If you are a titleholder of rental property, a question you should ask yourself is if it is more prudent to be considered the individual owner on record of the property or if it would be more beneficial to form a limited liability company (LLC) and transfer the title of the property into the LLC. There are pros and cons with deciding on whether or not to use an LLC. Always be sure to contact an experienced real estate attorney before proceeding with any legal maneuvering so you are provided with a full scope of information and understanding of both Federal and New York State law. Contact us at 917-567-1963 with any questions you may encounter when it comes to LLCs and real estate.
In this guide, we will go over what an LLC is, how an LLC can be formed, and what the common benefits are of having your investment or rental property in an LLC. Finally, we will also address the process of transferring your title into a limited liability company.
Let’s begin!
What is an LLC?
An LLC is a legal entity that is otherwise referred to as a limited liability company. With an LLC, a company is separate from the owner. As a sole proprietor, you are the company. The biggest advantage to forming an LLC is the benefit that any liability which the LLC incurs cannot be passed on to the owners. As an example, if you own a store that is in an LLC, and someone breaks their leg in your store due to a slip and fall accident, that individual can only recover the assets that are within the LLC – they cannot go after your personal assets.
If you are a sole proprietor, and someone gets injured on your business property, your personal assets such as your checking account are exposed to a lawsuit.
From the perspective of taxes, an LLC is viewed very much like a sole proprietorship or partnership where in both cases, whatever net income ( income minus expenses ) remains, it is passed onto your individual tax return (Form 1040), and taxes are paid on the individual level. This is another significant benefit with LLC’s compared to forming a corporation. A corporation is subject to double taxation, both on the corporate level and individual level. An LLC is considered a passthrough entity meaning all tax consequences are passed through to your 1040.
Let’s make a list of pros and cons so you know what you are getting into before starting an LLC.
Pros of an LLC
- As mentioned previously, members of an LLC are not liable to legal actions against the company. Your car, checking account, and house are not exposed to lawsuits.
- Filing taxes are generally easy since everything is funneled to the members personal tax return as opposed to dealing with any filings on the company level.
- Members expectations are clearly stated in the articles of organization or operating agreement.
Cons of an LLC
- There is a concept called “piercing the corporate veil” which means if you are doing something illegal or your personal transactions aren’t clearly separate from your business transactions, your personal assets may be liable to lawsuits. The best way to avoid losing the typical protection of an LLC is by doing everything legitimately. Don’t use the LLC debit card to pay off your mortgage. Avoid commingling funds and make sure there is a clear paper trail of your business activity.
- You are required to pay self-employment tax. Self-employment tax is a combination of Social Security and Medicare taxes. This means Schedule SE has to be filed ( https://www.irs.gov/forms-pubs/about-schedule-se-form-1040 ). If you use a software like TurboTax, this is not a huge burden. The software does everything for you. If you file your taxes with an accountant, they will probably charge you a little extra since this does complicate your tax return.
How do you form an LLC?
Let’s go over how to form an LLC. This is just a basic guide so if you do live in New York State and need help forming an LLC, feel free to call our law firm at (917) 567-1963.
Here are the 6 general steps to forming an LLC:
• Pick a name: Discuss with the other members of the LLC what name should be attached to the LLC. There are various online directories available that can let you know if a name is already occupied.
• Choose a registered agent: Decide on who should be the individual that receives all correspondence in reference to the LLC. Since relationships can become damaged in life, sometimes it is better to have an uninterested third-party designated as the registered agent. Our law firm can act as a designated third-party.
• File articles of organization: This form is considered to be the birth certificate of an LLC. This document is typically filed with your respective state.
• Get an EIN number: EIN stands for employer identification number. It is a 9 digit number used for tax purposes with the IRS.
•Create an operating agreement: This agreement dictates how much each member receives in profits, which member is responsible for which daily tasks, and so on.
• Create a business checking account: No one member should house all of the monies from the LLC in their personal checking account. Establish a separate business account for the sake of security and commonsense.
What are the benefits of having real estate in an LLC?
Now that we have an idea of how an LLC works and how to create one, let’s focus on the aspect of real estate.
Some of the key benefits of putting your real estate into an LLC is the personal insulation you create. During a lawsuit, if you do not have your rental or investment property in an LLC, your personal assets are subject to an action. Granted, you probably already maintain liability insurance for your rental property which is absolutely recommended. But why not go a step further and form an LLC to have additional protections placed on your assets.
To go even deeper, if you own ten rental properties, you should be maintaining ten separate LLCs. Here is a good example why:
You own a single LLC which houses 10 different rental properties. The income which you receive for each property is deposited into a single checking account.
In one of your rental properties, your tenant held a going-away party. Adult beverages were served and some of the guests decided to take the party to the balcony. Due to the amount of drinks and food available, the floors naturally became slippery. At some point, one of the guests on the balcony slipped and tumbled four stories. They suffered multiple injuries including broken bones and a concussion.
In such a case, since the floors were slippery due to the food and drinks, and the victim themselves were inebriated, they probably do not have a case however that will not stop them from naming you in the lawsuit. They will claim that the balcony was a safety hazard. As innocent as you may be, this lawsuit will be expensive and time consuming. Additionally, if you happen to lose, all 10 of your rental properties are exposed in the lawsuit. Not only are the properties subject to loss, but so is the shared checking account.
The easiest solution to avoid such an enormous potential for loss would have been to sit down with your attorney and create a separate LLC for each one of your rental properties. In addition to that, it would be beneficial to sit down with your banker and create a separate checking account for all respective properties.
There is certainly a cost associated with creating a separate LLC and checking account for each property be it a monetary cost or just the cost of time. But by analyzing the example I illustrated, it is well worth every penny and minute you spend on creating separate LLCs for all of your properties. A single accident that may not even be the fault of the landlord and owner can result in huge losses.
If you are a holder of several investment properties and don’t have these protections already in place, our law firm can set up a consultation with you to go over a strategy with you and offer you the best protection possible. Call us at 917-567-1963 to setup an appointment. We will review all of your holdings, discuss the potential risks you are exposed to, and go over every solution possible to give you a peace of mind.
How to put your real estate into an LLC?
Now that we have covered what an LLC is, the pros and cons of having an LLC, and why it’s a good idea to have your property in a limited liability company, let’s now turn our attention to actually placing your real estate into this pass-through entity.
When we talk about placing our real estate into an LLC, we generally refer to transferring a title into the new entity. Property title is a bundle of various rights that outline the kind of ownership you have in a property. All of these rights can either be held by one individual, a married couple, or several parties. A title may also be referring to a single document called a deed which serves as evidence of who the designated owner is of a particular property.
So to illustrate, if you and you alone bought a rental property, then the property deed will have your name on it. Now obviously, any liability associated with the rental property will have you named in a law suit. Once we transfer your property into an LLC, your name will no longer be on that deed but rather the name of the LLC.
One of the easiest ways to “transfer title” to an LLC, which simply means to change the ownership of the property, is by utilizing a Quit Claim Deed. This would be filed within your locality. We discuss what a Quit Claim deed is in another blog post:
Everything to know about a NY Quit Claim Deed
With a quit claim deed, you have the ability to edit information that was previously recorded on a deed. There may be some exposure to a title transfer tax. This tax is imposed when you transfer a title. An experienced attorney and title company can provide you more information on how and when transfer tax would apply.
Generally speaking, in New York City, this tax is imposed on the transfer of residential property valued at $25,000 or more at a rate of 1%. The city does impose a higher rate which is quoted at 1.425% for property valued higher than $500,000. However since we are dealing with rental property and no sale is actually occurring, you should take the time to sit down with a real estate attorney in order to truly understand what your exposure would be with transferring a title.
Remember to update all of your lease agreements when you successfully transfer your title into an LLC. The leases should display the name of the LLC as being the party that is owed the lease payments. Not only will this make more sense to the tenant but it avoids a court from “piercing the corporate veil”. If your personal name is on the lease as opposed to the limited liability company, it may appear that there is no separation between your personal dealings and that of the pass-through entity.
Ready to Transfer Title or Need Other Legal Services?
If you are interesting in transferring your title and deed to another party, or setting up an LLC, our law firm is ready to help you.
In addition to that, we can provide you with the follow real estate legal services:
- Lease Review/Creation: If you are looking to rent or want to rent a property out, we can assist you in reviewing a lease, creating the lease with the appropriate legal terminology in place, and be there with you during the lease signing.
- Real estate closings: If you are buying or selling a property, our law firm can help you every step of the way once that offer sheet is submitted. We can review and draft a sales contract, deal with the title companies, work with your mortgage professional, and go through every step needed to get you to the closing table.
- Real estate litigation: Whether you are dealing with a broker who has been acting dishonestly, your tenant is causing you issues, or there are title issues you are dealing with, litigation is always an option. Our law firm is equipped to see that you are represented well during one of these disputes. Whether you want the full force of litigation to be applied or would prefer a quick settlement, we will work with your needs to get you the best outcome possible.
- All other real estate issues: Zoning issues, mechanics lien, evictions, boundary disputes, property tax issues, contractual disputes, misrepresentation and nondisclosure problems, and recovery of down payment – we can help you with all of the above.
Feel free to call our law firm at 917-567-1963.
Richard Rozhik, Esq., is the founder of the Rozhik Law Firm. He is in excellent standing with the New York State Bar Association, The Brooklyn Bar Association, and is a community leader in the South Brooklyn Area. He has extensive experience in all matters dealing with real estate, no-fault law, personal injury matters, business transactions, contracts, and all general litigation matters.