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Creating LLC to Buy Rental Property

Ask the Real Estate Lawyer: Real Estate Law Q&A

REM # LAW 683

By Ilyce R. Glink and Samuel J. Tamkin

Summary: A reader has formed an LLC to administer rental propeties. He quickly found out that this is an expensive way to buy real estate because lenders give better tems to residential buyers. Now the reader would like to transfer his property to his newly formed LLC. Sam and Ilyce talk about ways to limit you liability as a property owner and how to get the best mortgage terms.

Q: I formed a limited liability company to administer two rental properties that I intend to purchase.
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I originally wanted a commercial mortgage because I wanted my limited liability company to purchase these properties, thereby upholding the liability protection inherent with this type of entity.

However, most banks wanted me to put 20 to 30 percent down for my commercial mortgage. So, I opted for a residential mortgage because I was able to put nothing down on one of the properties and just 5 percent down on the other.

To "restore" the liability protection I would have had if the limited liability company had obtained the mortgage and owned the properties, I thought that I should record two quitclaim deeds, one for each property, to release my personal ownership of them, and transfer the ownership to my company.

Is this the best method to achieve my goal of having the LLC own the properties to reduce my liability? Having quitclaimed the properties, what happens when I should decide to sell the properties? Can I have the title company record them for me on the day of the closing? Would this cause an issue with the lender?

A: A limited liability company (LLC) is a form of organization for an entity similar to other corporate entities. The main purpose of an LLC is to insulate its owners from personal liability should something happen at one of the properties owned by the LLC. An LLC can be used to own any type of property or even to run a business.

You have found out what many real estate investors have discovered: Owning property in an LLC can be expensive, particularly when residential lenders are willing to lend money at lower rates and with lower down payments as opposed to commercial lenders. Why wouldn’t you want to get the lowest rate and terms possible, even if it means using your own name?

You can’t transfer title from your name to an LLC at the closing of your purchase. The lender requires you to take title of the property in your name. After the closing you’ll have two choices.

One possibility is to keep the properties in your own name and make sure you have sufficient insurance to cover yourself in case anything goes wrong with them.

The second option is to transfer title of the properties from your name to the LLC which you control. Transferring the title is easy. You would sign a quitclaim deed from yourself to your new entity. You would also want to coordinate the recording of the deed with the title company and have them issue the new title insurance policy in the name of the LLC. You don’t want to transfer title to the LLC and later find out that there is a title problem with the property and not have title insurance coverage for your issue.

If you do transfer title, you’ll end up with one major problem -- your lender expects you to own these properties in your own name. The transfer of title from your name to the LLC would allow the lender to call the loan. Most loans have a clause that states that upon the sale or transfer of title of the property, the lender has a right to demand repayment in full of the loan.

Some lenders may allow the transfer of title, but most of the time residential lenders will tell a homeowner that the title must remain in the name of the original buyer, subject to certain transfers between spouses, in case of death, and for estate planning purposes.

By the way, did the lender ask whether you would be living in either of these properties as your primary residence or second home. If you applied for these residential loans and represented that they were for your own use and you intended to rent them, you are violating the terms of the loans that were given to you.

In some cases, the misrepresentation has serious legal consequences in addition to allowing the lender to demand the immediate repayment of the loan.

As far as transferring the properties to your LLC, only you can decide whether the transfer is worth it and whether to take the risk with your lender.

On the issue of whether the properties were represented to the lender as being for your own use, frequently real estate investors take advantage of a lender’s excellent terms for financing primary and secondary residences that are intended to be owner occupied but have no intent on living in these properties.

These misrepresentations distort the marketplace and are in most cases illegal.

Samuel J. Tamkin is a Chicago-based real estate attorney. Ilyce R. Glink’s latest book is 50 Simple Steps You Can Take To Sell Your Home Faster and For More Money In Any Market. If you have questions for them, write: Real Estate Matters Syndicate, PO Box 366, Glencoe, IL 60022 or contact them through Ilyce’s website www.thinkglink.com