When should real property be transferred to an LLC in California?

Using a limited liability company to hold property is a popular wealth management tool in California, but as with any tool, it must be used properly. LLCs allow owners to mitigate risks associated with legal action, personal financial responsibility, and other liability issues. That is because the LLC, not the individual, holds and owns the property.

There are numerous considerations when transferring real property into an LLC, which can only be determined based on individual circumstances. Some more common and significant advantages and disadvantages can be discussed generally.

Most of my writing is about insurance, so why the LLC conversation?

Obtaining homeowner’s insurance can be complex in California, so many property owners look for loopholes and opportunities to protect their property that offers added security.

We frequently come across properties titled under LLCs, even more so in the last few years as property owners get creative to find ways to insure their homes. An insurance broker will not advise on property titling but will work with the facts they are given to provide the best options.

However, depending on the use case of the property, a property titled to an LLC will have more limited options and likely less flexibility when the market softens again.

Property owners must consider the legal ramifications of improperly transferring ownership, and I wanted to bring up some of the high-level conversations I've had with property attorneys surrounding insurance.

Taxes

In general, LLCs don’t have any significant advantages over holding property as an individual or trust; however, it’s worth noting a few transfer considerations.

There are multiple opportunities for tax advantages, depending on property use. LLCs are valuable for rental properties because profits or losses pass through to the individuals.

Only the LLC owners pay taxes on the profits, not the LLC, so the double taxation element found in some other business registration or incorporation types does not exist. This is an essential distinction if property owners consider other business entities for their real property.

Property tax reassessments are often a significant consideration for California homeowners. Since different rules govern property owned by an LLC than that owned by an individual, it is crucial to understand the implications of transferring ownership.

Ownership should be maintained even when transferring to an LLC to avoid reassessment and a probable increase in property taxes. For example, if you own a house and want to transfer ownership to an LLC, you can avoid reassessment if you own the LLC.

Personal Liability

Limiting personal liability is a significant advantage of placing real property into an LLC, though it is not definitive.

In some situations, property within an LLC can be accessed by creditors to satisfy debts and liabilities (”piercing the corporate veil”). There are steps that can be taken to ensure greater separation between personal and business property, which is best reviewed with the appropriate council.

For general intent, though, holding property under an LLC means that liability begins and ends with the assets of the LLC. In other words, any litigation involving the real property owned by the LLC will not trickle over into the personal property held by the owner of the LLC. An owner's private real estate, bank accounts, and other assets are protected.

Privacy

High-net-worth individuals often value privacy, especially when it comes to the location of their homes. Keeping an owner’s name out of public databases can be challenging because LLC filings also include owners’ names and may jeopardize the privacy and security of these individuals. Anyone pursuing this method for privacy reasons must carefully balance these concerns with the risks of allowing a third party to take their place on the LLC filings.

LLC Costs

California requires every LLC in the state to pay a registration fee and an annual tax of $800. Additionally, any LLCs that make more than $250,000 per year must pay a fee based on the total income earned. These fees are relatively low, with income of up to $499,999 incurring just $900, but this is still a factor to be aware of.

Homestead Exemption

The Homeowners’ Exemption, sometimes referred to as the homestead exemption, allows qualifying property owners to claim a $7,000 reduction in the taxable value of their home.

The stipulation is that the property must be owner-occupied and the principal place of residence. If the property is owned by an LLC, this exemption cannot be claimed if the property is sold.

Mortgage Loans

Any mortgages on a piece of property will not transfer to the LLC with the title, so loans may become invalid once this transaction is complete.

Property owners should review their mortgage agreement carefully to determine if there is a due-on-sale clause. Transferring ownership may trigger this clause and make the mortgage balance due in full.

Capital Gains

The Code of Federal Regulations allows profits from the sale of a principal residence to be excluded from gross income (26 CFR § 1.121-1). However, property held in an LLC does not qualify for this exclusion, which means profits from the sale of LLC property may be subject to capital gains taxes.