Here is a synopsis of 3 conversations I had this past week with different real estate investors. Each of the investors set up a plan on the advice of a purported specialist. What inspired this post was the fact each investor worked with someone different and all 3 made the same mistakes. Don’t make these mistakes with your asset protection planning.
Q: You did what (words can not convey my befuddlement)?
A: I set up a Utah LLC and Quitclaimed my investment real estate into the LLC.
Q: Where is the property located?
Q: Is your property encumbered by a mortgage?
Q: Who told you to set up your structure in this manner?
A: The speaker at a recent real estate investment seminar I attended a few months back. He told us this is how all of his students protect their investments.
Q: Was the speaker an asset protection attorney or did you work with and asset protection attorney who specializes in real estate?
A: No, he is not but he told me he works closely with attorneys who design theses structures.
Did you spot all three errors? If not continue reading because your asset protection plan may depend upon it. I guarantee you the third error is the least obvious.
- Property not located in Utah should not be transferred into a Utah LLC unless the Utah LLC is registered in the state where the property is located. Companies who push Nevada, Wyoming, and Utah encourage real estate investors to establish LLCs in these states to hold title to their investment real estate. (See my previous posts LLC Asset Protection Benefits are Jeopardized When Filed in Another State or Running your Real Estate Business out of Nevada or Wyoming) Typically investors are told all of the benefits of establishing in these states (with the exception of Utah that has no benefits in my opinion) without the additional requirement of foreign registering the LLC in the state where the property is located. Why? Because many of the promoters of these states make money off annual fees charged to your LLC to keep it compliant. Further, even if you are told to foreign file in the state where your real estate is located, thereby incurring an additional filing fee, you are not told the benefits of your home state of organization do not carry over into the other state e.g., charging order protections, tax savings, anonymity, etc..
In this situation the better course of action would be to establish the LLC in the state where the property is located and have the home state LLC owned by a Nevada LLC (See Is it Time to Consider a Nevada Holding LLC) which does not conduct business in any state other than Nevada, i.e., it does not own any real estate it only holds interests in your various real estate holding LLCs.
- Do not transfer encumbered real estate into a LLC. Every residential mortgage has an acceleration clause a.k.a due-on-sale clause. This clause allows the lender to accelerate your mortgage if you transfer title to a third party or business entity. Now granted, while interest rates remain low their is little incentive for a lender to exercise this process however, if interest rates begin to climb then you may be at risk. In the late 70s and early 80s lenders were notorious for accelerating mortgages to force homeowners into higher interest rate contracts. (Many of these accelerations were the result of homeowners transferring their property into a grantor trust.) Accelerations became such a problem that congress weighed in on the matter and passed legislation preventing lenders from accelerating mortgages when the transfer was made to a grantor trust. This is know as the Garn St. Germain Act.
In this situation the real estate investor should consider establishing a land trust, i.e., a grantor trust, to hold title to their investment real estate. Although the land trust provides no asset protection this can easily be obtained by privately assigning the land trust to a LLC for asset protection. From the public’s point of view, the property is held in a trust and the LLC’s existence remains hidden like a trap waiting to spring on an unsuspecting creditor hoping to cash in on your success but only to be denied when the LLC is brought to light.
- NEVER USE A QUITCLAIM DEED. The type of deed by which real property is transferred is extremely important but this subtlety is lost on the asset protection salesman or real estate investment speaker offering this advice because their interest lies in making a sales commission on your action taking and besides, they really don’t know any better. You are about to.
As everyone knows, real property is transferred by deed. Deeds come in a variety of forms including General Warranty Deeds, Grant Deeds, Special Warranty Deeds, Sheriff Deeds, Bargain and Sale Deeds and Quitclaim Deeds. The warranty and bargain and sale deeds contain warranties regarding the title to the property, which are provided by the Grantor to the Grantee. A Quitclaim Deed provides no such warranties. A Quitclaim deed only conveys bare legal title, i.e., the interest held by the Grantor. This is extremely important when it comes to preserving your TITLE INSURANCE COVERAGE! In most most title insurance contracts the fine print in the policy states that, “The coverage shall continue in force in favor of an insured only so long as the insured retains an estate or interest in the land … or only so long as the insured shall have liability by reason of covenants of warranty made by the insured in any transfer or conveyance of the estate or interest.”
This highlights the difference between a Quitclaim Deed and a Warranty Deed. A Warranty Deed warrants certain matters pertaining to title. In contrast, a Quitclaim Deed warrants nothing. It conveys whatever interest the Grantor actually holds, if any. Thus, when you Quitclaim your property to a land trust or LLC you are voiding your title insurance coverage. When transferring title always use a Warranty Deed to protect your policy. More importantly, do not follow the advice of asset protection salesman who are willing to say anything for a commission and do not have a license to protect.