Issues to Consider when Transferring Real Property to an LLC
We frequently advise clients regarding transfers of real property to and from LLCs. Each transaction and property involves unique issues and should be reviewed independently by both a CPA and an attorney. However, the following are some of the most common issues to be considered:
Taxation. Prior to any transfer, a CPA should review the transfer for its effects on gain in the short term and long term and the tax treatment of the entity and its members. In addition to federal tax issues, the transaction should be reviewed by a CPA for excise tax issues. A transfer of real property will trigger excise tax if there is a change in beneficial ownership. Generally, excise taxes are not triggered if the transfer is made to a wholly owned entity where ownership interests do not change. That means if as transferor owns real property 50-50 with a partner, the target LLC for transfer must be owned 50-50 with the same partner. Any attempt to add a new member to the LLC or change ownership percentages likely triggers excise taxes.
Existing Finance/Lending. Before initiating a transfer, loan documents should be reviewed to for due on sale or prohibition on transfer provisions. Many mortgages and loans have a pay on sale or transfer provision which would allow the lender to call the entirety of the loan as due upon the transfer or real property to an LLC. Depending on the circumstances, it may be advisable to obtain the consent of the lender prior to completing a transfer.
Future Financing. If there is no debt, or if existing debt secured by the property will be refinanced in the future, consider the impacts of a transfer. For commercial properties, this may not be an issue. However, for single family residences, most retail lenders are not inclined or set up to lend to LLCs.
Title Insurance. Before initiating a transfer of real property, the title policy should be reviewed to determine whether the new entity will automatically be insured under the existing policy. Newer title policies include language including wholly owned entities in the “Insured.” If the title policy is older, a request can be sent to the title company to add an endorsement naming the new LLC or entity as an additional insured on the policy.
Form of Transfer. The following are are some of the more common deeds used:
a. Quit Claim Deed (QCD) – This is the most common deed for real estate transfers to a wholly owned entity. A QCD contains no warranties. It is used to release a party’s interest in a property without stating the nature of the party’s interest or rights. A QCD provides no warranties of ownership
b. Statutory Warranty Deed (SWD) – SWD conveys property with specified statutory covenants and warranties from the grantor to the grantee. SWDs are generally used in purchase transactions. In issuing a SWD, the grantor warrants that they are in possession of the property or will try to claim rights to it, and that the property is free and clear from liens or other encumbrances.
c. Bargain and Sale Deed (BSD) – A BSD is generally used to convey real property for valuable consideration. A BSD contains no warranties against liens or other encumbrances against title unless grantor specifically adds warranties into the deed. It is implied that the grantor has the right to transfer the deed. BSD are sometimes referred to as special warranty deeds.
Casualty Insurance. Simultaneously with any transfer, any casualty or liability policies should be updated to add the new entity as an insured under the policy. It is best to check with the insurance company prior to the transfer to make sure there will be no issue with this change in the policy.
Other Consideration. Depending on the type of property, the jurisdiction, and the improvements on the property, there may be a host of other issues requiring consideration and review prior to the transfer.
Again, any transfer should be reviewed by both a CPA and a real estate attorney prior to recording a deed and excise tax affidavit to avoid irreparable harm. This summary is not intended to be all inclusive nor a substitute for full legal review since it is likely that other issues should be considered prior to making a transfer.
