TL;DR — Key Takeaways
- An LLC can make sense for rental and investment property. For the home you live in, it frequently costs more than it protects.
- Transferring mortgaged residential property to an LLC can allow the lender to call the loan due. The federal protection that covers transfers into a revocable trust does not cover transfers into an LLC.
- A homeowner’s insurance policy generally insures you, not your LLC, and title insurance may not follow the property into an entity. Both need attention before the deed is recorded.
- A home held in an LLC generally loses the homeowners’ property tax exemption, because the owner is no longer a person occupying the home.
- Moving property into an LLC you own in the same proportions is generally not reassessed. Later changes in who owns the LLC can be.
- For most homeowners, a revocable trust does what they actually wanted from an LLC: avoiding probate and keeping control, without the lender, insurance, and tax problems.
An LLC can be a sensible way to hold California rental or investment property, because it separates the risks of operating a rental business from the owner’s other assets. For a personal residence it frequently backfires. Transferring a mortgaged home into an LLC can give the lender the right to call the loan, the home generally loses its homeowners’ exemption, insurance coverage may not follow the transfer, and the asset protection an LLC offers for a residence is thinner than most people expect.
The deciding question is usually not whether an LLC is a good idea in general. It is what problem you are trying to solve and whether an LLC solves it better than the alternatives.
Where an LLC makes sense
Rental property. A landlord faces liability from tenants, guests, and injuries on the property. Holding a rental in an LLC places that exposure inside the entity, so a claim arising from the rental generally reaches the LLC’s assets rather than the owner’s home and savings, provided the LLC is properly formed, adequately capitalized, and operated as a genuine separate entity. Commingling funds or ignoring formalities can let a creditor reach past the entity.
Multiple owners. Where several people own an investment property together, an LLC with a written operating agreement can govern decisions, contributions, distributions, and buyouts far more cleanly than co-ownership on a deed.
An operating business. Property that is part of a business, such as a building the business occupies, often belongs in an entity for reasons that go well beyond real estate.
Bay Legal’s post on the LLC in a California estate plan covers the planning case for entities in more depth.
Why it backfires for a home
The due-on-sale clause
Most residential mortgages contain a due-on-sale clause: if the property is transferred without the lender’s consent, the lender may declare the full balance due.
Federal law, in the Garn-St Germain Act, restricts lenders from enforcing that clause on specified transfers of residential property with fewer than five units. One of the protected transfers is a transfer into a trust in which the borrower remains a beneficiary and which does not transfer occupancy rights. A transfer into an LLC is not on the protected list.
That does not mean every lender will call the loan when an owner deeds a house to an LLC. Many never notice or choose not to act. But the right exists, and it tends to matter at the worst time: when rates have risen, when the property has lost value, or when the lender is looking for a reason. Relying on a lender’s inattention is not a plan. If an entity transfer is worth doing, it is worth getting the lender’s written consent first.
Insurance
A homeowner’s policy names you as the insured. After the transfer, the LLC owns the house and you do not, which can leave a gap between who owns the property and who the policy covers. Rental and entity-owned property generally requires a different kind of policy, and the carrier needs to know about the transfer.
Title insurance raises a similar question. An owner’s title policy insures the named owner, and whether coverage continues after a transfer to an entity depends on the policy’s terms and any endorsement. Some policies continue coverage for certain transfers to entities the insured controls; others do not. A title problem discovered after an uninsured transfer lands on the owner.
Both are solvable. Both are frequently overlooked.
The homeowners’ exemption
California’s homeowners’ property tax exemption reduces the assessed value of a home occupied by its owner as a principal residence. When an LLC owns the home, the owner is an entity rather than a person living there, and the exemption is generally lost. The dollar effect is modest in any single year, but it is permanent for as long as the entity holds title.
The asset protection is thinner than expected
People often put a home in an LLC to protect it from their own creditors. That is largely the wrong way round.
An LLC protects the owner from the LLC’s debts. It protects the LLC’s assets from the owner’s personal creditors only through a charging order, a court order directing that distributions the owner would receive go to the creditor instead. California’s charging order protection is weaker than in some states: a California court can order a foreclosure sale of the owner’s interest in some circumstances, and a single-member LLC offers particularly limited protection. A home placed in a California LLC to shield it from its owner’s personal liabilities may not be shielded at all.
California also offers a homestead exemption that protects a significant amount of equity in a principal residence from judgment creditors, and that protection is tied to a residence the debtor occupies.
If you are weighing an LLC for a property, the answer turns on what the property is and what you are protecting against. Call Bay Legal at (650) 668-8000 in Northern California or (213) 668-8000 in Southern California.
Reassessment
Transferring real property to an LLC is a change in ownership for property tax purposes unless an exclusion applies.
The exclusion that usually matters is for proportional interests: when individuals transfer property into an entity and receive ownership interests in the same proportions they held the property, the transfer is generally excluded under Revenue and Taxation Code section 62(a)(2). A married couple deeding their rental to an LLC they own fifty-fifty is the typical case.
The exclusion comes with a string attached. Under section 64(d), the transferors become “original co-owners,” and when more than 50 percent of their original interests are later transferred, cumulatively and in any combination, the property is reassessed. Separately, under section 64(c), any person or entity that obtains control of more than 50 percent of the LLC triggers reassessment of all real property it owns.
That means the reassessment consequences of an LLC often arrive years after the transfer, when interests change hands in an estate plan, a sale, or a buyout. The interaction with Proposition 19 for family transfers is covered in Bay Legal’s post on whether an LLC can protect a home from Proposition 19. Confirm the treatment with the county assessor and a tax professional before any transfer.
LLC or revocable trust?
For a residence, most of what people want from an LLC is delivered better by a revocable trust.
A revocable trust avoids probate on the home. A transfer into one is within the Garn-St Germain protection where the borrower remains a beneficiary and occupancy does not change. It generally preserves the homeowners’ exemption and does not trigger reassessment. And it keeps the owner in control during life.
What a revocable trust does not do is provide liability protection. A trust is not a separate business entity, and the owner’s creditors can generally reach trust assets while the trust is revocable.
So the common structure for an owner with both a home and rental property is a revocable trust holding the home and, where warranted, one or more LLCs holding the rentals, with the LLC interests themselves held in the trust.
When the answer is don’t
For most people asking whether to put their home in an LLC, the honest answer is no.
The transfer can expose the mortgage to acceleration, can create insurance and title gaps, costs the homeowners’ exemption, can set up a reassessment later, and delivers little protection for a residence against the owner’s own creditors. The probate and control benefits most people are actually looking for come more cheaply and more safely from a revocable trust.
The picture changes for rental and investment property, for property with several owners, and for property tied to an operating business, where an LLC often earns its keep. Getting that distinction right, before the deed is recorded, is the whole question.
Bay Legal advises on entity and trust structures for California real property. Reach us at (650) 668-8000, (213) 668-8000, or through baylegal.com/contact-us.
Frequently Asked Questions
When does holding California property in an LLC make sense?
Most often for rental and investment property, where the LLC can separate the liability of operating a rental from the owner’s other assets, and for property with several owners who need a written agreement governing decisions and buyouts. For a personal residence it frequently creates more problems than it solves.
What are the reassessment risks of transferring to an entity?
A transfer into an LLC in the same proportions the owners held the property is generally excluded under Revenue and Taxation Code section 62(a)(2). But the transferors become original co-owners, and a later cumulative transfer of more than 50 percent of their interests triggers reassessment under section 64(d). Any person gaining control of more than 50 percent of the LLC triggers reassessment under section 64(c).
Does a transfer to an LLC trigger a due-on-sale clause?
It can. The federal Garn-St Germain Act protects specified transfers of residential property with fewer than five units, including a transfer into a trust where the borrower remains a beneficiary and occupancy does not change, but it does not protect a transfer into an LLC. The lender may be entitled to call the loan, so obtaining written lender consent before transferring is the safer course.
How does an LLC differ from a revocable trust for property?
A revocable trust avoids probate, is protected from due-on-sale enforcement in the circumstances the Garn-St Germain Act covers, generally keeps the homeowners’ exemption, and does not trigger reassessment, but it provides no liability protection. An LLC provides liability protection for the property’s own operations but creates due-on-sale, insurance, exemption, and reassessment issues for a residence.
What insurance and lender issues follow an entity transfer?
A homeowner’s policy insures the individual, so the LLC generally needs its own coverage and the carrier should be told about the transfer. An owner’s title insurance policy may or may not continue after a transfer to an entity, depending on its terms and endorsements. And the lender may be entitled to accelerate the loan, so written consent is advisable before recording.
