Last updated October 12, 2020

When to Form an LLC for Real Estate?

Let’s talk about a major mistake that real estate investors make: When to form an LLC for real estate.

When to Form an LLC for Real Estate?

Video Transcript:

Hey, folks. Matt Horwitz, LLC University. Hope you’re doing well. Let’s talk about a major mistake that real estate investors make in regards to set up their LLC. Just got a phone call today and we’ve gotten dozens and dozens and dozens of these phone calls. People phone in saying, “Hey.” They’ve done some research. They’ve learned that they need to set up an LLC for their investment properties so that they can protect their assets, but they already bought their property in their name. They think that just setting up the LLC is going to somehow magically protect their assets. That’s not the case. If you think about it, those properties are owned by you personally. Just setting up an LLC, it’s not affiliated with that at all. An LLC doesn’t protect anything you do magically, right? You’re setting up an entity. You’re creating an entity, you’re creating an entity by state statue. That entity, therefore, needs to own the property and do the business. What I mean by that is that when you’re purchasing the properties, you’re purchase contract, your agreement of sale, the deed, any financing, all of that is in the name of the LLC.

The LLC holds title to the property, not you personally. Got a phone call today from a guy in California who owns three different properties all financed by three different banks and wanted to set up an LLC to protect his assets. I said, “Yeah, just so you know, don’t go ahead and set the LLC up right now. What you need to do is you need to call each one of the different banks to see if he can refinance or transfer the title and how that’s going to affect the loan.” Once people kind of understand like, “Okay, cool. I realize that I need to transfer the title into the name of the LLC.” Right. They realize they need to do that. Sometimes it’s called a dollar deed.

Basically, where you are in the United States, it’s going to be sometimes the name of the deed may be called something different. There may be different fees, but essentially you’re going to be selling the property for one dollar from yourself to your LLC, but if you have financing and you have mortgages attached to those properties you can’t just knock it out and do it really quickly. You have documents and documents and mortgages and clauses and things that you signed at settlement. Just because it’s going from you to your own LLC, it doesn’t matter. To the finance company, it’s going from the seller to a different buyer, right? You need to pick up the phone, call the different bank and say, “Hey, look. I need to get this title out of my own personal name and put it into the name of the LLC.”

Now, some people are going to be out of luck because some banks may not allow it. If they’re going to be lending to an LLC even with you personally guaranteeing the loan, it’s no longer going to be residential loan. It’s therefore a commercial loan and commercial loans take place usually within a different department in the bank. They have different terms and they have different rates. You’re essentially refinancing the property in the name of the LLC. It’s a bit of a mess really. Hopefully, if you’re watching this video you’ve caught it before you purchased your property. You need to purchase your property and obtain your financing in the name of the LLC and order for that LLC to protect your personal assets.

However, if you’ve already bought property in your personal name and you want to transfer it to the LLC the biggest thing that’s going to hold you up is a mortgage. You need to talk to the lender. You need to talk to the bank. Let them know about your situation and see if you can go ahead and do a dollar deed or a dollar sale. Transfer the property. You’re going to have to pay some title fees. You’re not going to pay full blown transfer tax. In different places it’s called different things. Sometimes it’s called the common level ratio. It’s really, basically, cheap and affordable way to do the transfer tax because you’re basically selling it to yourself for a dollar. This is much more of a title based question than it is a LLC formation based question. You really need to be calling the bank and the title company to figure out what needs to take place. Just so you know, in order to get that asset protection you have to transfer those properties out of your personal name into the name of the LLC. That’s the sale of real estate. Needs to take place at a title company and if you have mortgages and finances in place you’re going to need to be refinancing or I’m calling it a transfer, but there may be a more technical name for that.

Hopefully, that makes sense. Hopefully, that helps. Hopefully, you’re watching this video before you’ve purchased properties in your own personal name. Even with strong liability insurance, you want to have an LLC. In worst case scenario, both of those together are really going to be your strongest combination. Just having one or the other is a weak scenario. You want to protect your assets to the fullest. Hopefully, this video makes sense. If you have any questions, you know where to find us. Thanks.

We get phone calls like this all the time:

“Hey, I just did some research and realized I need to setup an LLC for my real estate in order to protect my assets.”

The very first thing I ask is, “Did you close on the property already?”

Far too many real estate investors say “Yes.”

I shout through the phone: “Nooooooooooo!” (picture that scene in the movie where the main character just loses his best friend)

Okay, I don’t shout through the phone.

But instead, I have to help them get their head straight.

They’ve learned that they need to set up an LLC for their investment properties so that they can protect their personal assets, but they already bought their property in their name.

They think that just setting up the LLC is going to somehow magically protect their assets.

That’s not the case.

If you think about it, those properties are owned by you personally.

Just setting up an LLC does not automatically “attach” it to the property.

In fact, the LLC is not affiliated with the property at all.

I wish just forming an LLC magically protected all we do.  But nope.  It doesn’t work that way.

You’re creating an entity. That entity, therefore, needs to own the property and “do the business”.

What I mean by that is, the LLC is purchasing the real estate, not you. Your purchase contract/agreement of sale, the deed, and any financing… all of that has to be in the name of the LLC.

The LLC needs to hold title to the property, not you personally.

I got a phone call today from a guy in California who owns three different properties all financed by three different banks (in his personal name) and wanted to set up an LLC to protect his assets.

I said, “Yeah, just so you know, don’t go ahead and set the LLC up right now. What you need to do is call each one of the different banks to see if you can transfer the title and how that’s going to affect the loan.”

He was bummed by the wake-up-call.

My advice to him was to first call all 3 banks to see what they have to say.

Due on Sale Clause

Many banks will have a due-on-sale clause if the property is transferred to another name.

If they agree to the transfer, he’ll need to deed the property from himself to the LLC for $1 (often called a ‘dollar deed’).

Depending on what state the real estate is located, the name of the deed may be called something different.

There will also likely be transfer tax.  Now the transfer tax will not be the same amount as if it were a full-price sale, but it could be a couple hundred dollars.

After you speak with the bank, you’ll need to call a title company and double check on transfer fees/taxes and any other closing costs (there will be small miscellaneous title fees).

Now, some people are going to be out of luck because some banks may not allow the transfer.

To the bank, there’s a new buyer (the LLC)… and the bank may need to qualify the new buyer.

Even with you personally guaranteeing the loan, it’s usually no longer going to be residential loan.

It’s therefore a commercial loan (because of the LLC) and commercial loans take place usually within a different department in the bank.

Commercial loans have different terms and they have different rates.

You’re essentially refinancing the property in the name of the LLC.

It can be a bit of a mess really.

Hopefully you’re watching this video before you purchased your property.

Purchase Real Estate and Obtain Financing in the name of the LLC

To get full liability protection, you need to purchase your property and obtain your financing in the name of the LLC and order for that LLC to protect your personal assets.

However, if you’ve already bought property in your personal name and you want to transfer it to the LLC the biggest thing that’s going to hold you up is a mortgage.

You need to talk to the lender/the bank.

Let them know about your situation and see if you can go ahead and do a dollar deed or a dollar sale to transfer the property.

If you can, you’re going to have to pay some title fees.

You shouldn’t have to pay full blown transfer tax… but again, you’ll need to call a title company in your county/city to double-check on this.

Hopefully, that makes sense and is helpful.

And hopefully you’re seeing this video before you’ve purchased properties in your own personal name.

Even with strong liability insurance, you’ll want to have your properties owned by your LLC(s).

In worst case scenarios, both liability insurance and your LLC will really be your strongest combination for asset protection.

Just having one or the other is a weak scenario.

You want to protect your assets to the fullest.

Need help with your LLC? Have a professional LLC service file for you:
Northwest ($39 + state fee) or LegalZoom ($149 + state fee)
Matt Horwitz
Founder & Educator, LLC University®
Forming an LLC shouldn't be so complicated. Our step-by-step guide will make the process a breeze – and no complex legal jargon! LLC University® teaches people how to form an LLC for free in all 50 states. We hope you find our free guides and resources helpful in your business journey.
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