will operate, and how it will disburse funds and profits.
The operating agreement is important, because it also one of the key determining factors as to whether your LLC will be treated as a separate entity, or if it will be seen as an alter ego of yourself.
In the latter determination, your LLC will lose all the protections afforded to it, and you will be held personally liable.
Although we stated that you don’t necessarily need an attorney to file the LLC with the state, we recommend that you do seek legal counsel for the operating agreement, depending on your potential financial exposure.
Step 3 How To Transfer Your Rental Investment Property to an LLC: Tax Identification Number and Bank Account.
One of the most important determinations a court will make when determining if your LLC is a separate entity, is looking at whether or not funds are comingled.
By far, with the operating agreement and acting inconformity with it, this is one of the biggest areas by which may rental investment property owners get caught up.
If you truly want to have your bases covered, and want the full protections of transferring your rental investment property to an LLC, we highly recommend that you obtain a tax identification number, and a separate bank account.
These two documents do not, in and of themselves, establish that you are a separate entity, but they do hold a lot of weight.
The tax identification number gives the LLC identification data that is used to tax it as a separate entity. If you attach your personal security number to your LLC, then you are the LLC.
The bank account demonstrates that you understand that your funds should not be comingled, and that the money going into and out of this bank account, is used for the benefit of your LLC under the conditions set forth in your operating agreement.
It is important to note that your tax identification number should also be the one that is attached to your bank account. You SHOULD NOT attach your personal social security number to the business bank account.
You could be doing everything correctly, but at the end of the day, if you attach your personal social security number to the LLC’s bank account, this provides an additional data point against your rental investment property LLC being a separate entity.
Also, if you plan to collect security deposits and rental income for your property, we recommend you set up another bank account as a trust account. All money that belongs to tenants should first be deposited into the trust account, and then distributed to the relevant parties at the times set forth in your lease agreement.
Remember, again, that any money provided to members or managers of your LLC should be distributed according to the operating agreement.
There is no prohibition against you transferring money from the rental investment property LLC, but how you do it should be in conformity with the operating agreement.
Last, remember to have proper accounting of every penny that flows in and out. Where it came from, and where it went.
Step 4 How To Transfer Your Rental Investment Property to an LLC: Obtain the Necessary Deed Forms.
Obtaining the proper deed form is the next step in transferring your rental investment property to an LLC.
You can get the forms necessary to transfer your rental investment property to an LLC from the county recorder’s office, or off the internet.
There are two types of deed forms that are generally used to transfer your rental property to an LLC. These forms are the commonly known Quit Claim Deed, and a Warranty Deed.
As a real estate investor, it is important for you to understand what these two types of deeds mean, and what they don’t mean, when transferring your investment property to an LLC.
The Quit Claim Deed
In essence, a quit claim deed means that you are transferring the property to another person or entity, without the guarantee that you own the property with a clear title. What this means is that you are not providing a guarantee against any liens and encumbrances, and the transferee is accepting this with full knowledge that someone may assert a higher claim.
The quit claim deed does not provide you with a guarantee that you actually own the property, or that the title is good.
The Warranty Deed
A warranty deed, on the other hand, sets forth that you are providing the property free and clear of any outstanding liens, encumbrances, mortgages, or any other form of superior stake or title. What this means is that the new owner rightfully owns the property.
When you purchased your investment property, the seller more than likely provided you with a warranty deed.
Which Deed Should You Choose
If you ask 10 experts which deed is best for you to transfer your rental investment property into an LLC, you will get 10 different answers.
Warranty deeds are generally used to transfer real property between the buyer and seller who are unrelated (in the business and personal sense).
While many real estate investors transfer their property to an LLC by way of a quitclaim deed, a warranty deed could be used to transfer your property because it provides the LLC with some remedy in the event there is a defect in the title. A warranty deed also preserves the property chain of title.
One of the glaring problems with transferring your rental investment property to an LLC via a warranty deed, when you have financing on the property, is that you cannot provide the guarantee because there is a loan attached.
While this may be of no consequence to you when you are a sole member LLC and you are transferring your rental investment property from you to your LLC, there is still an added consideration.
Courts may view the fact that you transferred the LLC, without a proper guarantee, with full knowledge that the transfer was merely a shame.
In other words, you provide another entity, your LLC, with a guarantee that you knew wasn’t valid, and in fact the LLC is an extension of yourself. No other person and entity would accept the transfer if they knew it wasn’t valid.
With the quit claim deed, you aren’t providing a guarantee, you are merely saying here is the title.
While these two scenarios may seem almost similar, legally, your best option might be to just go with the quitclaim deed.
Step 5 How To Transfer Your Rental Investment Property to an LLC: Sign the Deed Form and Transfer Title
Although states vary in what is required to record your deed, generally you are going to want to use your full name on the form, as well as your LLC’s full legal name. The LLC’s legal name is not the same as your Doing Business As, or DBA, name.
The transfer of your rental investment property to an LLC may also require you to annotate a monetary amount for the transfer. In contract terms, this is known as consideration.
The amount necessary for consideration may vary by state, with some state requiring no consideration for a transfer. It is best that you look up the amount necessary on the internet, or consult with your county recorder to determine how much money you have to transfer.
Another important note about the amount of consideration. We recommend that you transfer your property to the LLC with a meaningful monetary amount. We say this because, some courts may view the amount as a sham amount, and you are simply paying money to hide your alter ego.
This might be a bit of a stretch so long as you are following all of the other requirements under the law, but our thought process is to play it safe rather than be sorry. We may be a bit overly cautious at times, but it never hurts to be.
The amount of consideration doesn’t have to be an astronomical amount, just don’t make it a $1 transfer.
Finally, you need to sign and record the deed.
Signing and recording also varies by state, and even county sometimes.
You may be required to sign the deed in front of a notary. Don’t worry about bringing one because the clerks and some other officials at the courthouse are usually notaries.
You may also be required to have a “living person” sign on behalf of your LLC. What this means is that, although you are transferring your rental investment property to your LLC, you need to sign the document as the grantee in your official position in the LLC. For example, you will sign as John Smith, President, ABC Investments, LLC. You wouldn’t sign simply as ABC Investments LLC.
Once you have signed the deed, You will then officially record the deed to create a record of the transfer of property. This simply means you are creating a record by submitting the deed to the registrar of your county.
Now you have officially transferred your property to your LLC.
But there one additional step we recommend you take.
Step 6 How To Transfer Your Rental Investment Property to an LLC: Amend Your Lease Agreement to Reflect the Transfer
Once you have completed steps 1-6, we recommend you change any lease agreement to reflect that the LLC is now the landlord.
Again, this goes to creating a separation between you, and your LLC for your rental property investment.
You should have included a clause in your lease agreement that you can transfer the interest in your lease with the tenant. Although it is not overly concerning if you don’t have it in, it makes the process a lot easier.
In the amended agreement there are a couple of key points you should make sure you change:
1. Rent payments should be made to your LLC.
2. Any fee and penalties should be made to your LLC.
3. Any money transmitted should be to the LLC bank account, or trust account, whichever is relevant.
4. Any complaints, maintenance concerns, etc, should be directed to the LLC.
5. All communications should be made to John Smith at ABC Investments, LLC.
All of this is necessary to provide the evidence that your LLC is, in fact, a separate and distinct entity from you.
Wrapping Everything Up for the Transfer of Your Property to an LLC
Following the steps outlined in this guide will put you on the path to ensuring when you transfer your rental investment property to your LLC, you are afforded the maximum protections your LLC allows under law.
As a real estate investor, you don’t want to be caught in a situation where you thought you did everything correctly, but end up with an LLC that is not worth the paper that formed it, and you are now personally liable for anything that happens.
The property transfer is a big part of the strategy necessary to gain protections for your LLC.
It is not the end all.
There are additional considerations for you as a property investor to ensure you receive maximum protection, such as having the right type and amount of business insurance.
If you have any questions, or need help with the necessary documents for your LLC, please don’t hesitate to reach out to us.
As the only property management company in Fayeteville, NC owned by a military attorney, Linchpin Property Management is in the best position to help you with your investment property LLC formation.
Let us know if you need assistance.
The Team at Linchpin Property Management.
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