A common question asked by clients owning real property is whether they should hold their property in a limited liability company (LLC) for asset protection purposes among other reasons. If cost is not a factor, the answer is normally yes. But since cost is typically a material factor for most clients, the answer depends upon the circumstances, but evaluation of risk and cost is a good place to start.
Risk Assessment
First, what activities are taking place on the properties? For example, property used for commercial retail purposes creates much greater risks to the client than a vacation home that the client uses intermittently and primarily for personal use. The greater the risk exposure, the more valuable an LLC will be.
Options for Addressing Risk
Next, are there complimentary or better ways to minimize risk? Insurance is nearly always a necessity but pay close attention to coverage. Perhaps consider increasing the scope and amount of coverage to deal with claims that could be crippling if you chose a low premium, low coverage policy. Also, if the property is being rented, a well-written, landlord-friendly lease can go a long way towards allocating undesirable risk away from you and onto your tenant.
Title and Lien Holders
Next, do you hold title free and clear of liens or are there any mortgages or liens against the property? In order to transfer title to an LLC, it may be necessary to get written consent from a lender or other parties that have an interest in the property. Sometimes this is an easy process, but in other instances, it can be cumbersome and add expense.
Insurance Costs
Before making a transfer to an LLC or purchasing property in an LLC, it’s good practice to talk to your insurance company and determine what the cost of coverage will be. Some carriers may charge a higher premium to an LLC than if the property is owned by an individual. Also, consider whether it might be more cost-efficient to forego the use of an LLC and instead hold title individually but obtain an umbrella policy to increase coverage for yourself.
Financing Terms and Rates
As with insurance, there may be different financing rates and terms for a borrower that is an LLC versus an individual. For example, a loan program that provides a lower interest rate may be available to an individual purchasing residential property but not to an LLC borrower.
Formation and LLC Maintenance Costs
Calculate the cost to form an LLC, to pay annual state license renewal fees and registered agent fees, if any. Talk to an accountant and determine what the tax consequences will be if an LLC owns the real property and whether additional tax returns will be required. For personal residences, it can be tax unfriendly, and if your LLC has multiple members, depending on the circumstances, a partnership tax return may be required which will drive up the cost further.
Summary
While owning real property in an LLC may be wise for purposes of limiting liability, it is very important to evaluate the cost of doing so and whether there are other alternatives that may be more practical and cost efficient. If you’re considering whether an LLC may be right for you, I encourage you to contact our office at (206) 842-7676 or submit a contact form to set up an initial appointment.