Should I put investment property into an LLC or a trust?
Attorney · Los Angeles, CA · Member since 2015 · 65 posts · 51 votes
Three of us are planning to buy a single family home or duplex for a buy and hold plan this summer (or before). We know we most likely need to take title in our own names for mortgage purposes, but then want to transfer the property out of our names to protect us financially.
We can transfer into an LLC or a trust. Anyone have a preference on one versus the other, and why? Anyone have personal experience and care to explain the pros and cons? Thanks in advance.
(Note: I am a former realtor and am a current real estate attorney (we specialize in representing developers of affordable housing properties. I have experience setting up LLCs and drafting LLC operating agreements, etc.)
Are the three of you in business together currently or are you related in some way? That will make a difference in how you want to structure this. You are correct that holding the property in your name opens you up to liability which includes holding the property in an LLC that is not anonymous.
What structure you want to hold this in which also affects your tax & protection benefits, will depend on your relationship to the other owners, how long you wish to hold the property, where you all live, where the property is located, among other situations (i.e. will this tie into anyone's estate, will the property be sold eventually or is a 1031 exchange the best option, etc.)
* I am not an attorney and I'm not YOUR attorney. I'm simply happen to know the best ones :) *
Are the three of you in business together currently or are you related in some way? That will make a difference in how you want to structure this. You are correct that holding the property in your name opens you up to liability which includes holding the property in an LLC that is not anonymous.
What structure you want to hold this in which also affects your tax & protection benefits, will depend on your relationship to the other owners, how long you wish to hold the property, where you all live, where the property is located, among other situations (i.e. will this tie into anyone's estate, will the property be sold eventually or is a 1031 exchange the best option, etc.)
* I am not an attorney and I'm not YOUR attorney. I'm simply happen to know the best ones :) *
We are three close friends, but not related by blood. We currently are not in any business relations together. This will be our first investment purchase with hopefully 1-2 more this year and continued purchases in the coming year. We are planning these as buy and hold properties for the long term (more than 5 years).
Locations: We live in California and have not finalized our purchase location, but midwest states are the focus.
Tax: This won't be tied to estate of any party in the deal. We have not discussed property sale vs. 1031 exchange.
Thanks~
@Kellan Martz With three partners in CA I would assume an LLC. You could form the entity yourself, and it would only be an annual fee of under 300 for each partner.
If this was solely in your name, and you had several, I would point you toward an attorney who specializes in forming Delaware Statutory trust. These are actually great for long term holdings offering anonymity and asset protection without the 800 dollar fileing fee.
the LLC part is easy. Getting a mortgage might be a bit harder. If you buy and title the house in one of your names, the mortgage responsibility is of course totally on that person. It also gets sticky with a due on sale clause, because you're not only transferring to a single partner LLC, but a whole different entity.
It's an area I don't know a whole lot about - but you may want to consider a commercial loan under the LLC with 3 partners.
You have a couple of options. Curious as to what type of trust you are envisioning here? Are you talking about your own individual living trusts to split title 3 ways and just get a good umbrella policy? If so, you may want to consider a written co-ownership agreement. Are you looking for a trust that has asset protection available? If so, you may want to look into the concept of self-settled trusts to see if it defeats your intention. Perhaps a holding trust would work but it may not provide asset protection. An LLC is definitely an option as well which does give you the asset protection feature, and allows you to have a written agreement among the three of you for several possible issues that could arise in the future. You all likely should have your own living trusts be the members in the LLC if you have them (and definitely want to consider creating one if you don't... should protect against probate). Since you're an attorney yourself, you probably are familiar with a lot of these items and concepts, but just some food for thought.
*This post does not create an attorney-client or CPA-client relationship. The information contained in this post is not to be relied upon. Readers are advised to seek professional advice.
@Kellan Martz - Both.
Get the property purchased by a trust, with the trust beneficiary an LLC. That way, the trust will provide the anonymity protection layer, while the LLC will provide you with liability protection [the trust alone is rather impotent; one complements the other]. That would be the simple answer.
But since you are in CA, you get special treatment and the complicated route - you might want to look into the Delaware Statutory Trust (DST) to save on the outrageous $800 annual fee. How to solve the financing in personal name question, especially with multiple unrelated parties, is another complicating factor (but if you go directly to an LLC/DST, the loan will be commercial so that might solve this question).
And speaking of partners, doing business with friends is a sure way to lose them, so think hard before proceeding further. If you and/or friends have other assets, you might want your LLC to partner with their LLCs in the common asset holding LLC for the full protection. Here is a set of questions to clarify with the "friends":
What are the objectives of the joint venture?
- general trading principles
- what will the business actually be doing
Who puts what in?
- cash
- other assets
- services
- are any existing contracts of either to be taken over by the joint venture
- who actually does / will do what
Will any external funding be needed?
- who will it be raised from
- who will borrow it
- who will guarantee it
Who gets what out?
- sharing of revenue profits or losses
- sharing of capital gains or losses
- is any payment to be made to either other than as share of profits, eg for ongoing services
- will the participants be operating a ‘salary/dividend split’ – ie taking their month by month requirements by way of low salary, balance as dividends?
What, otherwise, will be the policy in relation to dividends – to what extent is it intended to distribute / retain surplus profits?
Who controls what?
- responsibilities for day to day running, in all relevant areas of activity
- tactical decision making (day to day)
- strategic decision making (longer term policies)
what things can only happen if both parties agree
what will happen if you can't reach agreement on some major issue - ie deadlock
What happens if either party 'wants out'?
- on what kind of notice will this be permitted
- does the other have 'first refusal' to take over the whole venture? - if so, on any favourable terms?
To what extent will the parties be free to carry on other businesses
- while the joint venture subsists
- if one party pulls out
Is it intended that spouses/partners should also be shareholders, to allow for tax advantages from a broader split of dividends?
Is there a vision that any others will become shareholders (or be granted grant options to acquire shares) in the company in the future?
- Who?
- Staff?
- Others?
- On what terms?
Participation in dividends?
Voting rights?
Are there any offshore angles:
- Is there potential for overseas sales or operations?
- Does anyone involved in the venture have any overseas connections?
- Does anyone involved in the venture have any plans to live overseas in the future?
Is there yet any written:
- business plan?
- marketing plan?
- cashflow projection?
Is there an ‘exit strategy’? If so, what is it – which of the following most closely hits the mark?
- ‘lifestyle’ business – ie simply intended to be run by and to provide an ongoing source of work and income for the proprietors, no clear vision for the long term future?
- possibility of future sale at some point?
A core object of the venture is to create an asset with a view to sale or flotation in 5 years?
Which aspects of the above do you feel most important at present? Which aspects concern you most? (NB each of you may have a different view here, the question is asked to help understand where each of you is coming from)
You are an attorney, so you clearly understand you have multiple complicating factors in your scenario and you should get your answers from a specialist (like @Scott Smith) and not from a free online forum post, right?
I would say LLC because my experiences with trusts are not good. When you go to refinance or do anything related to title, your chances of things being complex are far greater when the property is in a trusts, not to mention, many lenders are hesitant to work with you because their underwriters hate them.