If you are thinking about becoming or are a real estate investor in Washington State you will want to know how to protect yourself as a real estate investor to make sure that you set yourself up for success and minimize risk whenever possible. With that said you will want to weigh the costs of having the maximum protection with what each option is actually going to do for you and the costs of such protection. Below I have outlined some common questions and answers and various information that can help you in your real estate investment business. This is all meant to be general advice and you should consult your own accountant or real estate attorney should you have questions about your specific situation.
You can also listen to real estate investor attorney Richard Symmes on 1150 AM KKNW on how you can protect yourself as a real estate investor in Washington State here:
What is the easiest way to protect yourself as a real estate investor in Washington State?
At a minimum I would recommend that you hold property in an LLC and create a separate LLC for each property which would insulate each property from creditor claims against each business. An LLC provides for limited liability should a tenant or other party file a lawsuit against you or your business during a lease term or a rehab. Forming multiple LLC’s protects all the other properties from creditors of each property. This also keeps your personal assets safe and unreachable by a creditor. However real estate investors should be aware of something called piercing the corporate veil in which an individual may be held liable even if you have formed a business. The best way to avoid this from happening is to make sure you keep all business activities separate from your personal activities and bank accounts and actually treat the LLC’s you have set up as a separate business from yourself.
Should I form a Series LLC in a state other than Washington to Hold Washington Property?
Washington state does not have a legal entity called a series LLC, however several other states do allow for the creation of a series LLC. A series LLC allows for the owner to create one LLC holding company as a parent company and then as many other series businesses as part of a LLC stemming from the parent company. So it would be XYZ company which holds XYZ 1, XYZ 2, XYZ 3 etc. This allows for the creation of 1 LLC and filing fee’s with the state of incorporate and as many other sub companies that you want in the series.
A series LLC can be useful if you own several properties so you can create numerous series companies within the same LLC. With that said this type of business is not ideal if you just have a single or a few properties. You would also have to keep in mind that if you form a series LLC in a state other than Washington, the business would need to have an agent for service in the home state in which the company was formed and you would likely have to pay taxes of the state in which you have formed the company if applicable. Finally, you have to remember that Washington does not recognize the series LLC which may cause you issues down the road if there are disputes or litigation which require court intervention.
You would have to weigh these drawbacks with the cost to form several normal LLC’s in Washington and the fact that Washington does not have a state income tax. Therefore, if you just have a couple properties my advice would be to just stick with a Washington state LLC. If you own numerous properties then I can see how a series LLC can be useful but it may not be worth the additional cost time and effort.
Is the Transfer of Real Property to an LLC Taxable?
Most investors have to get a loan in order to invest in their next project and usually can get better interest rates if the loan is taken out personally and recorded against the property. This means that the property will initially be held in an individuals name and the investor will later want to transfer the interest to an LLC.
Do I have to Pay Washington State Tax on a property transfer to an LLC?
So, if you do transfer a property from an LLC, there is generally no Washington state excise tax associated with a quit claim deed transaction if there is no consideration (value) paid for the property. If there are taxes assessed it would be in accordance with the Washington Real Estate Excise Tax (REET). The tax also applies to sales or transfers of controlling interests in entities (e.g., corporations, partnerships, limited liability companies, etc.) that own real property. The exemptions to this tax can be found in the REET statutes, chapter 82.45 RCW, or in the rules or regulations adopted by the Department of Revenue, chapter 458-61A WAC.
Consideration means money or anything of value, either tangible or intangible, paid or delivered, or contracted to be paid or delivered, including the performance of services, in return for the transfer of real property. The REET applies to both transfers when two properties are exchanged and there is no exemption when the transaction involves an IRC §1031 exchange. Consideration also includes the amount of any lien, mortgage, indebtedness or other encumbrance given to secure the purchase price or remaining on the property at the time of sale, including the assumption of an underlying debt. A sale where the buyer assumes the underlying debt and pays no additional consideration is fully subject to REET.
Do I have to Pay Federal Tax on a property transfer to an LLC?
The answer to this question depends on how your LLC is taxed. If it is a sole member LLC and taxed as a disregarded entity there will be no federal tax incurred. If the LLC is taxed as a partnership or corporation the answer may be different based on several factors. You should consult your accountant.
Will My Mortgage Lender Call My Note Due If I Transfer a Property to an LLC?
Most likely not, but the due on sale clause in your mortgage note (not in every mortgage note but most) is more likely to be enforced if you fall behind on payments. The due on sale clause allows a mortgage company to call a note due in full should you sell or transfer your property so there is some risk to doing this.
The Garn St. Germain Act of 1982 addresses the basic conflict between homeowners looking to protect their assets, and the bank’s insistence that the homeowner buy the property in their own name. The Garn St. Germain Act prevents lenders from enforcing the due-on-sale clause when residential properties are transferred into a revocable trust and there is no change to the rights of occupancy.
It should be noted that if you have a loan that is not federally backed, then the Garn St. Germain Act may not apply.
Should I Transfer My Investment Property to a Revocable Trust or Land Trust?
A common question that many real estate investors have is whether they should transfer their property into a revocable trust or “Land Trust”. A revocable family trust can include real estate as well as other assets set aside for beneficiaries vs. a “land trust” generally just includes 1 property held in the trust. The main purpose of transferring property into a trust as a real estate investor would be to avoid the due on sale clause discussed above and for privacy as a trust is not a document that is filed publicly in your county’s recorders office.
States that don’t have specific rules for land trusts such as Washington state, simply govern them using standard trust laws based on the state laws available. In almost all cases, the investors who establish a “land trust” are establishing a revocable trust. The land trust laws and trust laws in general are clear that a revocable trust does not give the grantor (the guy that sets up the trust and puts the property into the trust) any type of asset protection. It doesn’t matter who the beneficiary is. All trust laws state that if the trust is revocable, the courts can require the grantor, when they are sued for any reason, to “revoke” the trust and give the property in the trust to the grantor’s creditors.
The goal of the land trust is to make it look like you the investor do not have any real estate in your name if you are sued. This is wishful thinking however as most attorneys and insurance companies may look into or ask questions through litigation discovery that could reveal who the true trustee or beneficiary is of the land trust and open you up to being discovered as the true owner. Think of the land trust as more of a smoke screen or costume designed to trick aggressive creditors into thinking you don’t own any assets of major value.
A land trust has three parts: a grantor, a trustee, and a beneficiary. When you choose to form a land trust, your lawyer can serve as your nominee trustee and you the real estate investor can become the designated beneficiary and eventually assign your interest to an LLC you own. This allows the investor to reap the rewards of property ownership, such as investment income, without being publicly identified as the owner. The trustee’s role is to manage the trust itself and the investor should be named as the successor trustee once your initial trustee resigns so that the real estate investors name does not appear on any publicly recorded documents.
As you can see a land trustee can be very complicated and defeat the purpose of anonymity if it is not set up correctly. Furthermore, keeping your assets in a land trust can cause issues when you try to sell or refinance your property as you most likely will have to transfer the property back to your personal name, the acting trustee or beneficiary prior to moving forward with refinancing plans depending on the situation.
Personally, I think going through this land trust process is more trouble than it is worth unless anonymity is of utmost importance. While it is nice if your name does not show up on public records for purposes of asset protection, this strategy can be easily defeated should a creditor initiate a lawsuit and delve deeper into your finances and holdings. With that said, if you believe that creditors won’t file a lawsuit because they can’t find any assets in your name, this may be a worthy asset protection strategy.
If you live in Washington State and are looking for a real estate investment attorney to assist with the protection of your real estate, give Symmes Law Group a call at 206-682-7975 to get the counsel you need.