Individual owners of real property who rent space or use their property for business purposes should consider transferring title to a limited liability company or corporation. The primary reason for having title held in the name of the business entity is to limit the owners’ liability against the claims of tenants, guests, invitees and others where the owner may be held responsible.
If a property owner is sued, and the aggrieved party is awarded a money judgment, the owner will be responsible for satisfying that judgment. And if the owner is an individual, that individual’s assets will be exposed to collection efforts. In particular, a judgment creditor is entitled to post-judgment discovery which may require the owner to produce financial statements, banking records, tax returns and other information. Armed with that information, the judgment creditor may then take steps to execute on the judgment. The owner’s bank accounts may be frozen and levied upon. Wages may become subject to garnishment. Real property may be subjected to a lien so that the judgment creditor must be paid from the proceeds of a sale. Simply put, a judgment against an individual puts all of the assets owned by that individual at risk.
On the other hand, if the owner of the premises is a limited liability company or a corporation, only that entity will be liable to satisfy the judgment creditor, and not the individual(s) having an ownership interest in the entity. The individual’s only exposure will be their capital contribution made in the business entity. If the property is owned by a limited liability company, only the assets of the limited liability company are at risk.
Note, however, that ownership of real property by an entity will not shield an individual from liability due to fraudulent or other wrongful conduct in circumstances under which a court would permit the judgment creditor to pierce the corporate veil in the interest of justice. Care must be taken not to abuse the corporate form. Further, a transfer of title to a corporate entity will not be recognized if the conveyance is made while there is a known claim against the individual owner.
In order to maximize the limited liability benefits of corporate ownership, seasoned real estate investors will often create a separate limited liability company or corporation to take title for each investment property they acquire. By doing so, the reach of a judgment creditor is limited to the equity in only one property, not several, and the investor can successfully avoid putting all of their real estate holdings at risk.
There are other benefits to owning real property in the name of a limited liability company. An LLC allows for easy transfer of an interest in real property without the need for a deed. A transfer of interest in an LLC can be accomplished with a simple document prepared in accordance with the terms of the LLC Operating Agreement. Note that transfers of LLC interest may result in a city or state transfer tax and the need for a transfer tax return.
Yet another benefit of ownership of real property by a business entity is the ability to better manage planning and restrictions on transfer. An LLC Operating Agreement can specify exactly how members can transfer membership interests in the LLC to new members or, how a membership interest may be transferred in the event of withdrawal, disability or death of an existing member.
If the property is encumbered by a mortgage, virtually all mortgages require the consent of the mortgagee before the premises may be transferred to an entity. Failure to do so may trigger the acceleration clause in the mortgage note, which would result in the full principal becoming due upon transfer.
Moreover, if the lender consents to the entity transfer, the lender may require the loan to be converted to a commercial loan with a higher interest rate. In such a case, a business decision will need to be made, balancing the risk of being sued with the added expenses of an interest rate increase. Thus, care should be taken not only to obtain the consent of the mortgagee to a transfer, but also to determine what conditions might apply.
Transfer to an entity is usually not recommended for a primary residence as it could result in the loss of STAR or other exemptions which require ownership by an individual.
Also, before any transfer, check with your insurer to (i) make sure your insurance rate will not increase dramatically due to ownership by an entity and (ii) notify the insurer to add the entity as the insured.
Review the proposed transfer with your accountant to confirm there will be no negative tax consequences resulting from the transfer.
Once the property is transferred to the entity, be sure to assign all leases to the new entity and notify tenants to pay rents and other charges due under the lease to the new entity. Set up a tax identification number for the entity and open a business bank account for receipt of rents and payment of expenses associated with the property. All of this will give you peace of mind knowing you have protected your personal assets.