Should I Title My Properties in an LLC?
Many clients come to me asking to title each property they are buying into a separate LLC. This seems to be the standard advice given to many investors because the most one can lose is that one property.
There are several problems with this advice:
If you are investing in single family rental housing or apartment buildings up to 4 units; you can lock-in a 30-year fixed rate loan at historically low interest rates, which will save you many thousands of dollars over the life of the loan. These loans are only available if one takes title to the property in one’s own name, individually; and one signs the loan documents as an individual. These 30-year fixed rate loans are not available if the property is held in the name of a corporation, partnership, or limited liability company (LLC).
Years ago, it did not cost anything to register an LLC with the State of Maryland. Then, an annual fee of $100 per LLC was imposed. It has since be increased so it now costs $300 per year for each LLC. If one had 5 properties, each in a separate LLC, the annual registration fee alone would be $1,500. One ought to be able to purchase a $5,000,000 umbrella insurance policy for about $1,500.
Keep in mind, the objective is not to have a bunch of LLCs. The objective is to manage the risk of owning rental real estate. What is the risk and what is the most cost-effective way to manage this risk?
I want to protect myself and my personal assets in the event of a lawsuit regarding my investment property. A typical scenario is a lawsuit from a current or former tenant claiming the landlord permitted a hazardous situation to exist on the property which caused some injury to the tenant. An example might be the tenant that slipped and fell on ice, breaking a leg or staining a back, as a result of the landlord’s failure to remove snow and ice hazards. Another example is a tenant who falls going down the steps and breaks a leg because there was no handrail. Worse yet; a tenant who dies in a fire and blames faulty smoke detectors or a blocked fire exit for his demise.
The first line of defense in protecting myself is liability insurance which pays claims of personal injury from tenants, their guests and visitors on my property. Insurance policies limit the amount of coverage provided; typical limits are $300,000, $500,000, or $1 million.
So, insurance pays all covered claims up to the policy limits. More importantly, since the cost of attorney’s fees can be substantial, the insurance company usually employs the attorneys who investigates the claim, prepares a defense, and appears at trial to represent the insurance company’s interests and my interests.
Not all injuries are covered by insurance, so I need to understand which ones are not. Most policies do not cover lead-paint poisoning and some do not cover mold. Discuss with your insurance agent what other issues are excluded from coverage.
As a rental property owner, it is important that I have a liability insurance policy with a reputable company and that I have a limit high enough to cover usual claims. $1 million coverage is suggested for most landlords. Once you accumulate a few properties, it is suggested to investigate the affordability of a $5 million umbrella, which provides a broader range of coverage up to $5 million.
What if I have a $500,000 liability policy and a jury awards the tenant $600,000 in damages? The insurance company would pay $500,000 and I would have to pay $100,000 out of my pocket. If my property is titled in my name as an individual, the tenant could collect on his claim by attaching a lien to my personal residence, my other investment real estate, my savings accounts, other assets, and even garnishing my wages.
A Risk-Pool Strategy
To manage the risk, while minimizing the cost of registration fees, many landlords create “risk pools” wherein a group of 3-10 properties are placed in the name of one LLC, and then another group of 3-10 properties is placed in the name of another LLC. Thus, in that worst case scenario, where I am sued for an uninsurable event or the jury awards more than the policy limit, the most I have at risk is the “pool” of investment properties under than one LLC.
Fixed Rate Financing
I have seen many investors purchase a property in their name individually, originate a 30-year fixed rate loan in their name individually, and, sometime after closing, transfer the property from their name individually into an LLC wholly owned by them. There is no transfer taxes due on a transfer from a property I own individually into an LLC in which I am the sole owner.
Some have argued that this is a violation of the “due on sale” clause in the loan agreement. I suppose most lawyers might see it this way. The other perspective is that the individual is still obligated on the loan documents and one could argue that, while the legal name of the “owner” has changed, and since the LLC is a “pass-thru” entity with the borrower being the sole member of the LLC that owns the property, the effective ownership of the property has not changed.