Purchasing an investment property as an individual that you plan to transfer to your LLC later can have a ripple effect on your liability and property taxes.
Q: I own a limited liability company (LLC) that holds some rental properties free and clear. The commercial lenders I speak with aren’t interested in a loan smaller than $750,000, and that is way more than I need. Hard money lenders are interested, but the rates and terms are prohibitive.
There are lenders that I have talked to that would lend me money but want the property to be in my name and not in the name of the LLC. So I would transfer the property into my name for the closing and then back to the LLC the same day. Is that a taxable event, and could you recommend another alternative?
A: We’ve answered many columns over the years about holding real estate investments in an LLC. For some people — hard core real estate investors — LLCs are a must. For many others, LLCs limit those real estate investors abilities to obtain financing on favorable terms.
When you buy investment residential real estate, you have a choice of lenders. Let’s say you’re buying a single family home to rent out and the home is selling for $300,000, you can go to a commercial lender to get a loan. That commercial lender’s interest rates, fees and terms will be less advantageous generally than residential lenders.
So, if you decide to apply for a loan with a residential lender, you may get terms similar or the same as most home buyers. The rates will be low, and the fees will be comparable to the fees that most every homebuyer pays. But, the residential lender will require that the residential investment property be owned by a person and not by a company, corporation or other type of entity.
Well, if you can’t own the real estate in an LLC, you then need to make sure you have good insurance coverage for liability issues just in case someone gets hurt on one of your properties. When you own a property in an LLC, you insulate yourself from liability coverage — or at least you hope you do. If something happens on the property, the owner is the LLC, not you. If the loss is huge, you might lose the property but the loss shouldn’t affect your other personal assets.
In reality, you should have good insurance in either case. If you have a great loss, the litigation expenses alone could cost a fortune and that expense will be there whether you own the property in your name or in the name of the LLC.
If you have liability coverage of only $300,000, that might not be enough to cover you for a disaster. But if you have liability insurance coverage of $5,000,000, that should take care of just about any issue other than those extraordinary issues that might occur, but rarely ever do.
If you have the property in your name with a policy that covers you for $5,000,000 or more, you should sleep soundly at night. Sam has some clients with larger buildings that might have an umbrella policy with liability coverage of $25,000,000 or more. Depending on what types of properties you own and the risk involved and the costs involved, you can decide how much coverage is right for you.
The benefit of having the properties in your name are the savings you’ll realize by obtaining financing at cheaper rates, and finding residential lenders willing to give you small loans and big loans.
Now, if you go the route of taking the property in and out of the LLC, you may find that taking the property out of the LLC could be a “sale” for IRS purposes and could cause you to pay taxes on that “sale.” You’ll have to talk to an enrolled agent, accountant or tax advisor to determine what your circumstances are and whether it would trigger any taxes. It’s beyond the scope of this column to try to come up with and then resolve the many layers of complexity that could cause the transfer to be a “taxable” event for IRS purposes.
Suffice to say, that you might find other issues arise if you take the property out of the LLC’s name and put it into your name and the back into the LLC. Some municipalities charge high fees to make these transfers. Other taxing bodies take the opportunity when title transfers to redetermine the “value” of your property for real estate tax purpose.
So, you need to be careful and understand that the IRS may not be the only issue you need to be concerned with when you start transferring title in and out of an LLC.
Finally, residential lender documents will state that if you “sell” the property or convey your property, the lender has the right to call the loan. While the lender may not take that action, you need to be aware that the lender would have the right to say that you are in default under the loan when you transferred title from your name back into the name of the LLC.
Good luck, and be sure to have a conversation with your accountant, tax attorney or enrolled agent before making this decision.
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