Converting properties to LLC

6 Replies

  Hi All, 

Just like many of you, I am new to BP. I have two rental properties in California on my name and one thing on my mind is liability. What does the process look like if I want to convert the rental units to be owned by an LLC? Where can I find some more information? Is it a problem if one of the properties I have was acquired using a 1031 exchange? Any help would be appreciated!

  Thanks, 

  Rudy

@Rudy T.

There are several considerations that can go into the analysis of whether you need an LLC or whether a large insurance policy will suffice. Will depend on several factors like the type of property, type of tenants, your risk tolerance, other assets you own, your estate planning, laws where the property is located, etc.

Any lawsuits would be limited to the assets of the LLC and not your personal assets (assuming you run the LLC appropriately and the corporate veil is not pierced). But, an LLC will not limit you from liability in total. You can still lose your investment in the LLC. If you're going the umbrella insurance route, make sure it will cover you for several things including just the routine slip and fall (like mold or earthquake). You'll also want to ensure you have a good property manager to look after the upkeep of the property if you are not there to notice anything deteriorating or which may need attention.

Creating an LLC in California would cost you a minimum tax of $800 every year. You would have ongoing filing requirements with the State and would need to keep business records and documentation. If you create an LLC, you will need a business account. Otherwise, if you hold them in your personal name you do not need a business account.

You also want to look at whether a pass-through entity helps your bottom line and your taxes. There is a new 20% pass through deduction you may qualify for that could help you, but not everyone qualifies. You should still be able to get this even if the properties are not in an LLC, if you qualify.


Another thing to be cognizant of is if there is debt associated with the properties. If you transfer them into an LLC, you may trigger a due-on-sale clause with the lender. It is also harder to get financing and loans direct to the LLC.

These are all things you will want to discuss with your attorney and CPA. If you need references for either of them in San Diego, let me know.

*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 should seek professional advice.

Originally posted by @Rudy T. :

  Hi All, 

Just like many of you, I am new to BP. I have two rental properties in California on my name and one thing on my mind is liability. What does the process look like if I want to convert the rental units to be owned by an LLC? Where can I find some more information? Is it a problem if one of the properties I have was acquired using a 1031 exchange? Any help would be appreciated!

Not needed, no real benefit.  Just make sure you're properly insured and leave it at that.   This coming from someone that has 30+ LLCs (but for larger multifamily.  I did it at first as a freddie lender required each be it's own entity.  Otherwise I wouldn't have)

@Rudy T. , as the posts above have mentioned, there are pros and cons to creating an LLC to hold your investment properties in California. To answer your specific questions (but not necessarily suggesting that you should go the LLC route), the California Secretary of State actually provides a pretty good walkthrough on how to create/organize the LLC in California: http://bpd.cdn.sos.ca.gov/llc/forms/llc-1.pdf.  You will also need to consider whether you need an EIN from the IRS, a separate bank account, and insurance endorsements for the LLC.  

Your question about the 1031 exchange property is very fact-specific. However, generally, if your single-member LLC is created properly and is considered a disregarded entity for IRS and state purposes, the transfer of the 1031 replacement property into the LLC will not cause a problem for the 1031 exchange process or for capital gains consideration.

@Rudy T. , there are no 1031 issues with contributing your property into a new entity. Your accountant will transfer the basis and handle that contribution. If the LLC is a single member disregarded entity as @Bryan Zuetel said then you are not changing the tax payer when you contribute that property into that LLC.  The activities of the property will continue to be reported on your schedule E.

Where it can affect 1031 is if you contribute the property into a regarded entity it becomes the tax payer for the property so when you later sell it will need to do the 1031 exchange and buy and sell.  

I've never cared enough to pursue but since we're on the subject... can some legal folks shed light on their opinion of a a disregarded LLC as a personal liability shield when the activity of the property is on the personal return of the LLC member and all income goes directly to the member? I'm kind of curious.