A primary purpose of an LLC, whether a traditional LLC or a series company, is to provide protection from personal liability for its members. For this reason, any property that could potentially generate a lawsuit or other liability, especially investment and rental property, should be held in the name of an LLC-not in a personal name and preferably not reflecting personal information such as the homestead address.
Ideally, 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, shell management LLC. This accomplishes separation of assets from activities, a core principle of asset protection derived from the legal concept of privity.
General Theory of Asset Protection
A sound asset protection structure (1) creates barriers to personal liability with one or more LLCs, at least one of which should be a series company if multiple properties or assets are involved (we prefer Texas and Nevada, two top asset protection states with similar statutes); (2) maximizes anonymity in the public records; (3) utilizes homestead protections afforded individuals by the Texas Constitution and Property Code; (4) deters lawsuits and judgment creditors; and, (5) in the event of suit, exhausts their determination and resources. Planning ahead is critical, particularly in the context of property ownership, since the range and benefit of asset protection measures decrease significantly after suit is threatened or filed.
Deeding Property to an Investor’s LLC
If possible, rental or investment property should be acquired directly in the name of an investor’s LLC. In a two-company structure, the optimum plan would be to acquire properties in the name of the management company and then, after closing and rehab, transfer them into individual series of the holding company (i.e., each property in its own series). Lenders, however, often require that an investor take title to the property in his or her personal name for underwriting reasons. If that is the case, property should nonetheless be moved without delay into the investor’s series holding LLC after closing. More on this below.
The series LLC is now the holding vehicle of choice for many real estate investors. Unlike a traditional LLC (which owns its assets in a single pool) a series company permits the LLC to 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. So if there is a lawsuit or a foreclosure that affects property in Series A, then other series (Series B, Series C, and so forth) are not affected or liable for the outcome.
The Series LLC as Grantee
The power of a series to hold title to property is expressly granted by the Business Organizations Code (the “BOC”) in Section 101.605(3). When deeding property into a series, the deed should specifically reflect which series the property is going into—for example, “ABC LLC—Series A.” Failure to do this will result in the property being acquired as an asset of the company at large, thereby losing series insulation and protection.
Care should be taken to correctly show the name of the LLC on all legal documents. 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 “Alamo Investments, L.L.C.” as grantee would be incorrect, since the addition of a comma and three periods means that this is a different company name. The same is true of capitalizations that do not correspond exactly to the official name. Think of it this way: the name of a registered entity as shown on the certificate of filing is like a screenshot; it must appear exactly that way on a deed or other instrument in order to avoid the need for later correction.
Similar issues arise when designating a particular series of a series LLC as grantee. This must be done correctly in order to convey the property as intended and avoid a correction instrument. Firstly, the company name must conform exactly to the certificate of filing as discussed in the previous paragraph; secondly, the series must be clearly and correctly indicated. The company agreement may establish the naming regime for series in any way that is reasonable, but series are most commonly alphabetical (Series A, B, C, etc.) or numerical (Series 1, 2, 3, etc.). It is also possible to name a series after the property that it contains, such as the “Oak Street Series.” But this is problematic; what happens if the LLC sells the Oak Street property and acquires another on Elm Street? Is action then necessary to change the series name so it can accommodate a new property with a different address? Probably so. Clearly, therefore, it is more practical to list the series in the form of letters or numbers.
Although series LLCs have been in use in Texas since 2009, one still sees errors in how series are reflected as the grantee on a deed. If Alamo Investments LLC is a series company, and the intention is to convey property into series A, then the correct formulation would be “Alamo Investments LLC-Series A, a series of a Texas series limited liability company.” A common miswording would be “Alamo Investments-Series A LLC,” which is incorrect. A series is not an LLC and should not have these letters after its name.
What happens if Alamo is a series company but no series is indicated on the deed-i.e., the conveyance is into “Alamo Investments LLC” with no mention of a series? In that case, the property is conveyed into the company at large and not into an individual series of Alamo. Series LLCs can own property both ways. Of course, transferring property into the company at large defeats the purpose of having a series LLC in the first place, so this usually indicates that an error has been made.
Lenders’ Views on a Specific Series as Borrower
In practical application, lenders vary on their willingness to approve a specific series as a borrower on a note and deed of trust. 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, standing alone, a legal entity. This is true in Texas even though a series can obtain its own EIN and be treated separately for federal tax purposes; a series may have its own bank account; and BOC Section 1.201(b)(27) states that a series falls within the definition of a legal “person.”
Accordingly, many banks and other lenders have applied the most conservative interpretation of the BOC and require that the series LLC at large (no series designation) be shown as borrower on the note and deed of trust and as grantee on the warranty deed. For investors wishing to hold assets in individual series, this is only a temporary obstacle, since post-closing the asset can then be deeded into its intended series—generally without any due-on-sale-based objection from the bank.
Will the lender call the note due if the security property is transferred into an investor’s LLC? Or into a specific series of a series company that was named as borrower on the note? There are two points to make on this subject. 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 to accelerate a note if a transfer of title occurs, so it is not correct to say that such a transfer “violates” or “breaches” the due-on-sale clause. Lenders may choose to act or not act under this clause—that is all.
Second, lenders seldom take action when property with a performing loan is transferred into the borrower’s personal company for asset protection purposes. In fact, this author has never seen that happen. Lenders are generally far more concerned with loans that are in default—although, as pointed out, transferring title is not a default, not even a technical one. Some lenders may send a threatening letter, depending on the circumstances, but little will likely come of it so long as the note remains current.
What should be done with the homestead?
It is neither necessary nor advisable to transfer a homestead into an LLC that holds investment properties. As a general rule, homestead-exempt assets should be kept separate from investment assets. Why? First, the homestead is already protected by the Texas Constitution and Property Code against forced sale or execution upon a judgment. Second, mixing the homestead with investment assets that are prone to incur liability and lawsuits is just not a good idea. The homestead should be kept out of the line of fire.
Our recommendation is to transfer the homestead into a living trust (also called an inter vivos trust). Trusts do not provide a liability barrier, but this is not a problem because the homestead is already protected. What the living trust accomplishes is probate avoidance (since the trust cannot die), providing for automatic transfer of the beneficial interest in the property without delay or expense. Even considering that Texas has expedited probate procedures, this is a real benefit. There is nothing to lose and everything to gain from using such an arrangement. A pour-over will should be executed along with the living trust to complete the picture.
General Warranty Deeds Versus Special Warranty Deeds
Deeds into an LLC may be made by deed with either general or special warranties, depending on the situation. In most cases, there is no reason for an investor not to use a general warranty deed when conveying property into a personal company. Under no circumstances, however, should a quitclaim be used, since these can create problems with the chain of title. If one is determined to avoid warranties, use a deed without warranties rather than a quitclaim.
Assumption or “Subject to?”
Most investment properties have at least a first-lien with outstanding debt. What should be said about this when deeding the property into an investor’s LLC? The choice has both legal and accounting implications. If nothing is mentioned about the debt, then the result by default is that the property has been conveyed subject to the debt. But it is important to be deliberate and intentional in drafting real estate documents, so the better practice is to expressly state whether the LLC will be assuming the existing indebtedness or taking the property “subject to.”
Other Clauses in the Deed
It is also advisable to include an “as is” clause in the deed-in bold and in all caps. This should be routine for all business transactions in which an investor is the seller, 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, assignment clauses should be included addressing these issues.
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 a marital status affidavit, non-homestead affidavit, or even a spousal signature-which could be awkward if the marriage is no longer solvent.
Transfers Made for the Purpose of Defrauding Creditors
It is preferable to transfer assets into an LLC before trouble arises. Otherwise the usefulness of doing so may be limited by rules against fraudulent transfers that reach back up to two years. Such transfers are generally indicated by so-called “badges of fraud” including:
(1) transfers to a family member;
(2) whether or not suit was threatened before the transfer occurred;
(3) whether the transfer was of substantially all of the person’s assets;
(4) whether assets have been removed, undisclosed, or concealed;
(5) whether there was reasonably equivalent consideration for the transfer; or
(6) whether or not, 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. What is not permitted (and what is subject to being set aside by a court) is the making of such transfers for the blatant purpose of assuring that a judgment creditor does not get paid. Fortunately, the transfer of an investment property into an investor’s LLC for purposes of asset protection is so sensible and routine that it should be relatively easy to justify in the event of a challenge.
Information in this article is provided for general informational and educational purposes only and is not offered as legal advice upon which anyone may rely. No attorney-client relationship is created by the offering of this article. This firm does not represent you unless and until it is expressly retained in writing to do so. The law changes. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well, since we do not give tax advice.
Copyright © 2021 by David J. Willis. All rights reserved. Mr. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his website, www.LoneStarLandLaw.com.