In the last couple of months I’ve helped several clients move real estate assets into LLCs that were set up to hold their assets. In most cases the costs were fairly reasonable. But in other cases, hidden costs created a real problem.
The problem for these few clients is different state attitudes towards asset protection and taxes – in particular, transfer taxes. This can change the entire asset plan for some, and can even result in our not recommending an LLC at all.
Transfer taxes are a tax assessed by a state when real estate is transferred from one owner to another. They can range from a few hundred dollars to several thousand dollars, depending on the state and the value of the property. When you’re buying a property from a 3rd party, you account for these taxes as part of the sale.
In many states, the subsequent transfer of that property out of your name and into your LLC is straightforward. These states say that as long as the true beneficial ownership isn’t changing, the name under which you hold your property doesn’t matter. As long as you are the 100% owner of the LLC, you will pay just minimal document recording fees (usually between $20 and $70).
If you’re only a partial owner of the LLC, then you may have a pro-rated transfer tax issue. For example, a husband who owns a property and wants to transfer it into an LLC owned by himself and his wife equally, could find himself paying tax on half the value of the property being transferred. In other states, transfers to spouses are not taxable.
But there are states that don’t care who (or what) you are transferring the property to. As far as they’re concerned EVERY transfer is a taxable event. Transfer property in these states, even into your own LLC, and you’ll pay the same amount of transfer tax again as you did when you bought the property originally. They might let you put the property into a revocable living trust without paying tax, but that won’t help your asset protection – only your estate planning.
Without getting onto a soapbox, I don’t think this is fair. I understand the state’s position: they are concerned that once the property is in an LLC, ownership can change from one individual to another, without any change in title occurring – and thus, no opportunity to collect additional property tax. But it’s hard for a client to understand that the money they’ve just spent on asset protection planning may be completely eclipsed by the money they’re going to spend to finish the job. Plus, if you’ve ever tried to refinance a property in an LLC, you know that often a lender will insist you hold the property personally before they will do the re-fi. Now you’re looking at another set of transfer taxes, which could significantly bite into the capital you’re trying to raise!
If you’re a real estate investor, plan ahead! Don’t automatically assume that an LLC is the way to go for asset protection. Take a look at the state or states you’re looking at investing in. Research the transfer tax issue ahead of time, and factor those costs into your plan.
Plus, the best time to get your investment properties into an LLC is at purchase. Whenever possible, take title to the property in the name of the LLC, rather than personally.