Most astute entrepreneurs will avoid running a business as a sole proprietor or as part of a partnership and opt to limit their personal liability by forming a separate entity to operate the business. A corporation or a limited liability company (“LLC”) is often the best vehicle to shield the business owner’s personal assets from claims that arise against the business. The same strategy can be implemented for real estate that is owned as rental property. Acting as a landlord is best viewed as being a business and a landlord should take the appropriate steps to shield their personal assets from any claims that arise in relation to the rental property.
Forming a corporation or an LLC in conjunction with the acquisition of an investment property to hold title is a good strategy to shield the landlord’s personal assets. For landlords who have already purchased rental property in their individual name, it is still possible to transfer the property to a corporation or an LLC. Although the process can be completed by simply recording a deed from the current owner to a registered company, careful consideration should be taken to avoid potential pitfalls or missteps in the process. If the landlord has an outstanding mortgage encumbering the property, the process of recording a new deed may violate the terms of the mortgage and allow the lender to require the entire loan to be repaid within 30 days. Additionally, if the landlord has a title insurance policy, the process of transferring the property to the separate entity may void the policy. Hazard or liability insurance policies will also need to be addressed to make sure the appropriate party is covered. Existing lease agreements should be reviewed to confirm any transfer to a business entity is effective or permissible under the lease.
Some landlords may utilize a realty trust to hold title to avoid having to undergo probate to pass the property to the landlord’s heirs. Realty trusts are effective in avoiding probate, but unlike a corporation or an LLC, a realty trust does not shield the landlord’s personal assets. To achieve the dual goal of shielding personal assets and avoiding probate, a landlord may desire to retitle the rental property under a corporation or an LLC that is owned by the landlord’s estate planning trust. This dual strategy can not only be utilized for investment properties but can also be used for other business interests such as shares of a corporation or membership in an LLC. By transferring the shares or LLC membership to a trust, the business can be passed to the business owner’s heirs without the need of probate. Business owners of a business that is taxed under the Internal Revenue Service’s Subchapter S, a so called “S-Corporation,” must be mindful that only certain types of trusts can be shareholders of an S-Corporation under the tax code.
Retitling investment property or a person’s ownership interest in a business should be done with care. Attorneys can guide landlords or business owners through the process to ensure their goals are achieved and assets are protected.
