Ways To Hold Real Property
By: Randall A. Denha, J.D., LL.M.
The most common advice on how a married couple should hold title to their home or other real property is to hold title as husband and wife or as joint tenancy. While this may be true in many cases, it fails to recognize the type of property that is being dealt with. Is the property residential property, rental property, commercial property or a family cottage?
Joint Names and Probate Avoidance
Many people hold property in joint name in order to avoid probate. In fact, probate has been described as “ a lawsuit that you file against yourself and then you lose.” Why? It involves costs, delays and publicity. People generally want to avoid probate and do so at all costs. Taking title in joint tenancy is often recommended because it allows a married couple to avoid probate upon one of their deaths. Probate is merely the court process of ensuring that assets belonging to the decedent are distributed according to his or her last will, or Michigan (or applicable state law) law if no will existed, and that all creditors are paid.
Income Tax Savings – the stepped up basis.
While the expense and inconvenience of probate can and should be avoided, focusing on probate alone when deciding how to hold title to real property can be a costly mistake. An important consideration, which should not be overlooked, is the income tax ramifications upon a death. Pursuant to Internal Revenue Code §1014, when a person passes away the income tax basis of his or her property (the amount he or she paid for the property) is raised or stepped-up to the fair market value on the person’s date of death. This increase in basis allows the recipients of the property to sell it without paying income tax, assuming it did not appreciate beyond the property’s value at death.
Ownership Inside A Living Trust.
Another way for a married couple to hold title to real property is as trustees of a living trust. This will ensure that probate will be avoided, income tax will be reduced upon sale of assets and that the maximum amount of estate tax will be avoided. Upon the death of an individual an estate tax will be assessed on all property owned. However, before the tax is assessed a credit against the tax is allowed. Currently this credit allows a single person to exempt $11,180,000 worth of property from tax, or if married, an amount equal to $22,360,000. In addition to this important credit there is an exemption for any property which passes to a spouse. While this marital exemption is extremely valuable in that it assures there will never be a tax upon the first death, it can cause a larger tax upon the second death. Without planning through a trust, the marital exemption can actually result in more estate tax being paid upon the second death.
LLC Ownership
If you own one piece of real estate as an investment, often the strategy is to establish an LLC in your home state, or use a Nevada or Delaware LLC, and purchase your property under that LLC’s name. This protects you on two levels: your personal assets are legally separated from your property in the event of a lawsuit aimed against your property, and your property is separated from your personal assets in the event of a lawsuit against you personally. Most people understand that maximum asset protection requires that you put one real estate property or one business in an LLC that owns no other property or operates no other businesses. We all know what happens if you put all your eggs in one basket and drop the basket – you lose all your eggs. The primary reason to put real estate properties and businesses in separate limited liability companies is so that a financial problem with one does not affect the value of any other properties or business.
On the other hand, if you own multiple properties place ownership of all of their properties under one LLC. While this is preferable to a sole proprietorship, it puts all of your real estate at risk in the event of a legal issue involving one of your properties.
Instead, if you own multiple properties, you may wish to consider the following approach by utilizing a multiple-entity strategy, such as the one illustrated below:
This strategy involves forming multiple LLCs—one for each piece of real estate. (LLCs are used because they are pass-through entities with strong liability protection.) Each property is then purchased under one LLC’s name, so that each LLC owns one property. Consequently, if one property is involved in a lawsuit, the other properties are out of reach and can continue to produce revenue. There are several disadvantages with owning multiple entities. They are more expensive to create and operate. The administrative burdens such as bookkeeping and tax returns are multiplied. You need a separate bank account for each entity. Multiple entities are more work and cost more than a single entity.
This can be further enhanced through the use a master holding company wherein the holding company owns all of the subsidiary LLCs to provide added protection. The problem with the parent – subsidiary structure is that you are taking your carefully and expensively created separate entities that you formed to maximize asset protection and putting them all in one basket. If a creditor sues the parent and gets a judgment against the parent, the creditor can reach all of the parent’s non-LLC assets, but if the subsidiary LLCs are Michigan LLCs the creditor can only serve a charging order on every subsidiary entity. The charging order would require the subsidiary LLCs to make all future distributions of money or property to the creditor instead of to the parent LLC.
You may think the risk of having a claim brought against the parent is low, but it may not be. For example, if you are driving to meet a prospective tenant who wants to rent a home owned by LLC #1 and you run a red light and kill or injure somebody, you and the parent and LLC #1 will be sued and you and the two LLCs will be liable. If the judgment exceeds the parent’s insurance coverage, the creditor will take everything the parent owns until the judgment is satisfied.
If you are contemplating the parent – subsidiary entity structure, you will have to decide, which is more important: (i) maximizing asset protection, or (ii) minimizing administrative burdens or expenses. Bottom line: If you do have a parent – subsidiary structure, make sure that your insurance coverage is adequate.
