Question: I own a rental property that used to be my personal residence years ago. Over the years, my wife and I have rented the house. It has been suggested that we create a limited liability company for the rental. Is this a good decision? And how would it affect our estate plan? We plan to leave the property to our children. We have created a living trust, mainly in order to avoid probate, and we want to make sure that objective is met. How would we deal with this?
Answer: Creating a business entity for your rental property may be a good decision, but you will want to carefully consider your overall objectives. The limited liability company, or “LLC,” operates as a stand-alone entity that can sue, in the event you need to evict a tenant, or be sued as the owner of the property. The main benefit is that in the event you were sued, your liability extends only to the assets of the LLC. The LLC may also offer certain tax advantages in that profits to the LLC “pass through” and are taxed to the owners of the LLC as individuals.
As for your concerns about probate, the existence of the LLC will not result in a probate action so long as you assign the LLC interests to the trust. This is usually done with a written assignment agreement.
Although the LLC may offer liability protection, it will come at a cost to you and possibly a hidden cost to your children. As for your costs, you will need to pay to create the LLC. In addition, every year you will need to pay $800 to the state in entity taxes, and you may have to pay an additional sum to your tax preparer for an LLC return, assuming you do not elect sole proprietorship tax treatment.
As for your children, the hidden cost they may face is a reassessment of county property taxes after the death of you and your wife. Under Prop 13, your current property tax payment is based on the assessed value of the home, which is generally the price you paid for the home plus a 2% annual increase every year. The assessed value is found on your property tax statement. The bill is due this week so a copy of it shouldn’t be far away.
When property changes ownership, the county tax assessor reassesses the value of the property for property taxes unless the law provides for an exception. For example, when one person sells a house to another, the change of ownership is reported to the county and the buyer’s property taxes will be based on the fair market value at which he or she bought the house.
But there is an exception for transfers between a parent and a child. When property transfers from a parent to a child, the real property is not reassessed. This results in the child taking the parent’s assessed value, which for long-time residents is usually much lower than current fair market value.
So it might be fair to assume that the transfer of the real property in the LLC will not be reassessed since the property is essentially going from parent to child. Not so. When real property is owned by an LLC, the authorities will see the transfer to the children differently. The transfer is not a transfer of “real property” but rather the transfer of an “LLC interest.” In other words, the children inherited an LLC interest not real property. Under the law, when more than one-half of the interest in the control of an LLC changes hands, which will happen if you leave the entire LLC interests to your kids, the county assessor will reassess the real property regardless of the relationship between the members.
For the parent-child exclusion to apply, the real property will need to be passed to the children outside the LLC. Take pause before making a decision as to how you hold the title to this property. Changes such as the ones here should only be made after careful consideration of all the risks and benefits. There are a lot of factors that go into these decisions, and you should visit with a professional to get the best advice tailored to your own set of circumstances.
Preston Morgan is a partner at Kopper, Morgan & Dietrich, a Davis law firm providing family law, estate planning and trust litigation representation. His column is published every other week in the Davis Enterprise. To pose a question to Preston Morgan, contact him at https://kopperlaw.com.
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