DAVID J. WILLIS ATTORNEY
Copyright © 2018. 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—not in a personal name and preferably not reflecting personal information such as the homestead address. If a traditional office address is not available, a PMB at a UPS or FedEx store is recommended for LLC business.
Ideally, property ownership should reside in a dedicated holding company while management functions (including entering into contracts, collecting rent, payment of expenses, and the like) are performed by a separate, shell management LLC. This accomplishes separation of assets from activities, a core principle of asset protection derived from the legal concept of privity. Investment properties held for the long term should be deeded into individual series of the holding company.
General Theory of Asset Protection
We should review the general principles that this firm advocates for asset protection. A sound asset protection plan: (1) creates barriers to personal liability with one or more LLCs, at least one of which should be a series company if multiple properties or assets are involved (we prefer Texas and Nevada, two top AP states with similar statutes); (2) maximizes anonymity in the public records; (3) utilizes homestead protections afforded individuals by the Texas Constitution and Property Code; (4) deters lawsuits and judgment creditors; and, (5) in the event of suit, exhausts their determination and resources. Planning ahead is critical, particularly in the context of property ownership, since the range and benefit of asset protection measures decrease significantly after suit is threatened or filed.
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 (i.e., each property in its own series). Lenders, however, often require that an
investor take title to the property in his or her personal name for underwriting reasons. If that is the case, property should nonetheless be moved without delay into the investor's series holding LLC after closing.
The series LLC is now the vehicle of choice for many 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.
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 Business Organizations Code that put the public on notice of the unique nature of a series company should, in our view, be included in the deed.
Will the lender call the note due if the property is transferred into an investor's 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—that is all.
Second, lenders seldom act when property is transferred into the borrower's personal company (we have never seen that happen, actually) and in any case they are far more concerned with loans that are in monetary (rather than technical) default—although, as pointed out, transferring title is not a default, not even a technical one. Some lenders will send a threatening letter, but little will likely come of it so long as the note remains 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 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 just not a good idea. The homestead should be kept 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 is not a problem here because the homestead is already protected. What the living trust accomplishes is probate avoidance (since the trust cannot die), providing for automatic transfer of the beneficial interest in the property without delay or expense. Even considering that Texas has expedited probate procedures, this is a real benefit. There is nothing to lose and everything to gain from using such an arrangement. A pour-over will should be executed along with the living trust to complete the picture.
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 property into a personal company. Under no circumstances, however, should a quitclaim be used, since these can create problems with the chain of title. If one is determined to avoid warranties, 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" (assuming no liability for) the debt. This choice should be carefully considered since it has accounting implications—for instance, whether or not the company intends to carry the loan on its books as a company debt. About half of transfers into an LLC that we prepare are made as assumptions, and about half are made as sub2s. The best practice is to include an express clause specifying assumption or "subject to" in the deed. Consult your tax adviser to determine which method is better in your case.
It is also advisable to include an "as is" clause in the deed—in bold and in all caps. This should be routine for all business transactions in which an investor is the seller, even if the transfer is being made into one's own company. If the property is rented it may also be appropriate to assign the escrow account, the seller's interest in the casualty insurance policy, and the security deposit to the LLC. If so, assignment clauses should be included addressing these issues.
For married investors, it is the preferred practice for both spouses to sign the deed into an LLC, since Texas is a community property state. If that is not done, it is possible that a future title company will ask for a marital status affidavit, non-homestead affidavit, or even a spousal signature—which could be awkward if the marriage is no longer solvent
Transfers Made for the Purpose of Defrauding Creditors
It is preferable to transfer assets 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 the transfer occurred;
(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 reasonably equivalent consideration for the transfer; and
(6) whether or not, after the transfer, the transferor became insolvent as a result (made his cash disappear).
Such transfers are called "preferences" in bankruptcy court. Read our web article on fraudulent transfers for a fuller explanation.
If one did not move property into an LLC prior to a lawsuit or judgment, can it safely 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. Any post-suit transfer made by an investor into his or her LLC should be defensible as a transfer for consideration made for business reasons having nothing to do with the lawsuit.
Information in this article is provided for general informational and educational purposes only and is not offered as legal advice upon which anyone may rely. No attorney-client relationship is created by the offering of this article. This firm does not represent you unless and until it is expressly retained in writing to do so. 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, since we do not give tax advice.
Copyright © 2018 by David J. Willis. All rights reserved. Mr. 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.