Taking Title to Property in a LLC
In our last installment on commercial real estate essentials, we discussed how taking title to property can have an impact on your finances and your personal liability. In this article we explore the topic of taking title to a property in a LLC (limited liability company).
First, the why: Why would you want to take title to property in the form of a limited liability company?
Three words: Limitation of Liability. Taking title to property in a LLC can, by definition, limit the personal liability of the members of the LLC. This occurs because the law sees an LLC as a separate legal entity; distinguishing it from its members. Consequently, any claims arising from the property would not be brought against the members, but instead the owner of the property—namely the LLC. In this way, taking title to a property in a LLC limits the personal liability of the its members. There are some exceptions to this rule of limiting liability, and those exceptions should be discussed with your attorney when considering whether to take title in a LLC.
Second, the when: When is it NOT advantageous to take title in the form of a limited liability company?
If taking title in a LLC limits liability, why not always take title to property in a LLC? Doing a cost/benefit analysis may indicate that the risk of claims against the LLC is low and the inherent costs of forming and maintaining the LLC is higher than you would like. In this scenario you would explore other ways to address the risk of claims against the LLC. Here’s what you need to consider:
• Risks of Property Ownership: Risks of property ownership include: environmental contamination; claims by third parties for personal injury or property damage occurring on the property; claims by or disputes with tenants on the property; liability to a lender with a deed of trust on the property; disputes with, or claims by, neighbors; and liability for correcting violations relating to improvements or operations on the property.
• The Cost of a LLC:
– Forming a LLC requires legal documentation. You must prepare and file Articles of Organization in your state of formation and you must prepare an Operating Agreement for the LLC. An Operating Agreement can range from fairly simple to complex depending on the structure of the LLC. In addition, if your property is located in a state other than the state of the LLC’s formation, you will need to register your LLC to do business in that state. This will take time and cost money, so it is important to understand whether the formation of the LLC will be simple or complex and the legal costs involved in formation.
– Forming a LLC and Maintaining a LLC results in state fees and taxes. States impose their own fees for forming and registering a LLC. You will want to ask your counsel about those fees to assess the overall costs of formation of the LLC. In addition, most if not all states impose annual taxes on the LLC. For example, California imposes an annual minimum tax of $800. You will also want to know the amount of these taxes, so that you can budget for your LLC going forward.
– Maintaining the Corporate Formality. As mentioned above, to maintain the limitation of liability provided by the LLC structure, the LLC members must observe corporate formalities. This means that, among other things, the LLC will have to have a separate bank account, separate financials, meetings, and maintain minutes of meetings.
• Other Ways to Address Risk:
– Insurance can address certain types of risk of property ownership. Consult with your insurance broker or attorney about types of insurance and costs. Obtaining certain protections from tenants in leases affecting the property is another way to address risk.
Third, the if: Can I always take title to property in a LLC?
You always want to ask if you can take title to property in a LLC.
• Section 1031 Considerations: If you are doing a Section 1031 tax-deferred exchange, you will need to take title to your replacement property in the same way that you held title to your relinquished property. You can do this with a LLC, if the LLC is a “disregarded entity,” which is a limited liability company wholly-owned by the taxpayer(s) in the same proportions as it/they owned the relinquished property. In the context of a Section 1031 exchange, you will want to make sure that taking title to property in a LLC will comply with this “same taxpayer” rule.
• Lender Considerations: If you are financing the property, you will want to confirm with your lender whether you can take title in the name of a LLC. Lenders often impose their own requirements with respect to holding title in the form of a LLC.
• Tax Considerations: Finally, there may be tax implications of taking title to property in the form of a LLC. You will want to consult your accountant or tax attorney regarding those potential implications.
The limitation of liability provided by taking title to property in a LLC is attractive, but it makes good business sense to evaluate the existence of risk that you are attempting to address, the cost of forming and maintaining the LLC and the cost and effectiveness of addressing that risk.
To fully understand the legal implications of your specific situation, please contact Jennifer Johnson, shareholder and member of the real estate group at Hopkins & Carley, one of the most competent and prestigious law firms in the Bay Area. Jennifer is an expert in leasing and has represented both landlords and tenants in office, industrial, mixed-use, grocery store, retail, medical and shopping center leases. Click here to contact Jennifer to discuss your specific needs, or email her directly at email@example.com.