If I buy a single family home to rent out in my name with a mortgage in my name, then quit claim the deed to my real estate LLC with the homeowners insurance for that property in both my name and the LLC's name, will this compromise the integrity of the LLC? In other words, will doing this make the LLC more vulnerable to someone being able to pierce the corporate veil?
That is a very good question!!!!
I don't suggest you hold your personal residence in a business entity, usually, a trsut is better suited IMO.
Now, I am not an attorney and that would be a good question for your attorney in your area, where the LLC is registered and the property is located.
I do see your issue of what we call "commingling of funds" and holding a personal interest in property held by the LLC, an insurable interest besides that as a member.
But, I would think that any loan would need to be related to the cause of action where piercing the veil was being sought. That probably would not be the case.
Providing a personal guarantee on a loan in the LLC name is clearly not an issue.
Now, I'm going through my thought process to arrive at a conclusion, my conclusion BTW.
Debts in the name of the LLC made prior to the formation of an LLC are not protected by the limited liability nature of the company. Same with the assumption of any debt in the name of the LLC. I mention this as the date of assuming or making a loan agreement prior to formation and registration could be an issue.
The LLC may assume debts made prior to its inception or after. The debts would not need to be assumed with consent of a lender but by agreement between the debtor and the LLC. The agreement to assume the debt becomes the liability of the LLC regardless of any personal liability remaining by the original debtor.
Now, is a debt assumed and being paid by the LLC a personal benefit to your personal finances? Yes, since payments reduce your personal debts and thereby increase your assets, having your LLC pay personal debts is commingling your business and personal economic standings.
But, to what extent, if the loan was made on a property and the property is assigned to the LLC, it is no longer your personal asset, as if you sold the property to the LLC on a Sub-2 basis. By agreement you conveyed title to the LLC and it assumed the debt. Seems that washes out the personal nature, more or less.
Now, what is generally accepted practice? Assume the LLC was formed and title passed as part of an estate planning matter. Assigning the existing debt is common practice and does not constitute commingling of funds. Would there be a different assumption if the LLC were conducting business? Probably not.
And, so long as the loan has no future advance feature, like a HELOC where any advance could be used personally there would not be a personal benefit. Note terms should be reviewed to ensure that no future advance or any setoff would involve any other asset held personally. Another example would be your personal home being additional collateral on the loan assumed.
Getting past my ramblings, I am under the impression that the assumption of a mortgage by your LLC in such matters does not constitute the commingling of business and personal funds. Such is generally limited to commingling cash, not so much any benefit. That's my impression. If I were auditing such a situation, my opinion would be that the transaction was not mixing personal and corporate assets but rather a contribution to the capital of the company and the existing liability being assumed in the transaction.
But two last issues: One, I'm not a judge, nor an attorney, so my reasoning may not apply in your neighborhood. Secondly, after going through this, I'm beginning to think that a more formal transfer would be more prudent than simply making out a quit-claim deed and having the mortgage show up on the books of the LLC. Consider doing a Sub-2 from you personally to the LLC with a Special Warranty Deed and assumption of the underlying mortgage and do so at your basis so that there is no tax issue. I know that in PA, a tax would be due based on the fair market value (by any deed) and other tax issues may apply. But, if that complicates other issues, th usual way is probably acceptable too.
As to the insurance matter, I'd say no, insurance remains covering you personally as you remain personally obligated on the loan and your insurable interest doesn't mix business and personal to the extent of any real benefit, IMO.
Bottom line, I see an economic benefit but not a financial benefit that I would peg as commingling of funds. But had to go through my thought process (and make you suffer) to get there! LOL :)
PS. See your attorney on the best way to convey to your LLC, assume debts and title.
I have heard that transferring a property from your personal name into your LLC offers little protection in terms of a corporate veil (just what I've heard). I would imagine that still having the mortgage in your name will only further solidify the non-entity nature of the deal. That would be alot to have to explain away in court.
If it were me, I would consider purchasing a 3M umbrella insurance policy and I'd just keep it in my name. You are going to incur transfer taxes anyway, as well as the cost of an additional insurance policy. As far as cost, it's six in one hand a half dozen in the other.
I agree with a personal residence, I don't think GA has transfer taxes. :)
Great advice Bill and Jerry - thank you. And a big thank you to Bill for giving such a detailed response!
It has been suggested that the corporate veil can be pierced:
1. With any single member LLC, the alternative being a multi-member LLC, that includes more than your spouse.
2. Any LLC that does not have a separate bank account
3. Any LLC where funds are co-mingles with either you or another enitity.
4. Any LLC that is sparsely funded or under capitalized
Having an LLC does provide legal asset protection. A trust provides zero protection at all, and with todays technology, it is nothing for an attorney to find out the back info of the trust.
Piercing the corporate veil is done when you do not follow the legal entities of an LLC. That means co-mingling assets such as using the business fund to pay for something personal or vice versa. This is an immediate way to bypass the protection. Also, you must establish a bank account for the company, have an operating agreement in place and issue Ownership certificates, along with a few other things. These are the easiest ways for someone to "pierce the veil."
This advice is all directly from an asset protection attorney, who I paid a lot of money for the information to set it up right.
Quit-claiming into an LLC still offers you the protection, and if you set up your LLC correctly using non-disclosure states they will provide the real protection that many believe a trust provides.
Several issues here:
1) Transfering the home to an LLC when there is still a residential mortgage on the property technically can trigger the due on sale clause of the promissory note/mortgage - while the bank may not actually call the note due now since interest rates are still so low, the bank has that legal right. How comfortable are you with that hanging over your head? Especially if interest rates jump?
2) Transfering assets to an LLC with no money exchanging hands (or even looking like it exchanges hands) is one (of several factors) that may weaken the protections offered by an LLC. Note that this is not co-mingling funds - it is just gifting an asset to an entity, which brings into question whether the entity (the LLC) has any separate existance from you the individual owner.
3) A single member LLC is more susceptible to veil piercing.
Please note - I am not disregarding the use of an LLC (even a single member LLC) for owning rental property. I'm just saying that you have risks: one (veil piercing) you had specific concerns about; and, one (due on sale clause) you did not mention....
Thanks Keith. That's some good information for me to look into.
@Brian W. I don't mean to offend anyone but most of the advice you have gotten here is bad, although @Mike Neubauer gave excellent advice. I do not like to admit this but I am an attorney. First the disclaimer, not all states have the same laws and precedents when it comes to LLCs. So if your states laws are different than mine not everything I say will be correct. If your state allows an LLC to have 1 member it is legal and will provide you with liability protection the same as any other limited liability company if you follow the rules. First of course you can transfer a property you own into an LLC without it being a way to pierce the corporate veil, that is how you fund them. The big thing is to follow ALL the rules. It is a seperate legal entity. Putting money in increases your stakehold in the company. Just follow the formalities when you do it.
You do not appear to understand enough about an LLC to form one or to fund one right now. If you do not understand about funding it, how to treat funds etc, you have no business getting 10 minutes of advice here to follow it. Go to an attorney in the state where you operate and pay him to draft it, explain it, and give you directions on how to operate it. Do not waste your money forming an LLC if you do not know how to keep the corporate formalities. Hold your business meeting every year, never comingle assests follow corporate protocal to pay dividends or whatever method has been adopted to remove money. Allways sign as managing member of your LLC never just with your name, file taxes for it. The list goes on, but most importantly if you do not know the rules you will break them. Maybe some states have a law about property trusts that protect assets but most trusts provide NO protection. No trust law I know of allows you to protect yourself with a trust you form for yourself. The really affective trusts are the spendthrift trusts you form for another person. You must truly part with the money, and can never use it for yourself. Apparently LLCs in some states are fairly expensive, in my state they cost $100 to form and annual reports rarely exceed $100. Spend a little money to get it right, it is possible a large potion of your investments could hinge on it someday.
@Jerry W. Have you been keeping an eye on the caselaw with regards to single member LLCs? The number of courts that disregard liability protection for single member LLCs is growing. I'm not saying it is universal. I'm not saying it is guaranteed. I'm not saying one should not form a single member LLC. I am saying that one should be aware that there are risks: a single member LLC may not provide the protection that is foremost in one's mind when forming an LLC.
Thank you very much to everyone who has responded.
To be clear though, having had both multi-member and single-member LLCs currently and in my past, I fully understand how to properly operate one. My question is more specifically geared toward the homeowner's insurance aspect.
I think I worded the original question poorly, so I will reword it below.
If I insure a property held in an LLC with an insurance company that currently insures my personal home and they place the investment property (that is held in an LLC) on my policy with the owner being the LLC as well as me personally, will this compromise the integrity of the LLC shield?
@Brian W. Anything that compromises the separation between the LLC and you as an individual can serve to weaken any liability protection offered by the LLC. Therefore, having the insurance policy list both you and the LLC as the owner; and, the fact that (as I understand it) there is still a mortgage on the property granted by you as an individual - both will make protection against liability weaker than it would be if the LLC was the only insured and the LLC granted the mortgage.
How much weaker? That I cannot say....
Separation is good.
Co-mingling is bad, whether its money, insurance or any other connection between the individual and the LLC
Single member, or spousal multi-member, particularly disregarded for Federal income tax are more vulnerable than multi-member LLCs with non-spousal members.
Great advice. Thanks a lot Keith and David.
@Jerry W. , good post, if you feel I wsa giving poor advice in my opinion please point it out to me, I'm a bean counter regulator type, not an attorney. My comments (rant) was to commingling of funds.
I believe the piercing issue has much to do with your jurisdiction, liberal or conservative views and attitudes as well as the cause of any action against you will vary.
I also agree that insurance is your best line of defense, right after operating legally and prudently with reasonable care.
I've said many times here that if it walks like a duck and quacks like a duck it will be viewed as a duck, if it meows you may have a problem. :)
You are right on.
Prudent care and adequate insurance are number 1 and number 2 before an LLC. Many investors have that backwards and have an LLC but don't take prudent care and don't have adequate insurance like a large umbrella policy.
Frankly, I have never lost sleep over liability issues in any business venture and while I have formed several LLCs and corporate entities, the main purpose was not to hide from liability, it's nice to have an additional layer of protection, but it's how you conduct your business that keeps you out of trouble, IMO!
I have posted about LLC liability in more detail in other spots but let me try to clear some things up although this may be oversimplified. First LLCs DO add a layer of liability protection. The amount of protection truly does depend on your state because it is the state law that makes them usable in your state that defines how much protection they give. I do not research law in other states about their LLCs, but I occasionally see a case from another jurisdiction cited. Second no LLC or corporation will save you from your own negligent or tortious act you do personally. You can have 10 layers of LLC but if you drive drunk while driving your LLC owned truck hauling supplies to your LLC owned rental and you wreck and injure another you are liable period. If you know an employees is a drunk, or terrible driver, or not licensed, etc. and you let him drive you will be liable. If however someone is injured because the steps going into a house are not level and you have a properly formed and managed LLC or corporation, you will not be personally liable, only the LLC assets are. Having a mortgage in your name and transfering the property into an LLC. if done properly will not be cause to pierce the corporate veil. Hold a meeting, approve taking the property subject to the mortgage, have your bank do you a letter approving the transfer. You will have to personally guarantee all of the loans of your LLC or Corporation anyway unless you have an extremely large net worth in your LLC, or your banker is nicer than mine. Keep the minutes showing everything. Do a new rental agreement to the tenant in the LLC name, and a letter to the tenant explaining the change is due to new ownership of the building, do a memo to your accountant explaining the transfer from you to the LLC, etc. Your basis in the LLC is determined by how much value you have put into the company. Buying insurance for you out of LLC funds could be a problem, but if you do it properly it should not. If you pass a resolution that says the company will purchase a general liability policy of a certain amount for ALL of the managing members of the LLC in order to induce them to keep actively working for the LLC etc. it would probably be OK, add in your personal house and it is a problem because that is not furthering the interest of the LLC itself. Law firms buy liability insurance for employees as a company benefit, but they wont insure the employees house. Next single member LLCs. If your state allows them, and most do now, they will provide liability protection. Courts must honor the laws passed by the legislators unless they are unconstitutional. However, a court must determine if the company is just an alter ego of the owner and not truly a seperate legal entity. If you have 5 managing members and as a company policy all are covered by a $2 million liability umbrella policy, and your minutes reflect why and everyone is treated the same you are probably ok. If you only have 1 member and he gets an umbrella policy paid for by the company it doesnt look as much like a business reason because you are the only one benefiting. The judge makes the final call, but having 5 members and 4 of them never do any work, or participate in any way except be named will also hurt your ability to protect from an attack on the corporate veil. It has been several years since I litigated a piercing the veil case, but the rules are pretty much the same as far as I know, follow all the corporate formalities, treat the money and business as if it belonged to someone else, so you only take money when it is approved through a formal meeting and vote, preferably done annually, just like IBM would vote a dividend to stockholders. I hope I have not confused @Brian W. or @Bill Gulley more. Again if you have a specific question your state could have different precedent than mine, but if you ask a local attorney, and he sends a brief letter saying buying liability insurance for each managing member for acts they do for the LLC will not be cause to pierce the corporate veil, then if you ever go to court on it and show the letter it will be a huge help.
@Jerry W. , nope, not at all confused. Our thoughts are consistant on each area you mentioned.
Another point might be the liability between partners as claims can be brought from those inside the LLC.
Treating all the same is a good practice. However we did do an LLC with different classes of members with different voting rights and responsibilities, along the lines of preferred and common stockholders. All went smoothly.
A well written Hold Hamless and Indemnification Agreement made by and between members, as a part of the Operating Agreement, might be a good idea.
Auto coverage is probably a commonly overlooked area by investor/LLC types.
Thanks for posting Jerry!
Fantastic advice Jerry. Thank you!
I think the question here is whether the corporate veil can be pierced.
The answer is always YES, it is impossible to guarantee against that. However, there are steps that can be taken to reduce the possibility of that veil being pierced.
Yes, it is true that case law shows that a multimember entity has stronger protection than a single member.
Yes, corporate formalities must be followed, this is a given, if formalities are not followed then the veil is very weak.
etc etc There are books written about all the steps, tricks and tips that should be followed. A local attorney must be engaged for more specific advise.
As for the specific case of whether the fact that there is an insurance policy which insures 2 properties, one in the name of the individual and one in the name of an LLC, where that individual is also a member of the LLC… I would not say that this circumstance by itself would be sufficient cause for piercing the corporate veil, there would need to be more reasons than just this. One could build an argument that this setup provides a financial benefit to the LLC which is a contribution from the member. Contributing to an LLC is not comingling, comingling is mixing assets without observing any rules and formalities.
An important clarification here is who would want to pierce the corporate veil and why?
The note holder?, this guy has recourse against the original borrower and the LLC. The loan may not be assumable and the fact that the property was transferred in violation of that may increase the options for the note holder.
What about the Tenant? Tenant is being served by the LLC who also owns the property but the lease is in the name of the individual. This tenant may have recourse against both, without needing to pierce the veil. Why would he want to pierce the veil?
What about a completely unrelated third party? As mentioned, I would think that their ability to pierce the corporate veil would need to have more circumstances that just the fact that the insurance provides coverage to both individual and LLC.
Now, if this were a multimember LLC, the other members not being only the spouse, I would think that it would be even more difficult to pierce the corporate veil against the third party members just because of the insurance.
And then again, just being practical, it would be better to separate this. Let the LLC have its own insurance policy and let the individual have its own. There may be no monetary benefit in having these 2 coverages in one. In fact, the coverages should be different. This point would be better answered by an insurance agent.
It hasn't been mentioned, but since there are a couple of lawyers on the thread and it's agreed that state law is controlling, what about the issue of establishing the LLC in a business-friendly state like Nevada or Wyoming (when the owner lives and holds his rentals in Ohio, for example). Is there added protection in organizing in one of these states, even though it'll likely mean greater LLC fees from having to register as a foreign entity in your home state?
I've never been a big fan of registering an LLC in NV, Wy or DE. The foreign entity is an issue. In PA it is even accompanied with a tax.
But a bigger issue is the liability issue. If somebody slips and fall on your property in Ohio, that is owned a NV LLC, where do you think that they will sue you Ohio or Nevada?
BTW great name
"what about the issue of establishing the LLC in a business-friendly state like Nevada or Wyoming (when the owner lives and holds his rentals in Ohio, for example)."
If the owner is in Ohio, the property is in Ohio, the tenant is in Ohio, and the cause of action (i.e., the disaster over which you are being sued) arises in Ohio. Where will the suit be filed? If you answered Ohio - you'd be correct.
What will an Ohio court do if the landlord is a NV LLC? The Ohio court will apply Ohio law. What advantage was there to creating the LLC in NV? None. Is any damage done by creating the LLC in NV? Possibly - the court sees everything is in Ohio, yet the business entity is in NV? The judge will ask (technical legal question coming up) WTF? And the judge may think you are trying to pull a fast one and be extra hard on you.
Question - what is the goal in forming a NV LLC to operate rental property in Ohio? My guess is that whatever your stated goal, forming the LLC in NV doesn't get you any closer to it than you could get by using a knowledgeable professional to form the LLC in Ohio.
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