As landlords expand their rental property portfolios, many opt to transfer property to a Limited Liability Company (LLC), creating a clear distinction between personal and rental income.
If you choose to go this route, moving to a single-member LLC won’t impact your overall tax liability, as you’ll still file through your personal tax return. However, the transfer could trigger various tax liabilities, like transfer and capital gains taxes.
In our guide, we’ll explore the tax implications of property transfer to an LLC, keeping in mind that costs hinge on the LLC’s structure and your transfer approach. Given the significant sums involved, investing in a tax-savvy professional is wise. Their fees are often tax-deductible, offering a strategic financial advantage.
Read on to discover how to navigate this LLC transfer terrain effectively for a seamless and tax-efficient property ownership experience.
Table Of Contents: Transferring Property To An LLC And Tax Implications
When transferring your rental property to an LLC for management purposes, you may become liable for various taxes. Learn more in our guide.
- Why Landlords Transfer Properties To LLCs
- Tax Consequences Of Transferring Properties To An LLC
- How To Transfer A Property To An LLC
- Property Transfer FAQs
- Will I incur capital gains tax when transferring property to an LLC?
- Can I use a 1031 Exchange to defer capital gains tax when transferring to an LLC?
- Does transferring property to an LLC trigger transfer taxes?
- Can I deduct expenses related to the property once it is in an LLC?
- How does owning property in an LLC affect depreciation?
- Will my property taxes change if I transfer it to an LLC?
- Are there self-employment taxes for rental income in an LLC?
- Get Your Taxes Right
Like many landlords, you may choose to transfer your property portfolio to an LLC to separate your rental business from your personal assets, such as your family home and vehicle. This transfer essentially protects personal assets in the event of a lawsuit linked to your rental business.
For example, a tenant could accuse a landlord of discrimination under the Fair Housing Act. If the landlord were found liable, they may have to pay fines and damages. However, if an LLC owns the rental property, the tenant cannot pursue the landlord’s personal income or assets to cover the damages.
Many landlords choose LLCs over other company structures as, under an LLC, rental income can be managed via pass-through taxation on the landlord’s personal tax return, avoiding corporation tax.
Also, an LLC can pass property ownership to heirs while minimizing estate taxes. Rather than passing property to a family member and incurring inheritance or estate tax, heirs can have membership interest in the LLC.
Some landlords also choose to move their expanding property portfolio to an LLC to provide an air of professionalism to their business. This can attract tenants and also investors, the latter to raise capital to expand the business.
Read our complete guide to LLCs for property management, including a detailed exploration of the pros and cons.
So, if you’re a landlord starting out with one property in your own name, there are several reasons why you might consider transferring your rental to an LLC as your business grows. But what are the immediate consequences of making the transfer?
Generally, LLCs don’t offer tax savings for landlords, as their taxes flow through personal returns. Operating your rental business under an LLC doesn’t alter your tax liabilities or deductions compared to individual status.
The decision to transition to an LLC should instead be based on tangible benefits, like limited personal liability and enhanced professionalism, as we discussed earlier.
However, transferring property from your personal ownership to LLC ownership may have tax implications, depending on how the transfer is structured and the composition of your LLC. In some cases, the transfer may be considered a “sale,” which could trigger capital gains tax, depreciation recapture, and other tax liabilities.
The tax consequences of transferring property to an LLC vary depending on whether the LLC is a single-member or multi-member entity. This is because a deed can only convey property from one grantor to one grantee. So, if you set up a single-member LLC in your name, and the property you’re transferring is also in your name, there’s no change in the grantor or the grantee, and therefore, you do not incur any transfer taxes or recognition of gain or loss.
If the title changes, such as adding another member to the LLC or transferring the property to an existing multi-member LLC, the tax outcomes outlined below may apply.
Read our complete guide to the disadvantages of LCCs for rental properties.
Depending on what US state your property is in, transfer taxes may apply for transferring ownership of a property to an LLC. For example, some states consider transferring real estate to an LLC as a sale, even if you are both the original property owner and the sole member of the LLC. This triggers transfer taxes.
In New York, the transfer fee, when applicable, is currently $2 for every $500 of property value up to $1 million, at which point an additional 1% mansion tax applies. But, in most cases, if you’re transferring property from your own name to a single-member LLC, the tax will not apply. Meanwhile, there are no transfer taxes in states such as Texas and Utah.
Similarly, if the property has appreciated during your ownership and the transfer to an LLC is considered a sale for tax purposes, this can trigger your liability to pay capital gains tax on the appreciated value.
New York currently taxes capital gains at 10.9%, which is the second highest rate in the country behind California, which is currently at 13.3%. This is in addition to federal capital gains taxes, which can be up to 50%, depending on your income.
Equally, if the property has depreciated in value during your ownership, transferring the property to an LLC can have tax benefits as you can claim depreciation on your tax return.
When you transfer your property to an LLC, this can trigger a reassessment of the value. If the property has increased in value, you can find yourself paying higher property taxes. It’s worth bearing in mind that property values are reassessed on a regular basis.
While not strictly a tax matter, transferring a property to an LLC may activate a mortgage due-on-sale clause. This clause could demand full repayment of your remaining mortgage balance, even though no actual sale occurs.
In response, you might need to secure a new mortgage to cover the outstanding amount, presenting a potential risk. Market fluctuations could limit you to less favorable rates.
Additionally, the LLC, not you personally, becomes the borrower, and the lender evaluates based on the LLC’s creditworthiness, financial stability, and ability to repay.
Carefully review your mortgage terms before the transfer to anticipate and address potential issues arising from the due-on-sale clause activation.
Once you’ve set up your LLC, there are several steps to transferring property to your company.
Step 1: Prepare The Deed
To transfer your property to the LLC, you’ll need to draft a new deed, typically either a warranty or quitclaim deed.
A warranty deed form provides a warranty from the seller that the title is clean and that if any unforeseen claims arise, the seller will defend the buyer.
A quitclaim deed makes the transfer without the same covenant or warranties.
Step 2: Address Your Mortgage
Before transferring your property, you’ll want to check with your mortgage lender to determine whether the transfer will trigger the due-on-sale clause or if you can continue with the same mortgage.
If it does trigger the clause, you may need to look into refinancing options to cover the amount due. Remember that the new mortgage will need to be in the name of the LLC.
Step 3: Review Your Taxes
Review what taxes you will be liable for if you transfer property to the LLC, principally transfer and capital gains taxes. This depends on the laws in the state where the property is located.
Step 4: Transfer The Property
You’re now free to execute the deed in the presence of a notary public or other designated authority in your state. The deed must then be filed with the county clerk’s office where the property is located. In New York, a Real Property Transfer Report must also be filed. This filing will trigger fees and tax liabilities.
Step 5: Update Insurance And Other Registrations
Since liability for the property has now been transferred to the LLC, insurance policies will need to be updated to reflect the new arrangement. Failing to do this can undermine the liability protection offered by an LLC.
Utilities, maintenance contracts, and other registrations should also be updated to be in the name of the LLC.
Step 6: Maintain Separate LLC Records
Once the transfer has been completed, it’s important to maintain LLC-specific records for all financial transactions related to the property using a separate LLC bank account.
Failure to properly separate your personal and LLC finances can again undermine the liability protection that the LLC is designed to offer. If a party can show that you’re treating the property now owned by your LLC as personal property, the courts can overrule the LLC’s protections.
Below are answers to some of the questions most frequently asked by landlords about the tax implications of transferring properties to an LLC.
Potentially. The IRS may view the transfer of property to an LLC as a sale, particularly if the LLC has members other than yourself. This could trigger capital gains tax if the property has appreciated since you purchased it.
However, if you are the sole member of the LLC, and it’s a disregarded entity for tax purposes, there may not be immediate capital gains tax implications.
Yes, if done correctly. A 1031 exchange allows you to defer capital gains tax if you exchange the property for another “like-kind” property. The LLC must be structured properly, and the exchange must meet specific criteria set by the IRS.
It depends on state and local laws. Some jurisdictions impose transfer taxes on the transfer of real property, including transfers to an LLC. You should check the specific regulations in the area where the property is located.
Yes. Generally, an LLC can deduct ordinary and necessary expenses incurred for managing, conserving, or maintaining rental property. This includes repairs, property management fees, property taxes, and mortgage interest.
The property’s depreciation schedule generally continues as it was before the transfer. However, if the transfer is considered a sale (for tax purposes), a new depreciation schedule might begin based on the property’s fair market value at the time of the transfer.
Transferring property to an LLC does not inherently change the property tax rate. However, the transfer could trigger a reassessment of the property value, changing the amount of property taxes owed.
Rental income is generally not subject to self-employment taxes. However, if you provide substantial services to tenants or operate the rental property as a business, the IRS may consider it self-employment income subject to self-employment taxes.
The tax implications of transferring your property to an LLC can vary based on local laws and your LLC’s setup. While the move can shield you from liability, it may also bring a substantial tax burden.
Before deciding on the optimal approach for managing your rental properties, it’s crucial to understand and prepare for the associated costs.
Note: RentPrep does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, or accounting advisors.