Considerations for Transferring Ownership to a Limited Liability Company
Many business owners and professionals make investments in rental real estate or commercial office buildings. Despite the potential economic benefits, owning real property in your own name can create personal liability. Limited liability companies, or “LLCs,” are increasingly being used as an alternative for real estate ownership.
An LLC has many of the characteristics of both a partnership and a corporation. Like a partnership, the LLC’s income (or loss) is passed through to its owners (referred to as “members”), who pay the income tax. Like a corporation, an LLC offers limited liability protection to its member(s). An LLC can be owned by only one individual, (which makes it an attractive alternative to a sole proprietorship), or by multiple parties (in which case a partnership tax return is usually filed).
Why Own Real Estate in an LLC?
An LLC offers limited liability protection to its members. If an individual owns real estate in their individual name, all of their assets are subject to the liabilities that arise from that ownership. If someone is injured on the property, the owner could be liable for that injury and the owner’s other assets may be available as a source of recovery for that individual. However, in the same situation, if the real estate is owned by an LLC, and the members have maintained the formalities and complied with LLC rules, the injured person is limited to recovery of the assets owned by the LLC, not the member’s personal assets. The LLC allows its members to build a “fence” around the liability associated with the investment real estate so that the injured person cannot reach the member’s other personal assets.
Ownership by an LLC Can Make a Difference in Many Situations
In the event of death, divorce, or incapacity of the property owner, subsequent legal proceedings can make property management difficult and expensive, and often require court supervision and approval. In these circumstances, LLC members can appoint a manager, such as a fellow owner, or member of a younger generation, to help manage the property. An LLC also has the characteristic of continuity of life for the organization. If there is a change in the LLC’s membership, there is no need for new leases or disrupting tenants.
Many investors own real estate in common with others without management agreements or buy-out arrangements in place.
This often results in deadlocks, valuation disputes and disagreements with spouses and heirs. When this happens, the real estate may have to be sold at an inopportune time. LLC documents provide for buyout, transfer and valuation formulas, as well as clear management authority upon which banks, tenants, third-party creditors and others can rely on.
Third party claims are another factor to consider. Creative plaintiffs (and their attorneys) are always looking for ways to expose real estate owners to hazardous property, civil rights, landlord-tenant and Americans with Disabilities Act claims. These claims can often exceed the value of the property. While the protection of an LLC is not absolute, LLC owners have a better chance of avoiding personal liability than individual owners, co-owners or general partners whose personal assets are fully exposed to creditors’ claims.
Limitations to LLC Ownership
There are some limitations for LLCs, which vary by state and is based on statutes and case law. Oregon’s case law, for example, allows an entity’s’ limitation of liability “to be pierced” where the entity is severely undercapitalized. In addition, no entity, including an LLC, can protect real estate owners from the strict liability of environmental laws, unless the owner was “purely passive” and not involved in management of the property at the time of the contamination. An LLC is never a substitute for an environmental review, good management or adequate insurance and safety practices.
A LLC is an attractive vehicle for reduced risk and prudent real estate investment. Real estate owners should take advantage of these entities to protect their personal assets from potential claims.
