DAVID J. WILLIS ATTORNEY
Copyright © 2014. All rights reserved worldwide.
Deeding Property to an LLC
An Essential Aspect of Asset Protection
by David J. Willis, J.D., LL.M
A primary purpose of an LLC, whether a traditional LLC or a series company, is to provide 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–never in a personal name and never reflecting the principal’s homestead address (POBâ€™s are recommended for LLC business).
Property ownership should reside 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 separation of assets from activities, a core principle of asset protection derived from the legal concept of privity.
Theory of Asset Protection
Asset protection (1) creates 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, two top AP states); (2) maximizes anonymity in the public records; (3) utilizes homestead protections afforded individuals by the Texas Constitution and Property Code; and (4) deters lawsuits and judgment creditors and, in the event of suit, exhausts their determination and resources. Planning ahead is critical. The range and benefit of asset protection measures decreases significantly after suit is threatened or filed.
The Series LLC
The series LLC is now the vehicle of choice for real estate investors. Unlike a traditional LLC (which owns its assets in a single pool) a series company permits the LLC 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 of other series. So if there is a lawsuit or a foreclosure that affects property in Series A, then other series (Series B, Series C, and so forth) are not affected or liable for the outcome. Because of this, a traditional LLC should be utilized only as a single-purpose entity ("SPE") to own major projects such as restaurants, apartment complexes, and retail stores.
Deeding Property to an LLC
If possible, rental or investment property should be acquired directly in the name of an LLC. In a two-company structure, the optimum plan would be to acquire properties in the name of the management company and then, after closing and rehab, transfer them into individual series of the holding company. However, lenders often require that an investor take title to the property in his or her personal name for underwriting reasons. If that is the case, the property should nonetheless be moved without delay into the investor’s into the investor’s series holding LLC after closing.
The power of a series to hold title to property is expressly granted by Texas Business Organizations Code §101.605(3). When deeding property into a series, the deed should specifically reflect which series the property is going into–for example, "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. Recitals from the BOC that put the public on notice of the unique nature of a series company should be included in the deed.
Use of a Trust to Achieve Anonymity
As mentioned, assets should be deeded into a series by specific designation. Is there a way to insert anonymity into this process? Yes, by utilizing an "anonymity trust" (our term). In an anonymity trust, title is taken in the name of, for instance, 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 legal entities–which is true–although trusts often act as if they were. 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!"–even though there is a deed of record in the trust’s name that has successfully preserved anonymity for the investor during his entire period of ownership. The real issue is what the title company will require now in order to move forward, which is usually one or both of the following: produce the trust agreement for their review, which is no problem; and/or go back and redeed 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 sale can go forward. The anonymity trust device served its intended purpose.
There must be an underlying trust agreement for a transfer into trust to occur. Merely reciting the word "trust" as grantee in a deed does not accomplish this. It is therefore necessary to go to prepare an actual written agreement, which may incur legal fees. Anonymity has its price.
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 Fannie Mae 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 property is transferred into 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, but little comes of it so long as the note is kept current.
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? First, the homestead is already protected by the Texas Constitution and the Property Code against forced sale or execution upon a judgment. Second, 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 a problem because the 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 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.
Avoid Standard Forms
All LLC documents, including deeds of real property into the LLC, should be custom-drafted by a knowledgeable asset protection lawyer with the goal of deterring lawsuits and maximizing protection from creditors. Standard forms available on the internet and from seminar gurus are usually insufficient and can actually be harmful. 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 Versus Special Warranty Deeds
Deeds into an LLC may be made by deed 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 quitclaim be used. Texas title companies do not respect quitclaims, 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 quitclaim.
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." 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. This is true for all business transactions in which in which an investor is the seller. 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 LLC, since Texas 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. Such 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 one did not move property into an LLC prior to a lawsuit or judgment, can it be done after? 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 adequate consideration might be 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 or her LLC should be defensible as a transfer for consideration made in the ordinary course of business.
Transferring investment property to an investor’s 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 and any statutes or cases referred to should be checked for updates. 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 © 2014 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 his website, www.LoneStarLandLaw.com.