LLC logistics as created as a partnership

14 Replies

Good morning all! Just a few short months ago, my 2 partners and I created an LLC for the purpose purchasing buy and hold rental properties. We closed on our first multi in July. The mortgage is only in one of the partners names because based on credit scores it made the most sense plus we knew we could spread the number of properties we could hold by keeping them separate. We even plan on having our wives involved increasing the number even more. My question is that although we have an LLC and all bills are paid out of a joint account, the mortgage is still only in one of the partner’s name. Are we even accomplishing the asset protection we intended by having an LLC? I hear about quick claiming the mortgage to the LLC but that can be dangerous in that it may be called to be due in full. Any suggestions would be appreciated! We are also discussing on how to file for taxes as this one partner will claim the taxes this year and the pla was to rotate between the 3 families. I look forward to your responses and thank you in advance! Jeff

So, @Jeff Piscioniere , wow, what a good start and wow, what a hodge podge potpourri of things! The mortgage is in one person name, and the title is held by who? The joint account is held by? What is the LLC role in all this?

I'm not a lawyer, nor CPA, and you need specialized advice.

But here are some suggestions:

- since you are dealing with partners, you need to have things very clear (what do you think it happens with the multifamily and the joint account if one of the partners hits someone's Lamborghini and crashes into a mansion and/or putting a person into hospital?) structured in terms of partnerships and asset protection. I think each one should have their own LLC partnering into an LLC for these type of endeavors.

You need to read these threads:

https://www.biggerpockets.com/renewsblog/effectively-conduct-joint-venture-agreements-as-a-real-estate-investor/

https://www.biggerpockets.com/forums/48/topics/596231-how-do-i-properly-construct-a-purchase-with-a-partnership

https://www.biggerpockets.com/forums/51/topics/591376-create-an-llc-for-first-partnership-best-way-to-do-so

https://www.biggerpockets.com/forums/51/topics/526244-taking-on-partner-s-and-limiting-our-liabilites

- one base idea of asset protection (and LLC) is to separate your personal affairs from the real estate investing. And also to separate the assets from activities. So, usually you establish an asset holding entity (the LLC or a land trust with an LLC as beneficiary) - this just holds title to the asset. And then you have an Operations LLC - a shell LLC that is the public facing entity, doing all the interactions with tenants, contractors, leasing, hiring, management, etc. with no assets and very little funds beyond whats required for proper capitalization and operations.

That's the basic idea, but things get complicated from there due to the partnership, financing, commingling, etc - which is your current situation. As I mentioned, you need specialized advice to untangle this - talk with @Scott Smith .

@Costin I. Great information and thank you! I am still unclear whether or not our property is protected by our LLC. We definitely have a well written out LLC with a good operating agreement however because the mortgage note itself is in the name of one of the partners, I’m unclear as to whether he specifically is at risk if something were to go wrong at the property. The question about the title is also a good one that I will have to find out about. I’ll be in touch if I have any further questions. Thank you again!

@Jeff Piscioniere

Where's this property located? State law is often relevant for these questions. 

Some general thoughts:

  • Unless the LLC owns the property, you don't really have any asset protection for liability related to the LLC.
  • Who actually owns the property? I have a hard time seeing a traditional lender granting a mortgage to the partner but title to the LLC.
  • Note that you don't "quiet claim" a mortgage --- you can't. You quit-claim the title. 
  • This entire system raises a lot of concerns for me --- at first glance at. Did you guys work with an attorney/CPA to come up with this? If not, hit the breaks and try to fix it.
  • Note that failure to disclose a silent partner for Freddie/Fannie type loans could constitute mortgage fraud. Again, I would really seek professional advice if you haven't done so already. 

Disclaimer: While I’m an attorney licensed to practice in PA, I’m not your attorney. What I wrote above does not create an attorney/client relationship between us. I wrote the above for informational purposes. Do not rely on it for legal advice. Always consult with your attorney before you rely on the above information.

@Jeff Piscioniere It depends on how the title is held (but I'm willing to bet is in the guy with the mortgage name, since the lender will most likely not allow other owners not tied with the note) and it depends on what you have in your operating agreement if the partnership is protected or you are exposed to problems partners might create. 

I'm not a lawyer, nor CPA, and you need specialized advice.

The property was not transferred (warning: with a QCD you'll likely lose title insurance, use WD when transferring) to the LLC, so you have no asset protection whatsoever - you have a person with a house and a mortgage who is also partner in an LLC that has somewhere in the operating agreement that it has a buy&hold rentals purpose. What is the link between the LLC and the property? None.

So, if the person on the title does something (gets sued for hitting someone with the car), the rental is at risk. You (the partners) will be fine...since you don't have a link to the property. "Fine" to the extent that person doesn't declare the property his (it is his, actually) and you the partners out of the deal.

If something happens with the rental (someone slips and falls because you didn't replace the balusters fully knowing the risk and despite the repeated requests from the tenant, in which case the insurance will not cover you since is considered gross negligence) and the person on the title gets sued, all his assets will be at risk, personal and the rental. Whatever he owns in the LLC should be protected though, if he/you maintained properly the LLC.

If one of the other partners in the LLC get in trouble, depending on how the LLC partnership is created, the LLC assets (that joint account...is that a business account?) might be at risk. But since in your case, the LLC doesn't own any property, there is not much at risk. Whatever personal assets you have is protected, since the damage is limited inside the LLC. So, in this case, the guy with the rental has protection.

Sorry, but it looks to me you have nothing - no rental, just an empty LLC (that's the bad news). Good news: you have nothing, so not much to worry about either. Clear as mud? Call/text me if need more clarification.

Again, I'm not a lawyer, nor CPA, and I might be wrong in my interpretation of your situation. You need specialized advice to untangle this spaghetti. 

Jeff,

You should review the Insurance coverage for the property to make sure the Named Insured matches the entity on the title. If the LLC is not on the title but did lend money toward the purchase it should be able to be added as a mortgagee. If the LLC is involved in the management of the property it may be able to be listed as an additional insured. A review of this whole deal/structure with your Attorney, CPA, and agent would be a good idea.

Originally posted by @Jeff Piscioniere :
Good morning all!

Just a few short months ago, my 2 partners and I created an LLC for the purpose purchasing buy and hold rental properties. We closed on our first multi in July. The mortgage is only in one of the partners names because based on credit scores it made the most sense plus we knew we could spread the number of properties we could hold by keeping them separate. We even plan on having our wives involved increasing the number even more. My question is that although we have an LLC and all bills are paid out of a joint account, the mortgage is still only in one of the partner's name. Are we even accomplishing the asset protection we intended by having an LLC? I hear about quick claiming the mortgage to the LLC but that can be dangerous in that it may be called to be due in full. Any suggestions would be appreciated! We are also discussing on how to file for taxes as this one partner will claim the taxes this year and the pla was to rotate between the 3 families.

I look forward to your responses and thank you in advance!

Jeff

Be very careful with the use of the word "partner". It has a very specific legal meaning that can often have negative effects. If your only business arrangement is that you are all owners of the same LLC, then they aren't your partners.

I'm also confused about the mortgage only being in one LLC member's name? Why is the mortgage not against the LLC? Does the LLC actually own the real estate? Or does just the one LLC member? What do you mean by increase the number of properties we could hold by keeping them separate? A "quit" not "quick" claim is a (typically bad) manner of transferring property. Make sure to check with an attorney in your jurisdiction before using one. In TX, they are frowned upon (they're not an actual deed) and will often not be able to be insured by a title company. Your state probably has its own rules.

You have a lot of issues going on here; I suggest hiring a lawyer in your state that ONLY represents your interests, and does not jointly represent you and your "partners" so you can get unbiased legal advice.

@James Miller ., 

You got enough to answer regarding your legal concerns. 

Let me summarize what happened here:

1 ) You have 3 member LLC.

2) House is bought personally with one of the partners in the mortgage. The house is not in the LLC yet.

It is not clear who actually owns the property? - of course not LLC. Does only one partner who has mortgage owns the property?

How did finances work? Did you guys equally paid for the property ? if so, all of you need to own the property.  You need to clarify this before we can help you. 

Regarding your taxes: 

No, you can not rotate taxes as you have mentioned. If you successfully transfer property to MMLLC, you LLC will file a partnership return. a partnership will generate K-1(s)( similar to W-2) for each partner with your share of rental activity. Then, you will report that in your personal return.

We all had a meeting the other night to discuss all our concerns and I brought to the table all the excellent information you all shared. The wife of one of the partners works at a bank and helped with the original mortgage origination process. We are going to “quit claim” (hope I got it right) the mortgage over to the name of the LLC which she assured us should not be an issue as she said banks are way too busy to ever discover it and make an issue with the due in full call. Is there anything else we should all be concerned with? Thank you!

You should make sure your state does not require you to notify the lien holder. TX does and it's likely real estate fraud if you don't. Your state may be different. 

Also, again, quit claims are bad. Use a real deed. Have a real estate lawyer in your jurisdiction draft the deed because if the deed isn't drafted just right, you'll lose your title insurance coverage (if you have any). You also want to talk to a CPA as you may be giving your co-owner a significant advantage in capital accounts. There may also be tax due if the real estate has appreciated between now the sale.

@Jeff Piscioniere I forgot to add: you *really* (like serious as a heartattack) need to hire a real estate attorney in your jurisdiction who ONLY represents you and not the co-owners or anyone else involved so you can get unbaised advice. Too many ways you could be taken advantage of here under the facts above and way too many actual and potential conflicts of interest for one lawyer to represent everyone. 

@Jeff Piscioniere  - be careful when choosing to use a Quit Claim Deed:

A person receiving a purported real estate interest via a quitclaim deed may receive no legal right to the property whatsoever. If the person seeking to transfer real estate with a quitclaim deed has no legal interest, nothing legally is conveyed. In the absence of title insurance--which is not available for a quitclaim deed--the person receiving the quitclaim deed has no legal recourse because the deed itself states that only the interest of the grantor, if any interest exists, is conveyed.

Whether title insurance terminates by transferring real property depends on the type of policy, and how “insured” is defined in the policy. You take a risk which could result in cancellation of your title insurance and complete loss of your real property without compensation in the event that a title issue regarding your real property arises.

Contact your title insurance company to determine coverage and if your policy does cover transfers , and when or how.

DOS - The transfer most likely will trigger the Due on Sale clause (DOS) - a detailed resource on Due on Sale you might want to read is: the-truth-about-getting-around-due-on-sale-clauses

Also, these threads might be worth reading:

386043-bank-called-my-due-on-sale-clause

183825-due-on-sale-clause-was-called-by-bank

232247-due-on-sale-clause

Then, if you choose to proceed, at least you'll know what you getting into.

@Costin I. Those were outstanding links including the second to last forum thread which I read all 132 comments. Got us talking as a group and thinking about what’s best to do. The most intriguing concepts I gathered was creating a land trust prior to quit claim. Sounds like a bank might only interpret this as an act In estate planning. The other realistic option to consider is the fact that other than being grossly negligent as a property owner and landlord, is it really necessary to have this and any subsequent properties in an LLC? Is increasing our home owner’s coverage enough? Would love to hear any feedback on those 2 options. Thank you!

The land trust should help with the DOS when transferring the property (and I already told you about my opinion on doing the transfer with a QCD). I'm not sure how that would work when you are dealing with multiple parties (because the trust idea works on the premise of an estate planing and don't know how you can make the case for that with unrelated parties), and that's why you need specialized advice from an asset protection lawyer familiar with the intricacies of your situation - contact @Scott Smith and he will be able to give you proper consult.

Insurance and asset protection is not one and the same, nor a question of one vs the other. You need insurance as the basic level of protection. You better have also umbrella insurance. Asset protection complements that and is another form of insurance - litigation insurance, because regular insurance doesn't cover you in all scenarios and for whatever limits. Your rental insurance is not going to cover you when you'll hit someone with your car on your way to work and you'll get sued for everything you own. Your rental insurance is not going to come into play if your partner(s) insults someone and gets sued for defamation and everything he owns (including your share in the rentals). Your rental insurance is not going to cover you when the wife of one of your partners shows the rental to a prospective tenant and makes the mistake of asking an over ponderal lady when is she due and gets (you all) sued for discrimination.

So, you want insurance regardless. If you have substantial personal assets, or cash flow and/or equity to protect, or other reasons to fear litigation, you'll also want asset protection. In your case, the partnership is a reason to have asset protection in place.

Here is a diagram that should give you some more insight, although it doesn't bring into play the partnership question, which complicates things:

@Jeff Piscioniere if you read all of the links on DOS, you saw that most investors think that banks calling a performing loan due is a rare occurrence. While that makes sense and you might think that's all that matters, the bank is also worried the note is no longer secured by an asset. And if in the past, that might been overlooked, in an environment of raising interest rates I would think they would welcome a reason to call the loan, grab the money and redeploy it at a higher rate, especially if the bulk of the interest was already collected (since you pay mostly interest in the beginning portion of the loan lifetime, and less later). So, like they say, past performance not a guarantee of future results.

That being said, in principle, you have options if hit with the DOS letter: you can refinance (if in a good position for that) or pay off the loan, or the problem can be cured easily by transferring the property back (and you can play this game back and forth repeatedly with the bank).

The main problem you have, IMHO, is the partnership. And that's why you need to have this spaghetti solved and placed in the LLC.

Or to rephrase - are you ready to lose your interests and participation in the property, if things turn on the bad side, for a variety of reasons? And, a more important question, if these are family or friends, are you ready to lose them, if a bad surprise arises?