Owning Property

Should You Transfer the Title of Your Investment Property Into Your LLC?

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Should you transfer [...]

In a perfect world, banks and/or lenders would lend money to new investment property LLC with no income or credit history, thus allowing you to purchase your investment property in the name of your LLC.

Should you transfer the title of your investment property into your LLC?  You could probably ask 10 different people for their position on this issue, and receive 10 different answers.  My position is that I do not like to transfer title from the individual to the LLC – for a couple of reasons.  First, transferring the title when the mortgage is still in your name triggers a due on sale clause within the mortgage/note.  Second, if you ever go to refinance, you will have to transfer title back out of your LLC to you individually, creating a strange series of transactions for your lender and/or title company to sort through.

My position rests on the assumption that you have properly formed your LLC, complying with all of the statutory corporate formalities including organizational minutes, bylaws, appointing the Board of Governors, Managers, Membership Units, etc.  In addition, all of your business dealings are done in the name of the LLC – your lease with the tenant will be between the tenant and the LLC, the tenant should pay the LLC, and the LLC has a separate bank account and accounting records.

From a legal standpoint, the tenant’s contract is with the LLC, not with the investor as an individual.  If something goes wrong, they should sue the LLC, not the individual.  That is not to say that someone couldn’t try suing the individual – it is not uncommon for a litigious person to throw everything against the wall to see what sticks.  Even if your strategy was to transfer title from your personal name to the LLC in order to “tie” the property to the LLC, the mortgage would still be in your name anyway, thus leaving the same issue for that litigious person to throw against the wall.  In addition, if you completed all of the other steps to adequately form and operate your LLC, the argument to be made is that it would be bad policy if a court ruled that in order to receive liability protection from your LLC, that you should have violated the due on sale clause in your mortgage/note.

Again, every new business must start the ball rolling somewhere.  Every new business is started with the capital or credit of the owner.  Eventually when you have built your portfolio, built your LLC’s credit history and property equity, you will no longer need to purchase properties with your own credit and in your individual name.  Your goal will be to get loans through the LLC and thus title in the name of the LLC.

Remember, most banks do not make loans to brand new LLC’s, therefore you must start the ball rolling by purchasing your property personally.  Perhaps the bank/lender will allow the LLC to purchase the property with the individual’s personal guarantee or co-signature on the note.  If the bank will not accept the personal guarantee, there are several other options to consider.  Some strategies could include the individual leasing the property to the LLC, which would then lease the property to the tenant.  Alternatively, there could be a written agreement between the individual and his LLC whereby the individual pledges and confers upon the LLC the right to possession of the investment property.  All of these alternatives should be documented through company minutes of the LLC that acknowledge and authorize the LLC’s use of the investment property.  Having these added formalities can only strengthen the liability shield created by the LLC.

Please feel free to contact me at the number below if you need assistance, have questions or concerns with respect to properly forming your LLC or incorporating additional investment property ownership strategies to strengthen the liability shield created by the LLC.

Matthew A. Engel, Esq.

Aase, Engel & Kirscher, PLLC

2499 Rice Street, Suite 236

Roseville, MN 55113

651-209-6884

matthew [dot] engel [at] aeklawfirm [dot] com

www.aeklawfirm.com

Reminder: Investment Property 201-Getting Started with Quickbooks

This is a must attend for all landlords.  Learn how to make your bill paying and record keeping much more organized.  This free seminar will launch you down the path of watching your costs and income much closer. If you are new to Quickbooks, this will help you get started.
This seminar is held in Burnsville [...]

This is a must attend for all landlords.  Learn how to make your bill paying and record keeping much more organized.  This free seminar will launch you down the path of watching your costs and income much closer. If you are new to Quickbooks, this will help you get started.

This seminar is held in Burnsville at 6:30pm on January 26.  Click here to register.

Partnerships and Rent Collection

Partnerships in investment property is a fairly common practice.  I was never one to want a partner initially, but after watching some successful investment property partnerships, I am convinced more than ever that there is at least one place they can be a huge benefit.  This place is in rent collection.
I am often amazed at [...]

Partnerships in investment property is a fairly common practice.  I was never one to want a partner initially, but after watching some successful investment property partnerships, I am convinced more than ever that there is at least one place they can be a huge benefit.  This place is in rent collection.

I am often amazed at how far a landlord will let a tenant go on paying their rent.  I even fall into this siren song occasionally:  “if I evict them today, I will get nothing, but if I wait just one more week (like the tenant says they need), I might get paid”.  While it rarely works out that you get paid, it always seems like the smoother path to wait another week that go to through the ugly process of filing and eviction.  Most individual landlords make this mistake.  Call it Minnesota nice or just the fear of confrontation, I have not met many individual landlords that are really as hardcore at rent collection as they need to be.

When watching several successful partnerships recently, I noticed that they seem to be much more business-like and unwavering at rent collection.  It is due on the 5th, by the 6th they send letters and statements, by the 11th they are filing evictions.  Maybe it is male ego or something, but it seems like one partner will not allow the other partner to deviate from the rental collection rules.  I suspect that individually, they might make exceptions if they weren’t accountable to anyone else.  Together the partners make a stronger team.

Rent collection is necessary part of being a landlord, but also one of the least enjoyed or maintained.  This is how you get paid, this is how you pay your bills. If you don’t have a partner in the business, be accountable to your spouse to collect all the rent and in a timely manner.

MAAR Report: Home prices continue to stabilize in November [Really?]

As much as I want to believe the following stats, I am skeptical.  I think they make some good assumptions and per the stats, sales prices are rising.  I think it is a little early to call the war won and that we are on a recovery.  If you pull your head out of just [...]

As much as I want to believe the following stats, I am skeptical.  I think they make some good assumptions and per the stats, sales prices are rising.  I think it is a little early to call the war won and that we are on a recovery.  If you pull your head out of just the housing market and take a look at the rest of the economy, how can you say we are on the recovery road?  With unemployment at 10%+, a 2nd stimulus package looming, congress’s approval rating at historic lows, and inflation just waiting to take off from all the money printing the Fed is doing, I suspect we are going to being the housing market get worse again before it gets better.

From the Minneapolis Area Association of Realtors, December 10, 2009

Extremely heavy buyer activity and shrinking inventory led to strengthening Twin Cities home prices in November.

The November median sales price of $170,000 was a slight increase from October—a rare occurrence in this month that typically marks the beginning of a temporary winter price swoon. This mark is 2.9 percent behind last October, the lowest year-over-year price decline in more than two years.

“This is the surest sign we’ve seen yet that we’re on recovery road,” said Steve Havig, President of the Minneapolis Area Association of REALTORS® (MAAR). “We’ve seen sales growing for almost a year and a half, and prices are starting to reflect that, particularly in the lower price ranges.”

The median sales price of traditional homes (excluding foreclosures and short sales) in November was $190,000, down 15.6 percent from a year ago. Since a heavy share of buyers in November were likely first-timers who typically buy in the more affordable price ranges, prices in the traditional segment have been weighted downward. Foreclosures posted a November figure of $127,500, up 2.0 percent from a year ago, while short sales prices were at $143,500, down 15.6 percent from a year ago.

There were 2,987 signed purchase agreements in November, a big dip from October due to seasonal trends and to the tax credit’s initial expiration date. That’s still up 10.2 percent from a year ago—the 17th consecutive month of year-over-year increases in pending sales. Closed sales posted a whopping 67.0 percent jump from a year ago, again due to the tax credit.

The Months Supply of Inventory has dropped to 5.7 months, the lowest mark since April 2006. Traditional homes have 7.6 months of supply, foreclosures have 1.4 months and short sales have 12.8 months.

“Supply is dropping in the traditional and foreclosure markets,” said MAAR President-Elect, Brad Fisher. “Short sale supply is stagnant because of the headaches involved in purchasing them. The process needs to improve, but industry and government efforts that are coming soon could help.”

All information is according to the Minneapolis Area Association of REALTORS® (MAAR) based on data from the Regional Multiple Listing Service of Minnesota, Inc. MAAR is the leading regional advocate and provider of information services and research on the real estate industry for brokers, real estate professionals and the public. MAAR serves the Twin Cities 13-county metro area and western Wisconsin.

Best Property for First Time Investor

I was meeting with another Realtor on our team on Friday.  He wanted to discuss buying investment properties sometime in the future as a long term retirement plan.  One of the questions that came up was “what type of property would you buy if you had to do it all over again”.  I had actually [...]

I was meeting with another Realtor on our team on Friday.  He wanted to discuss buying investment properties sometime in the future as a long term retirement plan.  One of the questions that came up was “what type of property would you buy if you had to do it all over again”.  I had actually answered this question a long time ago when a reader asked “What Type of Property Investment is Best for First Time Investors“.  Now 2+ years and 100’s of properties later, I would have to answer:  a nice single family home.  I have really come to appreciate the simplicity of buying, owning, and managing a single tenant in a single property.

Single family rentals have some great pros:

• More desired by the average tenant than a duplex or apartment, consequently it is easier to rent a single family home.
• Higher rent possible.
• Tenant takes care of all lawn care and snow removal (typically).
• Minimal monthly landlord expenses (usually just water/sewer/garbage).
• Single Family Home tenants tend to be less transient.
• Easier to sell this property in the future to either an owner occupant or investor.
• Problem tenants can’t sour other tenants (unlike multi-family).

Now, there are some drawbacks, but I think they are manageable:

• When the property is vacant, no rent is coming in.
• Capital improvements can not be spread out across a larger gross rent.  In other words, a duplex may generate $800 per month in cash flow versus a single family home that generates $400 per month.  Unfortunately, the roof on the single family house may cost just as much as the duplex to replace, resulting in it taking twice as long to recover that cost.

Ultimately, this Realtor friend is making the right decision to buy an investment property.  The type doesn’t matter, just get in the game.

Can any owner of rental real estate qualify as a real estate professional?

Disclaimer: I am not an attorney or tax accountant.  This is a summary of information I have learned over the years.  You should consult a qualified professional for full information.
So in additional to your regular job/career (which have nothing to do with real estate), maybe you own an investment property or two.  Typically these [...]

Disclaimer: I am not an attorney or tax accountant.  This is a summary of information I have learned over the years.  You should consult a qualified professional for full information.

So in additional to your regular job/career (which have nothing to do with real estate), maybe you own an investment property or two.  Typically these investment properties will generate paper/tax losses when factoring in your initial down payments and depreciation.  It would be nice to deduct these paper losses against your other income for tax purposes. Unfortunately, under current tax law, losses from passive activities, which you do not “materially participate” (definition below), cannot be deducted against non-passive income (from your job or business which is your principle source of income).  Rental real estate activities are automatically treated as passive activities, even if the owner “materially participates” in the management, operations, leasing, etc.

One exception is that taxpayers can deduct up to $25,000 in losses and credits from passive real estate activities against non-passive income if they “actively participation” in those activities (active participation is a much lower bar than material participation).  The exception on the exception is that this does not apply to taxpayers with adjusted gross incomes over $100,000.

What’s “material participation” in an activity?
Material participation in an activity means involvement in the operations of the activity on a regular, continuous, and substantial basis. If a person passes one of the following seven tests, IRS accepts that as establishing material participation in an activity:

• participating in the activity for more than 500 hours in the tax year (the most frequently utilized test);
• participating in the activity if the taxpayer’s participation is substantially all of the participation in that activity by any individuals (including non-owners);
• participating in the activity for more than 100 hours in the tax year, if nobody else (including nonowners) participated more;
• participating significantly in the activity, if participation in all “significant participation” activities for the tax year exceeds 500 hours (but this test isn’t accepted for showing material participation in rental activities);
• having materially participated in the activity during any five of the ten tax years before the year at issue;
• with respect to personal service activities, having materially participated in the activity for any three years (not necessarily consecutive) before the year at issue;
• showing regular, continuous and substantial participation on the basis of all the relevant facts and circumstances, but only if more than 100 hours of participation during the tax year can be shown (and management services aren’t taken into account for purposes of this test unless certain stringent requirements are satisfied).

Why do I want to be a Real Estate Professional?
If you qualify as a “real estate professional,” your rental real estate activities are not automatically treated as passive.  Consequently, you will be entitled to deduct losses from that activity against non-passive income.  Additionally, the $25,000 deduction cap is removed to all you to deduct an unlimited amount against your non-passive income.

So how do you qualify as a Real Estate Professional?
Here is the summary details:

• You must materially participate in a real estate business (renting and leasing do qualify).
• More than 50% of the personal services you perform in all your businesses during the year must be performed in real estate businesses in which you material participate.
• Your personal services in a material participation real estate business must account to more than 750 hours per year.
• You must own at least 5% of the business that materially participates in the real estate business.  In other words, you can’t be the receptionist of large leasing company, work their 40 hours per week and claim material participation (as you don’t own 5% of the company doing that work).
• These tests are applied annually. This means that you may qualify as a real estate professional in some years but not in other years. As a result, the same real estate activity may generate passive losses in some years and non-passive losses in other years.

How do I prove Material Participation?
The extent of an individual’s material participation in an activity may be established by any reasonable means. But the most reliable means of showing material participation consists of keeping appointment books, calendars, daily time reports, logs, or similar documents that provide a detailed account of what yoy did with respect to an activity, when he or she did it, and how much time it took. Failure to document material participation is one of the most common ways of losing the right to treat rental real estate activities as non-passive (and to be in hot water during an IRS audit).