Generally, in Washington state, income producing real property should be placed into a Washington limited liability company (“LLC”).
What is real property? Real property is any property that is of a non-movable nature: land, house, condo, building, etc. It is distinguished from personal property.
What does it mean to be income producing? Usually a person wouldn’t place a personal residence into an LLC. Though the residence may be valuable, it does not produce income and is not easily segregated from personal use. The target property for placement in an LLC is real property from which income is derived and not used for personal use. Perhaps it is a building from which a person operates a business. Perhaps it’s a single family home rental. Perhaps it’s land leased to a car wash. Perhaps it is a vacation rental property. All of these are income producing and all would be good options for placement in an LLC.
What is the benefit of placing income producing property into an LLC? The main reason is to reduce liability exposure. Property owners owe a legal duty to those that come on the property. The level of “duty” owed to a person on your property usually depends on the status of the guest. And, that level of duty effects the potential liability of the property owner. Insurance provides good protection against potential liability. But, insurance has its limits and can’t protect against all possible liability. An entity with limited liability (corporations and LLCs and limited partnerships) can provide effective liability protection to protect the personal assets of the entity owner. The assets within the LLC (the property) are still subject to valid creditor claims. But, when corporate formalities are followed, the assets of the owner held outside the LLC are not subject to creditor claims. These claims can be of the “personal injury” variety (e.g. slip and fall on property) or claims for products or services provided to the LLC (e.g. unpaid rent or machinery lease payments unpaid).
Why use an LLC specifically? Of course, there are many choices for entity selection: the c-corporation, s-corporation, limited partnerships, LLCs, etc. The LLC offers liability protection and also, importantly, pass-through taxation. Contrasted with the c-corporation which pays two levels of taxation (corporate tax and dividend when profits are distributed to the owner), the pass-through taxation of an LLC offers significant tax savings for most taxpayers. The s-corporation is also eligible for pass-through taxation, but it runs the risk of losing s-corporation eligibility based on its limited list of eligible owners. The fear of losing s-corporation eligibility tends to favor an LLC taxed as a partnership where the rules are more favorable for ownership.
What happens if I don’t put the asset into an LLC? Maybe nothing. However, the owner runs the risk of facing a liability greater than is covered by any applicable insurance.
Side benefit for out of state property in LLC: When a person places real property into an LLC, it changes the ownership type from that of real property to personal property (LLC ownership is akin to stock certificate ownership). So, the owner no longer owns real property, but instead the LLC owns the real property and the owner owns the LLC. Typically, real property in a foreign jurisdiction (e.g. another state) is subject to that state’s probate proceedings upon death. However, if the property is in an LLC, it will not be subject to the foreign state’s probate proceedings.
Cautionary notes: It is usually best to acquire the property in the name of the LLC. This means that a person should set up the LLC before purchasing property and then purchase the property in the name of the established LLC. If the property is owned before the LLC is created or if the property is outside the LLC, the owner can execute a simple deed to put the property into the LLC. The caution here is that, if the property is subject to a mortgage or deed of trust or real estate contract, the transfer would likely be a technical violation of the loan agreement which would authorize the lienholder to call the loan. It is therefore wise to check with your lender prior to placing property in the LLC. Also, owners must respect the formalities of entity ownership by keeping separate books and records to effectively show that the entity is separate from the owner himself. For example, owners should never use company assets or funds for personal use. Finally, always remember to sign contracts and other LLC paperwork in the name of the entity and with your title. For example: Beau Ruff, President of Ruff Property LLC. Talk to a qualified business attorney for more information.
* Licensed, not practicing.
The opinions voiced in this material are for general information only and not intended to provide specific advice or recommendations for any individual or entity. This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
Securities offered through LPL Financial, member FINRA/SIPC. Investment advice offered through Cornerstone Wealth Strategies, Inc., a registered investment advisor and separate entity from LPL Financial.