Tax Consequences of Transferring Property to LLC
Setting up an LLC can help protect your personal assets and offer you some nice tax advantages, but before committing to the transfer, be sure to understand the potential tax consequences.
What exactly are the tax consequences of moving a property you already own into an LLC? While the transfer itself may not trigger taxes, the future treatment of gains, distributions, and sales proceeds could change. Mapping out those scenarios helps you determine pros and cons before making a final decision.
So, let's discuss what you need to know about how transferring and owning property in an LLC affects your taxes in the future and saves you a bundle down the road!
What is an LLC?
An LLC is a legal business structure combining aspects of partnerships, sole proprietorships, and corporations for flexibility. Like a corporation, it functions as a separate legal entity from its owners.
The LLC protects all of the personal assets of its owners and members from any liabilities related to the business. For rental properties, an LLC shields your personal bank accounts, investment accounts, and other properties from being seized for rental property lawsuits, damages, accidents, and debt.
The impact of transferring property on your taxes
Moving a rental property into an LLC is non-taxable event, but that doesn't mean there is zero impact if you transfer property title. Let's look at some of the possible future tax consequences to consider:
Potential tax bill from gains
If the rental property has appreciated significantly and you transfer it into the LLC at a much higher value than your original tax basis, it could trigger capital gains taxes when you sell. This issue often comes up when you've deducted depreciation expenses over many years, lowering the property's basis on paper.
Consult with a certified public accountant to project and minimize any taxable gains. Strategies like a 1031 exchange may help defer federal income taxes.
Loss of stepped-up basis
For rental properties you inherited or received as gifts, the tax basis likely increased to the fair market value when you acquired the property. This gave you a higher depreciable basis and reduced taxes.
However, transferring the property into the LLC will cause you to lose this stepped-up basis advantage. The basis will revert back to the original purchase price paid by the previous owner.
Property taxes and fees
Transferring rental property into an LLC can impact your property tax payments. First, when deed ownership changes, your county may reassess the property at its current fair market value for tax purposes rather than the previous taxable value. This could lead to an increased assessed value and higher property tax bills.
Additionally, some county recorders charge an assignment tax when transferring a mortgage to new ownership for rental properties. This is typically 1-2% of the total mortgage amount. You'll need to pay this when changing the property's title.
Why transfer rental property to an LLC?
While there are potential tax factors to consider, there are major benefits of transferring rental real estate into an LLC. Here are common reasons why a property owner might consider this approach:
The liability protection an LLC provides is the number one reason real estate investors use this structure. An LLC protects your personal liability because all your personal assets remain outside the business. This protection helps your real estate business by guarding against:
- Legal judgments: Any legal judgements that tenants, contractors, or others win do not apply to the property owner's personal assets. If tenants sue for injuries, rental property damage, discrimination, or any other claims, they can only win judgments against the LLC's assets.
- Foreclosures: If a property owned by an LLC faces foreclosure, authorities can seize only that property. Your personal property remains protected if you default.
- Individual claims: Contractor injuries and claims remain limited to just the LLC rental property and assets.
Additionally, if you have multiple rental properties, housing each rental property in its own separate LLC creates limited liability protection. Issues with one property do not put other LLC-held properties at risk.
Entity structures and taxes
A major advantage of an LLC over personal ownership is the tax efficiency benefits it provides, including:
- Pass-through taxation: Rather than facing double taxation like corporations, profits and losses pass through the LLC to members' personal tax returns. Income taxes are only paid once at individual rates, avoiding the corporate tax.
- Tax filing flexibility: Single-member LLCs receive tax treatment similar to sole proprietorships. Multi-member LLCs report like partnerships. No separate corporate tax return gets filed, simplifying paperwork.
- Loss deductions: LLC real estate investors can fully deduct rental property losses against active income sources on their personal tax return, subject to passive activity loss rules. These deductions offset taxable income.
- Liability shield for tax debt: Transferring assets to an LLC shields them from any IRS tax liens filed against you personally. The LLC separates and protects your property.
If you face a lawsuit or judgment for your personal finances, creditors and lawsuits usually can't touch assets owned by an LLC. This protects all your properties and assets held under different LLCs.
If you default on a mortgage or loan for one property, other LLC properties are fully protected. Creditors can't seize anything titled to another LLC.
An additional advantage of using an LLC is the privacy it can provide over your personal real estate holdings. Public records only disclose the LLC ownership information rather than your personal details, limiting public knowledge of all properties and assets owned under your name.
Housing each rental property under its own individually named LLC takes this one step further. Tenants, contractors, and even lenders may not learn of your other real estate investment property holdings, since they are in entirely separate LLC entities.
By compartmentalizing each asset, LLCs allow for property ownership anonymity, providing an extra layer of privacy protection.
Costs of creating and operating an LLC
While LLCs provide major advantages, you also need to be aware of the ongoing costs involved:
State LLC formation fees
You must register and file formation documents with your state to establish an LLC. Formation fees are typically $50-$500, depending on the state. You may also need to publish notices in local newspapers as part of the formation process.
Annual state fees and taxes
In addition to LLC formation costs, most states charge annual fees to maintain the LLC. Depending on the state, these range from $25 to $800 annually.
Accounting and legal expenses
LLCs involve more complicated tax filings and paperwork than personal ownership. Most real estate investors work with CPAs and tax professionals to handle LLC accounting correctly. You may need legal or tax advice to establish the LLC properly.
LLC record keeping, annual filings, and issuing financial statements require more administrative time. As the LLC owner, you'll also want to uphold formalities like holding yearly member meetings. Proper documentation and records are key to maintaining full liability protection.
How to transfer property to an LLC
If you decide to move forward with transferring rental property to a limited liability company, follow these steps:
1. Choose an LLC name and set it up
First, spend some time brainstorming and choosing the perfect name for your LLC. It should be something short, simple, and professional. Do a name search with your Secretary of State's office to make sure that the name is available.
Once you've settled on a name, file the articles of organization and pay the required state fees to establish the LLC officially — this process creates the LLC as a legal entity. Designate yourself in the filings as the registered agent and manager of the LLC. Also, issue membership shares if there will be multiple members.
2. Obtain an EIN
Every LLC needs its own Employer Identification Number (EIN) to handle taxes and other business functions. The EIN serves as the tax ID number of the LLC when reporting income, expenses, payroll, opening an LLC bank account, and more.
You can easily apply online for an EIN through the IRS website; it's free and just takes a few minutes.
3. Open a separate bank account in the LLC's name
Visit your bank and open a business bank account using the LLC's EIN. To avoid commingling any personal funds in this account, make sure to use it exclusively for the LLC's rental property income and expenses. Keeping LLC funds separate provides liability protection.
4. Record a new deed transferring property to the LLC
To officially transfer ownership of your rental property to the LLC, you need to work with your local county recorder's office. This involves using either a quitclaim deed or a warranty deed:
- Quitclaim deed: This type of deed transfers whatever interest you have in the rental property to the LLC without any guarantees about the property's title. You can use a quitclaim deed form when the transfer is not a sale and to transfer the property between closely related entities or individuals.
- Warranty deed: A warranty deed provides more protection to the grantee (the LLC in this case) as it guarantees that the grantor (you) holds a clear title to the property. This type of deed form assures that there are no encumbrances or claims against the rental property.
5. Notify your mortgage lender
Contact the lender for rental properties with a mortgage to begin the formal approval process. You'll sign an assumption agreement and a new note in the LLC's name. The lender will likely charge an assumption fee.
6. Update stakeholders
Besides updating your mortgage lender, you should also provide the new LLC ownership information to other stakeholders, including:
- Tenants: Make sure to send notices to all tenants indicating the change of ownership and providing the LLC's information for paying rent. You want records showing you notified them of the transfer.
- Insurance company: Assign policies to the LLC for liability, property damage, and loss of rent coverage.
- Utility companies: Update all utilities like power, water, and gas to bill the LLC for rental property expenses.
- Other parties: Additional parties could include property management companies, service providers, homeowner's association (if applicable), and any other entity that needs to be aware of the change in ownership.
7. Change licenses
If you have any rental property licenses, permits, or registrations with the city, change them to reflect the new LLC ownership. This includes rental licenses, trash/dumpster permits, elevator licenses, and other required governmental registrations.
8. Consult an accountant about tax considerations
Discuss the rental property transfer with a tax professional to project tax implications. Key areas to discuss include:
- Capital gains and property taxes: Clarify if transferring the property triggers capital gains tax and affects property tax valuation.
- Rental income and depreciation: Discuss how to handle rental income, expenses, and depreciation for the property under LLC ownership.
- Pass-through taxation and deductions: Understand how the LLC's pass-through taxation impacts your personal taxes and mortgage interest deductions.
9. Comply with ongoing LLC requirements
After transferring the property, be sure to comply with the ongoing legal and tax requirements of running an LLC. This includes keeping your personal and business finances separate, maintaining proper records, and fulfilling any annual reporting requirements.
The last word on transferring property to LLC
Rental property owners who are trying to decide whether to transfer rental real estate into an LLC should weigh options like liability protection benefits against tax implications and costs.
You'll want to consult with both a knowledgeable real estate attorney and a CPA to analyze your specific situation before moving property to an LLC. Review your assets, property appreciations, incomes, and financings. Consider the potential tax consequences from capital gains, loss of basis, or increased assessments.
Strategic planning and timing is key here. Work with your advisors to run scenarios before creating your LLC and transferring your rental property to maximize advantages and minimize taxes or surprises.
Transfer property to LLC FAQs
Can I transfer assets from one LLC to another?
Yes, you can transfer assets from one LLC to another, but it requires proper documentation and adherence to state laws. Check with a tax professional to understand any potential tax implications.
How can I minimize tax consequences when transferring property to an LLC?
Minimizing tax consequences requires careful planning and consultation with tax professionals. Strategies may include structuring the transfer to maximize tax deductions, utilizing tax-deferred exchanges, and choosing the most tax-efficient LLC tax classification.
Can I deduct losses from transferring property to an LLC?
No, losses from transferring property to your LLC are not tax deductible.
This article is intended for informational purposes only and should not be considered legal, tax, or financial advice. Each individual's financial situation is unique, and laws and regulations are subject to change. It is strongly recommended that readers consult with qualified professionals, such as attorneys or tax advisors, before making any decisions regarding LLCs or property transfers. The authors and publishers of this article are not responsible for any actions taken as a result of this content.