Things You Should Know to Transfer a Rental Property from Personal to LLC

Transferring a rental property from an individual to a Limited Liability Company (LLC) can offer numerous benefits, including legal protection, tax advantages, and streamlined real estate property management. This guide provides a step-by-step process for smoothly transitioning your rental property to an LLC.

What Is an LLC?

An LLC is a legal business entity that combines the benefits of a corporation and a partnership or sole proprietorship. It's a popular choice for small businesses and real estate investments due to its flexibility and tax benefits.

One of the primary advantages of an LLC is that it offers limited liability protection to its members (if there is more than one owner). Personal assets are typically protected from business debts and legal liabilities. In most cases, members' liability is limited to their investment in the company.

Why Should I Consider an LLC for My Real Property?

When owning and managing multiple rental properties, there are various legal and financial considerations to keep in mind. One option that property owners often explore is transferring their real estate holdings to an LLC. This strategic move can offer numerous advantages and benefits, making it an attractive option for rental real estate investors and businesses.

Advantages of Transferring Rental Property to an LLC

Personal Liability Protection

Personal liability protection is a critical advantage offered by transferring property from an individual to an LLC.

When an individual owns a property, they are personally liable for any legal claims, debts, or obligations related to it. If a lawsuit arises or the property incurs significant debts, the individual's assets (i.e., savings, investments, and personal property) could be at risk.

A title company typically issues title insurance to protect the interests of the LLC.

Limited Liability Protection

One of the other primary benefits of an LLC is limited liability protection.

When you transfer real estate to an LLC, the property owner's personal assets are shielded from the property's debts and legal liabilities. In the event of lawsuits, creditors typically cannot pursue the personal assets of LLC members, providing an extra protective layer.

Tax Advantages

LLCs provide tax flexibility and potential advantages for rental property owners.

An LLC is treated as a pass-through entity by default for tax purposes. This means the LLC itself does not pay federal income taxes.

Instead, the profits and losses generated by the property are "passed through" to the individual members of the LLC. Each member reports their share of the profits or losses on their personal tax returns.

This avoids the double taxation issue that often affects traditional corporations, where the entity and its owners are subject to taxation.

Can I Transfer My Mortgage to an LLC?

Transferring a mortgage from an individual to a Limited Liability Company (LLC) can be a complex process and is generally subject to the terms and conditions set by the mortgage lender.

Communicating with your mortgage lender, seeking legal or tax advice, and carefully evaluating the implications before proceeding with any mortgage transfer to an LLC are crucial.

Keep the factors below in mind when you're considering what to do with your rental property so that you aren't caught by surprise.

Due-on-Sale Clause

Most mortgages include a due-on-sale clause, also known as an acceleration clause. This clause typically stipulates that the full outstanding balance of the mortgage becomes due and payable upon the transfer of ownership or any change in title to the property.

Transferring the mortgage to an LLC may trigger the lender's right to demand immediate repayment.

Property with a Mortgage

The buyer holds legal ownership and is considered the mortgagor, while the lender is the mortgagee. The buyer can possess and use the property if they fulfill the mortgage terms, including making regular mortgage payments.

If the lender approves the mortgage transfer to the LLC, the LLC will need to qualify for the mortgage as a borrower. The lender will likely assess the LLC's creditworthiness, financial stability, and loan repayment ability.

The LLC may need to provide financial documentation, business plans, and other relevant information to demonstrate its capacity to assume the mortgage responsibility.

Transfer Tax Implications 

Local government authorities typically assess and levy property taxes based on the assessed property value.

In most cases, the transfer of a mortgage to an LLC does not directly impact the assessment or payment of property taxes.

The responsibility for property tax payments usually remains with the property owner, regardless of whether an individual or an LLC owns the property. The LLC would pay property taxes once the transfer ownership is complete.

Transfer Property Title

The transfer of property title typically requires the preparation of a new deed. The existing property owner (individual or entity) would execute a new deed that transfers ownership from themselves to the LLC.

The type of deed used may vary depending on local laws and practices, but commonly used options include a warranty deed or a quitclaim deed.

Costs of Creating and Operating an LLC

By considering the costs of creating and operating an LLC, you can set realistic expectations and build a solid foundation for your rental property business or any other venture you pursue under the LLC structure.

Obtain an EIN

An EIN is also known as a Federal Tax ID Number. It is a unique identifier for your LLC, similar to an individual social security number. The Internal Revenue Service uses the EIN to track tax obligations, file tax returns, and identify your LLC for various federal tax-related matters.

While not all LLCs are required to have an EIN, obtaining one is highly recommended for several reasons.

First, an EIN is generally required if your LLC has multiple members or intends to hire employees.

Additionally, having an EIN helps separate your business's tax obligations from personal tax matters, simplifies record-keeping, and enables you to open an LLC bank account in the name of the LLC.

Form an LLC

To form an LLC, you are required to file certain formation documents with the appropriate government agency. This typically involves submitting articles of organization or a similar document.

An attorney or law firm can assist in establishing this entity.

The filing fees vary by jurisdiction, and it's important to research the LLC professional fees specific to your location. These fees can cost up to a few hundred dollars, depending on the state or country where you're forming the LLC.

Set Up an LLC Bank Account

Opening a business bank account for your LLC is essential for maintaining clear financial records, separating real estate business and personal finances, and simplifying accounting and tax processes.

While the process and requirements may vary depending on the bank, there are costs to consider for having a separate bank account, including initial deposit and monthly maintenance fees. These fees can vary depending on the bank and the type of account you select.

It's important to research and compare different banks to find one that offers competitive fees and legal services.

What Deed Should I Use to Transfer Real Estate to LLC?

The county recorder handles real estate records within their jurisdiction. When transferring real estate from an individual to an LLC, you will typically need to use a deed to document and effectuate the transfer legally.

The specific form of deed to use may vary depending on the laws and practices in your jurisdiction. 

Below are the two common types of deeds used for transferring property to an LLC.

Warranty Deed

A warranty deed is a commonly used form of deed for property transfers. It provides the highest level of protection to the buyer (in this case, the LLC).

This is because the seller (the individual) guarantees that they have a clear title to the property and will defend against any claims that may arise.

Quitclaim Deed 

A quitclaim deed is another type of deed that can be used to transfer property to an LLC. Unlike a warranty deed, a quitclaim deed does not provide any personal guarantee regarding the title or condition of the property.

Instead, it transfers the interest or rights the seller has in the property to the buyer (the LLC).

Steps for Transferring Rental Property to an LLC

Below is an outline of the steps you may take to transfer rental property to an LLC:

1. Obtain the appropriate form, typically available from your local county recorder's office or online resources.
2. Fill out the warranty or quitclaim deed form.
3. Identify the parties involved, including the grantor (the individual transferring the property) and the grantee (the LLC receiving the property).
4. Provide a detailed and accurate description of the property being transferred.
5. Indicate the consideration or purchase price associated with the transfer.
6. Sign and date the warranty or deed form in the presence of a notary public.
7. Sign and record the deed with the appropriate county recorder's office.

Tax Consequences of Transferring Property to an LLC

When you transfer rental property to an LLC, be sure to keep the effects of this process on your taxes in mind.

The state may impose taxes on both the property transfer to the LLC and the income generated by the LLC from that property. 

Additionally, a capital gains tax may apply if the property has appreciated in value. However, if the LLC is a single-member LLC classified as a disregarded entity for tax purposes, the transfer generally has no immediate tax consequences. 

There may be future tax consequences if the LLC has multiple members. Changes in beneficial transfer ownership could trigger excise taxes. It's crucial to review loan documents for any due-on-sale or prohibition-on-transfer provisions before initiating the transfer. 

The attorney or title company thoroughly investigates the property's title history. Depending on the municipality, transferring the property title between a business entity and a personal name may also incur transfer taxes.

A tax advisor assesses the current tax situation and evaluates the potential tax implications.

Update Leases, Permits, Contracts, and Utilities

Local permits, contracts, and other legal documents should also be revised to reflect the LLC as the new owner, ensuring the legal rights and obligations are properly assigned.

Additionally, utilities should be notified and updated to reflect the LLC as the new account holder, guaranteeing seamless management of utility services.

It is worth noting that the utility company may require the LLC to pay a refundable security deposit as part of this process.

Payroll Taxes for Employees

If the rental property has employees, such as property managers, maintenance staff, or administrative personnel, the LLC will become responsible for paying employee payroll tax. This includes withholding and remitting federal, state income, Social Security, and Medicare taxes.

Contact Your Lender

It's important to note that contacting your lender and discussing the transfer of investment property to an LLC is critical to ensure compliance with loan agreements and address any potential issues.

Each lender may have different requirements and policies, so consulting with them directly and seeking professional advice is recommended to navigate this process successfully.