12 Mar Buying residential property in New York City (Part III)
by Maurizio Gardenal partner, Studio legale internazionale Gardenal & Associati Milano, and Anthony Bruozas, Attorney at Law
Articolo pubblicato su “Diritto 24″, rubrica del Sole24Ore.com, 12 marzo 2012
How can I best protect myself if I plan on leasing my property to someone else?
To minimize the risk associated with renting one’s condo to someone else, one should consider holding the title to the property through an artificially created entity. It is prudent that one transfer one’s personal ownership interest into a corporate entity whereby a corporate shield is created such that it is more difficult for an injured party to reach one’s personal assets. For instance, if one’s tenant slips and falls in the shower during the course of his lease of the condo, he may claim that his injury was not due to the consumption of too many martinis but rather, due to a defective or unreasonably dangerous condition associated with the shower stall. Thus the property owner who has leased his condo is at risk of being sued by his tipsy tenant. To minimize this risk, the owner should transfer his personal interest in the real estate into a corporate entity.
In the United States, among other things, the limited liability company (“LLC”) is such a device one should consider. Unless fraud can be demonstrated, when one’s ownership interest is in the form of an LLC, the extent of the liability can be limited to the amount of value associated with the property. In other words, it is very difficult for an injured party to “pierce” the shield that is created with the establishment of an LLC or of a corporation.
Before transferring the property’s deed into an LLC, the LLC itself must first be formed. To transfer a deed to an LLC, the deed will need to be prepared in the LLC’s name and filed and recorded in the appropriate municipal office located in the jurisdiction in which the property is located (usually the county’s recorder of deeds office). The deed must be signed by the person or entities transferring the property, and will of course require a duly-authorized notarization.
There are different types of deeds that may be used to transfer the title to the property. For example, some deeds may contain warranties purporting to protect the grantee-purchaser from possible defects in the title of the property. The type of deed used to transfer the property to an LLC generally will depend on the particular property at issue and the individuals or entities involved. Also, a property owner’s ability to transfer the deed to an LLC may depend on whether the property is subject to a mortgage. Unless the underlying loan is paid in full prior to or at the time of the transfer, the deed will only transfer subject to the mortgage. Moreover, the loan and/or mortgage documents may prohibit a transfer of the property unless the loan is paid in full or the lender consents.
Whether or not the lender holding the mortgage permits the deed and the mortgage to transfer to the LLC, will depend on the circumstances. For example, the lender may allow the LLC to assume the loan and mortgage, either with or without changes to their terms. Alternatively, the lender may require that the LLC obtain a new loan in the name of the LLC, and that the existing personal loan be paid off with the proceeds of that new loan. In either case, because the loan is being made to an entity and not to a private individual, the lender may request personal guarantees from the members of the LLC or additional collateral.
If it otherwise qualifies, the LLC can obtain a loan from a mortgage company. Before applying for a loan or mortgage, it is important to determine the proposed amount of the loan, how the loan proceeds will used by the LLC, and the expected source of the funds necessary to repay the loan. Typically, lenders will grant loans only if they are satisfied that the borrower has the ability and resources to repay the loan. One should also keep in mind that the real estate purchased by the LLC typically must be pledged as collateral for the loan.
Thus, it is wise to use an LLC to hold one’s US real estate in order to protect one’s personal assets and property from claims that might occur during the term of the leasehold of the real estate. If the LLC is formed and managed correctly, Europeans should be able to limit their potential liability in the event of a claim being filed against the LLC.
When a foreign buyer dies, his estate will be taxed by the US government at a rate close to 46%. This is easily avoided if the foreign buyer does some upfront planning and sets up the LLC and a foreign corporation. The LLC would own the property, the foreign corporation would own the LLC, and the buyer would hold shares of stock in the foreign corporation. Under this scenario, since the property is “owned” by the foreign corporation, the US government would receive nothing upon the death of the foreign buyer. This is a great tax savings for foreign buyers and is not very expensive to implement. This structure also allows for the easy transfer of the property from one party to another by the selling of shares of the corporation rather than the sale of the property that might trigger a taxable event.
If I have properties in several states, where should I incorporate?
Many investors establish the physical location for their LLC in the state where they conduct their business. However, in deciding where to form a company, there are many factors to consider, such as the cost of formation, tax laws, and general laws governing the actions and liabilities of the LLC or corporation within each state.
Business owners typically choose to incorporate in the state of Delaware. Delaware has no minimum capital requirement, no sales tax, no personal property tax, a relatively low franchise tax, and advanced and flexible laws governing corporations and LLCs. Also, Delaware is one of the few states that permits “series LLCs,” which may be an attractive option for investors with multiple properties.
One factor investors should consider when forming a company in a given state is that the company may also have to qualify to do business in other states where it owns properties or otherwise conducts business. The LLC is often referred to as a “foreign” LLC in states other than the state in which it was formed. Generally, qualifying a company to do business in a state other than its state of formation is similar to the formation process, and the LLC or corporation may be required to pay filing fees and provide certain information and documentation to the state.
The costs of forming and qualifying a company to do business may be an important factor to consider in determining where to form the company. For example, if investors are considering forming a company in Delaware but all of the properties to be owned and operated by the company are located in New York, then the investors may elect to form the company in New York, not Delaware, and avoid the dual costs associated with forming the entity in Delaware and then qualifying that entity to do business in New York. However, the costs associated with forming and qualifying a company are only one of many factors to consider when forming and qualifying a company. Also, if a company is required to qualify to do business in a state but fails to do so, it may be subject to penalties.
What is a series LLC?
A series LLC is an umbrella entity consisting of one LLC with multiple “series” or “cells.” Series LLCs are generally of interest to individuals who have several large assets (such as multiple properties) for which they desire to maintain separate liability protection. To best understand how an LLC and a series LLC differ, a typical non-series LLC (if properly formed and maintained) will generally protect its owner’s personal assets from the LLC’s business obligations. However, it will not protect one asset owned by the LLC from being used to satisfy a judgment relating to another LLC asset.
Under a non-series LLC, all assets owned by the LLC are potentially subject to any claim or lawsuit against the LLC. For example, assume that a typical non-series LLC holds several properties. If a person is injured at one of the LLC’s properties and sues and wins, then all of that LLC’s assets – even the other properties that it owns – can be used to satisfy the judgment obtained against the non-series LLC. The LLC could potentially lose all of its properties based on a lawsuit or claim that is related to only one of its properties.
A properly formed and maintained series LLC will treat each created series as a separate entity, with its own rights and obligations. Theoretically, under a series LLC, if someone is injured at Property no.1 (which is an asset of Series no.1) and sues the LLC and wins, then only the assets of Series no.1 should be at risk with regard to the claim.
The series LLC originated in Delaware, but the laws of some other states (such as Illinois and Oklahoma) also allow for series LLCs. In states such as California, Texas and New York that require high fees to maintain separate companies, the series LLC may be registered as a single foreign entity, thus allowing one to save on annual filing fees. The “Delaware Series LLC” needs to qualify only once as a foreign company doing business in the state where the property is located.