Today, amidst the turmoil and uncertainty brought on by the COVID-19 pandemic, individuals may want to take advantage of lower property values in certain areas of the country and purchase real estate with the intention of renting it and creating and receiving regular cash flow. It is important to note that for federal tax purposes, if the purchaser intends to use purchased real property as their primary residence, such real property will not qualify as rental property. In order for purchased real property to qualify as rental property, a purchaser must have the necessary motive to rent the purchased property to third parties and make a profit. If property qualifies as rental property, the purchaser is entitled to certain federal tax deductions and may take advantage of other significant benefits under the U.S. Internal Revenue Code.
Therefore, assuming a purchaser possesses the correct profit motive for purchasing the real property, the immediate question that the purchaser must decide is: what is the best way to title the rental property for asset protection and estate planning purposes? Specifically, should a purchaser title the rental property in their own name or use a single purpose entity such as a limited liability company, corporation, limited partnership or other limited liability entity (a “Company”) to make the purchase?
If the purchaser rents the property to third-party renters, either on a short- or long-term basis, the renters and their families and guests could bring a lawsuit claiming harm caused by some aspect of the property while such claimant was staying there. Moreover, if the purchaser holds title to the rental property in the purchaser’s own name, they will have personal liability for any losses to any claimant whether the claim relates to the property or not. For example, if a purchaser owns rental property in their name, that asset can also be liquidated to satisfy the purchaser’s third-party claims and judgments unrelated to the investment rental property. Essentially, that personal liability has the legal effect of opening all of the purchaser’s personal assets to the claims of creditors.
Using a Company to purchase rental property can help protect a person’s assets from the claims of their creditors. For example, if renters or other third-parties bring claims involving rental property owned by a limited liability company, the maximum potential liability of a member of the Company would ordinarily be limited to the dollar value of their ownership interest in the Company, leaving their other assets outside of the Company protected from any claims or judgments.
Nevertheless, if someone decides to invest in more than one rental property, they should consider using a separate Company to purchase each rental property in order to prevent the cross-defaulting of liabilities. Such cross-defaulting happens where one Company owns multiple rental properties. If a Company owns more than one rental property and loses any claim in court, any judgment entered against the entity could be recorded and become a lien on title against all of the Company’s rental properties until paid off. Moreover, even after the judgment has been satisfied in full, the entity still needs to incur the time and expense of clearing up title at each of its properties to remove the judgment lien of record from title.
From an estate planning perspective, as an individual accumulates assets and acquires a high enough net worth to start being concerned that their estate will be subject to U.S. estate tax, owning rental property in a Company will only affect the value of the person’s ownership interest in the Company (after deducting the value of the ownership interests of the other members, partners or shareholders of the Company, includable in the person’s estate for U.S. Estate Tax purposes). Moreover, using a Company to own rental property makes it very simple to fund a U.S. Federal Credit Shelter Trust or other trust prepared in connection with an Estate Plan since it only involves a retitling of the person’s ownership interest in the Company to the individual’s applicable Trust.
Also, from a practical point of view, having a Company hold rental property makes the transfer of all of the rental property’s accounts (i.e., real estate taxes, utilities and other third party services) very simple and much quicker and efficient in that all that needs to occur is the transfer of ownership interests in the Company.
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This alert should not be construed as legal advice or a legal opinion on any specific facts or circumstances. This alert is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The contents are intended for general informational purposes only, and you are urged to consult your attorney concerning any particular situation and any specific legal question you may have. We are working diligently to remain well informed and up to date on information and advisements as they become available. As such, please reach out to us if you need help addressing any of the issues discussed in this alert, or any other issues or concerns you may have relating to your business. We are ready to help guide you through these challenging times.
Unless expressly provided, this alert does not constitute written tax advice as described in 31 C.F.R. §10, et seq. and is not intended or written by us to be used and/or relied on as written tax advice for any purpose including, without limitation, the marketing of any transaction addressed herein. Any U.S. federal tax advice rendered by DarrowEverett LLP shall be conspicuously labeled as such, shall include a discussion of all relevant facts and circumstances, as well as of any representations, statements, findings, or agreements (including projections, financial forecasts, or appraisals) upon which we rely, applicable to transactions discussed therein in compliance with 31 C.F.R. §10.37, shall relate the applicable law and authorities to the facts, and shall set forth any applicable limits on the use of such advice.