DAVID J. WILLIS ATTORNEY
Copyright © 2013. All rights reserved worldwide.
Deeding Property to an LLC
An Essential Aspect of Asset Protection
by David J. Willis Attorney
A primary purpose of an LLC (whether the company is a series company or a traditional LLC) is to provide asset protection, including protection from personal liability for its members. For this reason, any property that could potentially generate a lawsuit or other liability, especially investment and rental property, should be held in the name of an LLC (we prefer Texas and Nevada LLC´s) – never in a personal name and never reflecting the principal´s homestead address (POB´s are recommended for LLC business).
In this firm´s recommended two-company structure, ownership resides in a dedicated holding company while management functions, including entering into contracts, collecting rent, and payment of expenses, are performed by a separate, stand-alone shell management LLC. This accomplishes a separation of assets from activities, a core principle of asset protection.
The Theory of Asset Protection
Asset protection in Texas is about (1) creating barriers to personal liability with one or more LLC´s, at least one of which should be a series company (we prefer Texas and Nevada); (2) maximizing anonymity in the public records; (3) utilizing homestead protections afforded individuals by the Texas Constitution and the Property Code; and (4) deterring lawsuits and judgment creditors and, in the event of suit, exhausting their determination and resources. Planning ahead is critical. The benefits of asset protection measures usually decrease substantially after a suit is threatened or filed.
Although there is no such thing as a "bulletproof" asset protection plan (in spite of whatever internet and seminar promoters may claim) you can get close. The rule is this: the more fences a plaintiff and his attorney have to jump, and the more money they have to spend in order to get to you personally, the better protected you are. For more details, see Asset Protection in Texas.
The Series LLC
The series LLC – we prefer series companies formed in Texas or Nevada – is now the vehicle of choice for real estate investors. Unlike a traditional LLC, a series company permits a single entity to hold multiple properties in separate, insulated "compartments" – Series A, Series B, and so forth. The assets and liabilities of each series are confined to that series only and are segregated from the assets and liabilities pertaining to other series. In other words, if there is a lawsuit or a foreclosure that affects property in Series A, then Series B, Series C, and so forth are not affected or liable for the outcome. Because of these features, the traditional Texas LLC should be utilized only as a single-purpose entity (SPE) to own major projects such as restaurants, apartment complexes, and retail stores.
For addition details on the advantages of a series LLC, see our web article LLC´s in Texas – The Series LLC.
Deeding Property to a Texas or Nevada Series LLC
If possible, rental or investment property should be acquired directly in the name of an LLC. If our recommended two-company structure is used, the optimum plan would be to acquire an investment property in the name of the management company and then, after closing and rehab, transfer it into the holding company where it will reside until sold.
However, lenders often require that an investor take title to the property in his or her personal name for internal underwriting reasons. If that is the case, the property should nonetheless be moved without delay into the investor´s LLC after closing – specifically into a series of the holding company (which should always be a series company) – using a general or special warranty deed. When deeding property into a series company, the deed should specifically reflect which series the property is going into; for example, title should be taken in the name of "ABC LLC – Series A." Failure to do this will result in the property being acquired as an asset of the company at large, thereby losing series insulation and protection. This firm also favors including recitals from the Business Organizations Code in the deed that put the public on notice of the unique nature of a series company.
Use of a Trust to Achieve Anonymity
As noted above, assets are generally deeded into a series by specific designation – e.g., "ABC LLC – Series A." We are occasionally asked, however, if something additional can be done in order to achieve anonymity, and the answer is yes, by utilizing an "anonymity trust" (our term). In our anonymity trust format, title is taken in the name (for instance) of "The Series A Trust," with no mention of either the LLC or of a trustee. Those familiar with trust law will immediately object, pointing out that trusts are not, formally speaking, "legal entities" – which is technically true – although trusts often behave as if they were in the real world. Furthermore, county clerks have no problem accepting for filing a deed that shows a trust as grantee with no mention of the trustee´s name.
The problem arises later when a title company is asked to insure title as part of a subsequent sale of the property. When it comes to anonymity trusts, title companies and their attorneys will rush to assert "You can´t do that!" Well, the fact is we can and we did and there is currently a deed of record in the trust´s name which has preserved anonymity for the client during his entire period of ownership. The real issue is what the title company will require now in order for us to move forward, which is usually one of two actions: produce the trust agreement for their review, which is no problem; and/or go back and re-deed the property into the trust with specific mention of the trustee´s name – also no more than a minor inconvenience. Once these steps are taken, the title company´s objection is removed and the sale can go forward. The result is that the anonymity trust device has served its intended purpose.
Note that there must be an underlying trust agreement for a transfer into trust to occur. Merely reciting the word "trust" as the grantee in a deed does not accomplish this. It is therefore necessary to go to the expense of preparing an actual written agreement to keep in the client's records. Anonymity has its price.
Due on Sale Issues
Investors often worry about the "due on sale" clause in their deed of trust. Will the lender call the note due if the property is transferred into an LLC? There are two points to note on this subject. First, the standard due on sale clause contained in the FannieMae deed of trust prohibits nothing; it merely gives a lender the option to accelerate a note if a transfer of title occurs – so it is not correct to say that such a transfer "violates" or "breaches" the due on sale clause. Lenders may choose whether or not to act under this clause.
Second, lenders seldom act when real property is transferred in the borrower´s personal company and, in any case, are far more concerned with loans that are in monetary (rather than technical) default. Some lenders will send a threatening letter if they discover that their collateral has been transferred, but little comes of it so long as the note is kept current. Nor is credit affected. Accordingly, the due on sale clause is a risk factor, but a negligible one in most cases.
What should be done with the homestead?
It is neither necessary nor advisable to transfer a homestead into an LLC that holds investment properties. As a general rule, homestead-exempt assets should be kept separate from investment assets. Why? Firstly, the homestead is already protected by the Texas Constitution and the Property Code against forced sale or execution upon a judgment (See our companion article entitled Homestead Protections in Texas). Secondly, mixing the homestead with investment assets that are prone to incur liability and lawsuits is not a good idea. The goal should be to keep the homestead out of the line of fire.
Our recommendation is to transfer the homestead into a living trust, also called an inter vivos trust. Trusts do not provide a liability barrier, but this not usually a problem because homestead is already protected. What the living trust accomplishes is probate avoidance, since the trust cannot die. The trust provides for automatic transfer of the "beneficial interest" in the property without the delay and expense of probate. Even considering that Texas has expedited probate procedures, this is a substantial benefit. There is nothing to lose and everything to gain from using such an arrangement. A "pour over" will should then be executed along with the living trust to complete the picture. Read Living Trusts in Texas for details.
Avoid "Standard Forms"
All LLC documents – including deeds of real property into the LLC – should be drafted by a knowledgeable asset protection lawyer with the goal of deterring lawsuits and maximizing protection from creditors. So-called "standard forms" (available on the internet and from seminar "gurus") are usually insufficient and can actually be harmful to an investor´s asset protection goals. In the case of a warranty deed, there is no standard form in Texas. No serious investor or businessperson should ever consider using a non-lawyer internet service to form an LLC – especially a series LLC – or prepare warranty deeds or other LLC-related documents.
General Warranty Deeds vs. Special Warranty Deeds
When deeding real property into an LLC, should a general warranty deed or a special warranty deed be used? In answering this question, it is useful to examine the difference between the two. The distinction pertains to the grantor´s warranty of title. A deed with general warranty conveys the property "to Grantee and Grantee´s heirs, executors, administrators, successors, and assigns against every person whomsoever lawfully claiming or to claim the same or any part thereof." The legal effect of this is to warrant title all the way back to the origins of the real property records.
A special warranty deed, on the other hand, conveys the property "to Grantee and Grantee´s heirs, executors, administrators, successors, and assigns against every person whomsoever lawfully claiming or to claim the same or any part thereof, when the claim is by, through, or under Grantor, but not otherwise." Title is therefore warranted from the grantor, but no further back than that. Commercial properties are typically conveyed by special warranty deed.
Deeds into an LLC may be made with either general or special warranties, depending on the situation. In most cases, there is no reason for an investor not to use a general warranty deed when conveying a property into his own personal company. Under no circumstances, however, should a "quit claim deed" be used. Quit claims, technically speaking, are not even true deeds. Texas title companies do not respect these documents, so using them can create problems with the chain of title. If one is determined to avoid warranties, then use a deed without warranties rather than a quit claim.
Clauses in the Deed
One factor that should be considered in deeding property into an LLC is whether or not the property is to be transferred with an assumption of the existing loan or "subject to" the existing loan (i.e., the LLC does not take liability for the loan). This choice has accounting implications – for instance, whether or not the company will in the future be carrying the loan on its books as a company debt. Most transfers into an LLC are made "subject to" – but this can vary with the circumstances. The best practice is to include an appropriate clause specifying assumption or "subject to" in the deed.
It is also advisable to include an "as is" clause in the deed. If the property is rented it may also be appropriate to assign the security deposit to the LLC, so a clause should be included addressing this issue. Consideration should be given to assigning any escrow account as well.
For married investors, it is the preferred practice for both spouses to sign the deed into the Texas LLC, since this is a community property state. If that is not done, a title company may later ask for a marital status or non-homestead affidavit.
Transfers Made for the Purpose of Defrauding Creditors
If the objective is to protect an asset, it is preferable to transfer that asset into an LLC before trouble arises. Otherwise the usefulness of doing so may be limited by rules against "fraudulent transfers" that reach back up to two years (these rules apply in many foreign jurisdictions as well). Fraudulent transfers are generally indicated by so-called "badges of fraud," including:
(1) transfers to a family member;
(2) whether or not suit was threatened before it was filed;
(3) whether the transfer was of substantially all of the person´s assets
(4) whether assets have been removed, undisclosed, or concealed;
(5) whether there was equivalent consideration for the transfer; and
(6) whether or not, after the transfer, the transferor became insolvent as a result (e.g., made his cash and property disappear).
Such transfers are called "preferences" in bankruptcy court.
If you did not move property into an LLC prior to a lawsuit or judgment, can it be done now? The answer is a qualified yes – if it is done for consideration and in the ordinary course of business. Since most investment properties carry indebtedness, an example of a transfer for consideration would be the payment of $5,000 (a random number, but one with substance) plus an agreement on the part of the LLC to assume and pay the existing indebtedness on the property. Such a transfer made by an investor into his LLC would be perfectly defensible as a transfer for consideration made in the ordinary course of business.
Transferring investment property to a Texas or Nevada Series LLC should be part of an overall asset protection plan – a plan that should be made prior to a catastrophic event such as a lawsuit or judgment. In preparing such a plan, one needs at least two professional resources: a good CPA to consider the tax ramifications of any action, and a skilled asset protection lawyer who has experience (including courtroom experience) keeping the wolves away.
Information in this article is proved for general educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well. This firm does not represent you unless and until it is expressly retained in writing to do so.
Copyright © 2013 by David J. Willis. All rights reserved worldwide. David J. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at www.TexasSeriesLLC.com and www.LoneStarLandLaw.com.