WHAT IS THE BEST WAY TO PURCHASE REAL ESTATE ?
August 03, 2017

When purchasing real estate, whether its residential, commercial or mixed use property, clients often ask: “What is the best way for me to purchase the real estate?” The answer, not unlike most answers to legal questions is: “It depends.” The overriding goal in all cases is to protect yourself to the maximum extent from any personal liability and exposure and attain peace of mind. Remember, deeds and other evidences of real estate ownership are readily available online for the public. That means that any curious third party, be it a personal injury attorney investigating the feasibility of a lawsuit against you, a creditor (current or future) or simply any nosy busybody can obtain information with relative ease indicating who owns a piece of property, when it was purchased and for how much. This is unsettling for most of us so we need to take measures to minimize the information about our personal assets.

If you are purchasing a residential home, there is likely a bank loan (a mortgage) involved. In that case, the purchaser needs to satisfy the requirements of the bank. Most banks want an individual to stand behind the obligations and act as guarantor of the loan. However, this does not mean that there are no options to minimize your exposure. In this scenario, purchasing property in the name of a trust is advised. The named owner on the deed is the trustee. The trustee (even if it’s the same person as the individual setting up the trust) is the legal owner of the real estate but solely in his or her capacity as trustee and not individually. Legally, this difference is significant particularly to a creditor or any third party looking to inquire about your personal assets; in such a circumstance, the trust is the true legal and beneficial owner of the real estate with a trustee signing on the trust's behalf but with no individual ownership interest. This type of ownership should be carefully considered by professionals who have licenses and expose themselves to potential third party lawsuits regularly, i.e. doctors, builders, lawyers and other similar professionals. Banks are familiar with this ownership structure and are increasingly comfortable with processing loans in which a trust is the owner of the real estate being purchased and mortgaged.

If the real estate being purchased is for commercial use, even more creditor and asset protection is required. Commercial properties may involve tenants, contractors and relationships with other third parties such as customers, vendors and the like. Each of these third parties can threaten or bring an actual lawsuit against the owner of the real estate at any time in its dealings. For example, a tenant can sue the landlord for liability in failing to maintain the premises or a customer for a slip and fall. For commercial acquisitions, we recommend a double layer of protection as follows: purchase the property in a limited liability company (LLC) and in turn the LLC should be held in the name of a trust. In this way, the individual standing behind the transaction is clothed in two layers of protection. For commercial purchases, banks are very familiar with a purchaser’s desire to hold title in the name of an LLC and typically process the loan without issues.

Forming an LLC to own the real estate can be done by your attorney or accountant with relative ease and minimal cost. The LLC is a separate legal entity that operates and does business under its own name and where the owners are not personally liable for the debts and obligations of the LLC. The LLC obtains a separate taxpayer identification number, maintains a bank account in its own name and signs contracts such as leases in the name of the LLC rather than the in the name of any individuals. The LLC operates through its managers or officers but not in any individual capacity. Internally, the LLC provides flexibility for the owners to craft their understandings between and among each other as they see fit. The internal governance is set out in an operating agreement of the LLC. The operating agreement is tailored to the individual needs and circumstances of the company and its owners. For example, certain managers can be named to handle certain tasks; profits and losses can be split in accordance with the understanding of the owners; and other issues that are relevant can be covered in such an operating agreement. The general benefit at large of this structure is the limited liability and lack of personal exposure of the owners of the LLC. Again, it is well advised that individual owners transfer title of their respective LLC interests to their trust to provide yet another layer of protection, limited liability and shielding of personal assets.

There are special tax rules of LLC which may make this ownership structure favorable. Obviously there are many nuances and every situation is different. For purposes of this general guidance, LLCs are treated as a “disregarded entity” for tax purposes. This means that the IRS classifies an LLC with one owner as sole proprietorship in which income and gains from the real estate are taxed at the individual level (this is true even if the owner of the LLC interests is a trust). There is no double taxation in this case. If the LLC has more than one owner, a “multimember” LLC, the IRS taxes these entities as partnerships and the owners enjoy the pass through taxation of profits and losses to their respective individual returns. Your accountant can provide more insight on the various nuances of the LLC in light of your individual circumstances. However, the general takeaway is that LLCs, especially when there is an additional lawyer of trust ownership of the LLC interests, offer protection of individual liability and in most cases avoids personal exposure while allowing for flexibility of ownership and control.

There are of course additional options such as owning real estate in the name of a corporation and other entities which can be considered depending on the facts and circumstances.

This discussion would not be complete without mentioning an additional thought. Some clients tell us “why do I need an LLC and/or trust when I have liability insurance?” Well the answer is that if you are relying solely on your insurance company as a mechanism and tool to avoid exposure of assets, then you have created a gap in your peace of mind. It is common knowledge that especially nowadays, insurance companies look for loopholes in coverage when determining payment on a claim. In fact, they go out of their way to deny coverage for a particular issue. In addition, insurance policies have limits which may not be sufficient in certain cases. Fighting with an insurance company on the one hand and fighting with your creditor on the other can be devastating and debilitating to a business and a person. Insurance should be used as yet an additional layer of risk protection and not the only one.

As discussed in this article, while no one can predict the future and consequences of any situation, a well thought out and properly structured multi-layered plan that is tailored to your situation is the best protocol in protecting your assets, your investment and your peace of mind.

The best time to consider proper legal structure is before you make the actual purchase, during contract negotiations as your attorney would need to make modifications to a contract of sale depending on your needs. It is critical that you meet with your attorney beforehand to give him or her the full picture of your situation, your goals, concerns and circumstances.

The attorneys at Beress & Zalkind PLLC are readily available to meet with you and evaluate your needs to craft a solution that works for you.

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