Deeding Property to an LLC

A primary purpose of an LLC, whether a traditional LLC or a series company, is to provide protection from personal liability for its members and managers For this reason, investment real estate that could potentially generate liability or a lawsuit should be held in the name of an LLC—not in one’s personal name and preferably not reflecting gratuitous personal information.

Asset Protection Strategies

Broadly speaking, an asset protection strategy:

(1) creates barriers to personal liability with one or more entities, at least one of which may be a series LLC if multiple properties or assets are involved;

(2) achieves a measure of anonymity in the public records;

(3) utilizes protections for the investor’s homestead that are afforded by the Texas Constitution and Property Code;

(4) deters lawsuits and judgment creditors; and

(5) in the event of a lawsuit, exhausts the plaintiff’s determination and resources.

Deeding investment property to an LLC is an essential part of an asset protection strategy for real estate investors. Planning ahead is critical since the range and benefit of available asset protection measures can decrease significantly after a lawsuit is threatened or filed.

The Two-Company Structure

Ideally, investment property ownership should reside in a dedicated holding company while management functions (entering into contracts, collecting rent, payment of expenses, and the like) are performed by a separate management LLC. The goal is to accomplish a clear separation of assets from activities, a core principle of asset protection derived from the legal concept of privity.

Title to Investment Property

In a two-company structure, the optimal plan (if practically feasible) is to acquire properties in the name of the management company and then, after closing and renovation, transfer them into individual series of a series holding company (with each property in its own series). This is usually more easily done if the property is bought for cash.

Lenders often require that an investor take title to the property in his or her personal name for their own underwriting reasons; so, if a loan is involved and the property is taken into one’s personal name, it should be moved without delay into the investor’s holding company after closing.

Traditional Versus Series LLCs

Series LLCs, implemented in Texas in 2009, have become the holding vehicle of choice for many real estate investors. They provide a reasonably safe way to hold multiple similar properties inside the same LLC—thus avoiding a multiplicity of entities which was the traditional way the real estate investment business was conducted.

Unlike a traditional LLC (which owns assets in a single pool) a series company can hold multiple properties in separate, insulated compartments—Series A, Series B, and so forth. The assets and liabilities of each series are confined to that series only and are segregated from the assets and liabilities of other series. If there is a lawsuit or a foreclosure that affects property in Series A, then other series (Series B, Series C, and so forth) should not be affected or liable for the outcome.

Deeding Property to a Traditional LLC

When deeding property into an LLC (whether traditional or series) care should be taken to correctly show the name of the LLC on the deed. For example, if the name of the company as shown on the Secretary of State’s certificate of filing is “Alamo Investments LLC,” then listing the grantee as “Alamo Investments, L.L.C.” would be incorrect since the addition of a comma and three periods makes this a different company name. This kind of error is made often in deeds, even by lawyers and title companies.

The same is true of capitalizations that do not correspond exactly to the official entity name. Think of it this way: the name of a registered entity (LLC or corporation) as shown on the certificate of filing is like a screenshot; it must appear exactly that way on a warranty deed in order to avoid the need for a correction instrument later. The best formulation for the grantee clause for a traditional LLC would be:

Alamo Investments LLC,
a Texas limited liability company

Deeds into a Series LLC

The power of an individual series to hold title to real property is expressly granted by Business Organizations Code Section 101.605(3). When deeding property into a series, the deed should specifically reflect which series the property is going into.

Example: what happens if no series is indicated on a deed of property into a series LLC—i.e., a conveyance into “Alamo Investments LLC” with no mention of a specific series? In that case, the property is conveyed into the company at large and not into an individual series of Alamo, which likely defeats the purpose of forming a series LLC in the first place.

Since series LLCs can own property both ways, one needs to be conscious and deliberate about the result one is trying to achieve. The deed must be specific and correct, both as to the grantor clause and the grantee clause. When transferring property into a series LLC as grantee, the correct formulation is:

Alamo Investments LLC—Series A,
a series of Alamo Investments LLC,
a Texas series limited liability company

A common miswording is “Alamo Investments—Series A LLC,” which is incorrect. A series is not an LLC and should not have these letters after its name. Only the full name of the company should be followed by “LLC.”

Another factor needs to be considered, since series fall into three categories—ordinary, protected, and registered. If the series involved in the transaction is a protected series (as it likely should be) then the correct formulation would be:

Alamo Investments LLC—Series A,
a protected series of Alamo Investments LLC,
a Texas series limited liability company

Individual Series as Borrower

Lenders vary on their willingness to approve a specific series as a stand-alone borrower on a note. While BOC Section 101.605 expressly grants individual series power to “acquire, sell, and hold title to assets of the series, including real property, personal property, and intangible property” and to “grant liens and security interests in assets of the series,” many lenders have focused on the fact that—notwithstanding such expressly-granted powers—an individual series is not technically, by itself, a legal entity.

This is true even though: (1) a series can obtain its own EIN and be treated separately for federal tax purposes; (2) a series may have its own bank account; and (3) BOC Section 1.201(b)(27) states that a series falls within the definition of a legal person.

Most of what occurs in this area arises from the underwriting policies of individual lenders (which vary widely) rather than strict application of the Business Organizations Code.

Due-on-Sale Issues

Will a lender call the note due if security property is transferred into an investor’s LLC? There are two points to make in response to this question. First, the standard due-on-sale clause contained in the Fannie Mae deed of trust (and most others) prohibits nothing; it merely gives a lender the option (but not the obligation) to accelerate a note if a title transfer occurs—so it is not correct to say that a title transfer without lender consent violates or breaches the deed of trust. Lenders may choose to act or not act at their discretion in such situations—that is all.

Second, lenders have been historically reluctant to act when a monetarily performing loan continues to be kept current after a title transfer into a borrower’s personal LLC. In fact, this author has never seen that happen. Lenders are generally far more concerned with loans that are in monetary default—although, as pointed out above and in most residential cases, transferring title without lender consent is not a default, not even a technical one.

What should be done with the homestead?

It is neither necessary nor advisable to transfer a homestead into an LLC that holds investment properties. There are two reasons homestead-exempt assets should be kept separate from investment assets:

(1) the homestead is already fully protected by the Texas Constitution and Property Code against forced sale or execution upon a judgment (in the absence of actual fraud); and

(2) mixing the homestead with investment assets that are likely to incur liability and lawsuits is just not prudent for asset protection.

A better strategy is to transfer the homestead into a revocable living trust. Strictly speaking, trusts for the homestead are not an asset protection device; instead, they exist to avoid probate and provide for a smooth transition to the next generation. Since the trust cannot die, beneficial interests in the trust are undisturbed by the death of the original property owner. Even considering that Texas has expedited probate procedures, this is a real benefit—so long as the trust is a qualifying trust under the Property and Tax Codes. This requires careful drafting.

General Warranty Versus Special Warranty Deeds

Deeds into an LLC may be made by deed with either general or special warranties. In most cases, there is no reason not to use a general warranty deed when conveying property into a personal LLC. Under no circumstances, however, should a quitclaim be used since quitclaims can create problems with the chain of title. If one is determined to avoid title warranties then a deed without warranties should be used rather than a quitclaim.

“Subject To” Versus Assumption of Existing Debt

What should the warranty deed say regarding existing indebtedness when title is transferred into an investor’s LLC? The choice has both legal and accounting implications.

If nothing is mentioned then the result (by default) is that the property is conveyed into the LLC subject to the debt—in other words, the LLC makes no express promise to pay the loan and has no obligation to do so. The alternative is for the deed to recite that the LLC agrees to assume to debt. Note that even if this agreement is made, it becomes an obligation of the LLC to the investor-grantor—not to the lender. Why? Because the LLC has not signed the lender’s note.

Other Optional Clauses in the Deed

Inclusion of an “as is” clause in the deed (in bold and in all caps) should be routine for all business transactions in which an investor is the seller. This is true even if the transfer is being made into one’s own company. If the property is rented it may also be appropriate to assign the escrow account, the seller’s interest in the casualty insurance policy, and the tenant’s security deposit to the LLC. If so, a broad assignment clause should be included.

For married investors, it is the preferred practice for both spouses to sign the deed into an LLC since Texas is a community property state. If that is not done, it is possible that a future title company will ask for an explanation of marital status. Some sort of curative action—a marital status affidavit, non-homestead affidavit, or even a spousal signature—may be required.

Transfers for the Purpose of Defrauding Creditors

Transfer of investment assets into an LLC should be accomplished as part of a regular and routine asset protection strategy, well before trouble arises. Otherwise, the usefulness of doing so may be limited by rules against fraudulent transfers, meaning intentional and fraudulent avoidance of the obligation to pay a debt.

Such transfers are called badges of fraud and can reach back up to two years. Concerns about fraudulent transfers can arise:

(1) if the transfer is made to a family member or other insider;

(2) if suit was threatened before the transfer occurred;

(3) if the transfer was of substantially all of the person’s assets;

(4) if assets have been removed, undisclosed, or concealed;

(5) if the transfer was made without reasonably equivalent consideration; or

(6) if after the transfer the transferor became insolvent as a result (made his cash disappear).

Texas law recognizes that life goes on even after a lawsuit is threatened or filed—even, in fact, after a judgment. People still buy and sell assets, move residences, and so forth in the ordinary course of life and business, and this is allowed (Prop. Code Sec. 42.004). What is not permitted—and what may be set aside by a court—are asset transfers for the blatant purpose of avoiding a debt or judgment creditor. That statute states that this is illegal if done “with the intent to defraud, delay, or hinder” such a creditor.

Fortunately, transfer of an investment property into an investor’s LLC for purposes of asset protection is so sensible and routine (and within the ordinary course of business) that it should be relatively easy to justify in the event of challenge by a creditor.

Transfers involving a Terminated LLC

LLCs have two annual filing obligations to the Texas comptroller which are due by May 31st of each year: (1) a public information report (PIR) and (2) a franchise tax report (even if that is only a “no-tax-due report). For most people, these tasks are delegated to one’s CPA, but they must be done.

Failure to file a PIR or a franchise tax report will eventually result in official termination of the entity—what in the old days was called “forfeiture of its charter.” When this occurs, the LLC loses its ability to conduct business, including purchases or sales of real estate.

So what happens to the title to real property? “When [an LLC] is dissolved its property becomes the property of its [members] in proportion to their respective shares, subject, however, to the rights of the creditors of the [LLC] whose debts must be satisfied out of the [LLC’s] property. . . . The title rests in the [LLC’s members].” This transfer of title to the LLC’s members occurs by operation of law. Humble Oil & Refining Co. v. Blankenberg, et al., 235 S.W. 2d 891 (Tex. 1951).

Reinstatement after Termination

Texas Business Organizations Code Section 11.201(1) provides that an entity may be reinstated if its termination was due to mistake or inadvertence. However, a terminated entity may be reinstated if its legal existence is necessary to convey or assign property (TBOC Sections 11.201(4)(A) and 11.202). Reinstatement of a series LLC also reinstates any protected series of that LLC (TBOC Section 11.253(e)). Reinstatement must occur with three years from the date of termination (TBOC Section11.253(d)). Once reinstatement is official, the LLC is free to do business again.