Of the various strategies for managing personal liability and increasing flexibility in asset management, transferring real estate to a limited liability company (LLC) has been widely used by investors. While often used as a planning strategy, transferring property to an LLC may be more administratively feasible than some alternatives.
Even so, transferring an asset to an LLC has tax consequences that you should know about before choosing this strategy. From potential capital gains taxes to the loss of step-up in basis benefits, knowing what may come helps you prepare for the transfer and avoid unpleasant financial surprises. Below, Realized 1031 has shared a guide discussing these tax implications and their effects.
Transferring a real estate property, currently owned as a personal asset, to an LLC has a few benefits that make the strategy appealing to property owners.
How do these benefits emerge? An LLC is a type of company that formally separates its owners (members) from the business itself. Thanks to this legal distinction, the LLC becomes the official owner of the property. Meanwhile, you and any partners operate as members of the company rather than direct owners of the real estate. This separation provides a legal and financial buffer while also streamlining management.
Here are some of the tax consequences you may encounter when transferring a real estate asset into an LLC.
There are two ways to structure ownership when transferring property to an LLC. If you are the sole owner of the LLC, it can be treated as a disregarded entity for tax purposes—meaning the transfer typically doesn’t trigger immediate capital gains tax.
The other type of ownership is when the LLC has multiple members. In this case, the IRS may actually recognize the transfer as a sale, which may trigger capital gains taxes, especially if the property has appreciated since the original purchase.
For assets held for more than a year, capital gains tax rates apply. Those in the highest tax brackets will be liable to pay up to 20% of the taxable gains. If your property earned $200,000 during the transfer, then you may need to pay $40,000 in federal capital gains taxes. We haven’t included state capital gains taxes or factors that could reduce the capital gain such as adjusted basis, holding period, and available exemptions.
Local governments and states may also impose transfer taxes when you change the ownership of a real estate asset. Typically, the rates are based on the asset’s value, but the specific calculation method and the responsible party can vary significantly depending on the jurisdiction. Local and state governments may impose transfer taxes when real estate ownership changes. The applicability and responsibility for these taxes depend on the jurisdiction's laws and the transaction's details.
You may also need to pay recording fees, which are distinct from the transfer taxes. Changing the ownership of a real estate asset will involve some official documentation and process, and the recording fee pays for these administrative costs associated with updating public records to reflect the new ownership. To be more specific, one document that needs to be updated is the deed, which needs to reflect that the LLC is now the owner of the property.
While not tax-related, payments demanded by the due-on-sale clause can require a huge sum. This clause is usually included in mortgage contracts, and it requires you to pay the remaining mortgage balance upon the sale of the rental property. A transfer to an LLC, which can be recognized as a sale, triggers this clause. Because of this possibility, it’s critical to communicate with your lender during the early stages of the transfer.
Certain jurisdictions treat the act of transferring real estate to an LLC as a trigger for property tax reassessment because of the ownership change. Given this possibility, it’s important to understand that the reassessment could lead to an increase in your property tax expenses, particularly if the property’s market value has grown since its previous evaluation.
The step-up in basis typically allows heirs to receive property with a tax basis equal to its fair market value at the date of death, minimizing capital gains if sold. However, when property is owned by a multi-member LLC, particularly if taxed as a partnership, the rules around basis adjustment at death may be more complex and may not apply uniformly to all members. Estate planning should take these nuances into account.
If you’ve already considered the tax implications of the transfer and are ready to go ahead, the next step is to form the LLC and transfer the property. Here are the steps for each phase.
The first stage is creating the LLC itself, which, while generally straightforward, does involve a few complicated steps that may require professional guidance.
The first, and arguably best part, is choosing the name of your LLC. You have full control of what the designation will be, so you can choose something that truly represents your goals or yourself (for sole proprietorships). Just make sure that you follow your state’s LLC naming rules, and end the name with “LLC.” Ensure the name isn’t already in use in your state.
The articles of the organization serve as the document detailing key information about your LLC. These details include the name, the members, and the address. You’ll need to submit this document to your state’s business filing office, which is usually the Secretary of State.
Your registered agent is responsible for receiving legal and tax documents on behalf of the LLC. This can be you, a partner, or a professional service.
The operating agreement is another important document that outlines your LLC’s ownership and operating procedures. In addition, the operational agreement assigns member roles and describes profit distribution. While not strictly required, the operating agreement is a best practice when there are multiple people in the LLC.
While an LLC is a pass-through entity, it still needs to be registered with the IRS for various other applications. So, you need to apply for an EIN upon the creation of the LLC.
A business bank account keeps your LLC’s finances separate from your personal accounts to maintain liability protection and proper bookkeeping.
Once you’ve officially formed your LLC, the next step is to transfer your rental property into the company. This process may involve tax consequences and should be handled carefully.
Typically, you’ll use a quitclaim deed or warranty deed to transfer ownership from yourself to your LLC. You’ll need to sign, notarize, and file this document with the county recorder’s office where the rental property is located.
This step is only necessary if you have an existing mortgage on the property. Since there’s a transfer of ownership, you’ll need to report this to your lender and address due-on-sale concerns, as mentioned above.
If you already have existing tenants, you’ll also need to update the lease agreements to reflect the new landlord — the LLC. We also recommend informing the current tenant of the changes, especially if you’re implementing new payment schemes.
Contact your insurance provider to transfer the property’s liability and landlord insurance coverage to the LLC. You may need to purchase a new policy under the LLC’s name.
During and after the transfer, maintaining proper documentation and record-keeping will be crucial. Having details of the transfer process on hand will help with future administrative tasks and may even protect you should legal issues arise.
Transferring rental property into an LLC is one approach for addressing liability and estate planning concerns, but it is not the only option. Investors may also consider a Section 1031 exchange into a Delaware Statutory Trust (DST) structure.
A DST allows eligible investors to acquire fractional interests in institutional-grade real estate through a passive ownership structure. While investors do not manage the property directly, the DST sponsor handles day-to-day operations. Under this arrangement, liability is typically limited to the trust, meaning that creditors generally cannot pursue individual investors for obligations related to the underlying property.
In addition, a properly executed 1031 exchange into a DST may allow for deferral of capital gains taxes, provided that IRS requirements are met. However, investors should be aware that DST investments are illiquid, involve risks related to real estate market fluctuations, and are typically limited to accredited investors. They may not be suitable for all clients.
Transferring real estate to a limited liability company (LLC) may offer certain structural and legal benefits, such as separating ownership from personal assets and introducing flexible ownership arrangements. However, this approach can also involve important tax considerations.
Depending on the structure of the LLC and the nature of the transfer, investors may face capital gains tax exposure, transfer taxes, property tax reassessments, or a potential loss of step-up in basis treatment in estate planning scenarios.
Before proceeding with a transfer, investors should consult with qualified tax and legal professionals to fully understand the implications. In some cases, alternative strategies—such as Section 1031 exchanges or DSTs—may also be worth evaluating based on individual goals, risk tolerance, and tax planning needs.
The tax and estate planning information offered by the advisor is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
Article written by: Story Amplify. Story Amplify is a marketing agency that offers services such as copywriting across industries, including financial services, real estate investment services, and miscellaneous small businesses.
Sources:
https://www.investopedia.com/terms/l/llc.asp
https://www.nerdwallet.com/article/taxes/capital-gains-tax-rates
https://www.investopedia.com/terms/d/due_on_sale_clause.asp
https://smartasset.com/financial-advisor/stepped-up-basis
https://www.investopedia.com/terms/a/articles-of-organization.asp