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The Wrong Way to Transfer a Real Estate LLC

4 Mins read

“My father died last year owning four residential properties in our area. Three of the real estate properties were occupied by family members and were left in his will to me and my two sisters (his children), one property to each child. The fourth property is a commercial property (multi-family apartment building) and both we and our estate attorney are confused about what my Dad intended to do with this one. The will says that the rental income from the property is to go to me for the rest of my life, but the will says nothing about how the estate is to dispose of the property itself. The property is owned by a limited liability company (LLC) of which Dad was the sole owner. My estate attorney suggests I speak to a business attorney but I really don’t know where to begin. Can you help?”

An ownership interest in a LLC (called a “membership interest”) is considered personal property under the laws of virtually all states in the U.S. When the owner of that interest dies, the interest becomes part of his or her estate and passes to the heirs via a will or other testamentary instrument (such as a living trust agreement).

The property – the apartment building in this case – is owned by the LLC and does not change hands when the LLC member dies. This is generally a good thing as it saves money in real estate transfer taxes, although you should check with a local attorney to be sure that transferring the entire 100% ownership interest in the LLC does not constitute a transfer of the property itself for tax purposes (I’m not enough of a real estate lawyer to answer that question).

The attorney who drafted your Dad’s will was probably not familiar enough with LLCs to know that when you put title to real property into an LLC it converts into personal property (the membership interest in the LLC). The will provision that dealt with the fourth property should have clearly mentioned the LLC by name and said how exactly his 100% membership interest was to be divided among his heirs.

Because your Dad’s will did not specifically mention the LLC or the membership interest, and especially because your Dad’s will was extremely clear that only the income from the fourth property was to go to you, I’m pretty sure that your Dad did not mean to leave the membership interest entirely to you (sorry to be the bearer of bad news here). Since the LLC membership interest is not specifically bequeathed to any of you, it becomes part of the “residual estate” (whatever is left over after specific bequests to family members are made).

You will need to see who gets your Dad’s “residual estate” under the will. If your Mom survived your Dad, she probably will receive the residual estate and will become the LLC owner, subject to your right to the rental income for life. If your Mom predeceased your Dad, the LLC owning the apartment building will be owned by you and your sisters jointly. Each of you will have a one-third membership interest in the LLC, meaning your two sisters can outvote you on important matters affecting the property.

If that’s the case, you should speak to a business attorney about drafting a new LLC Operating Agreement (similar to a partnership agreement) between you and your sisters. Because your Dad clearly meant for you to enjoy the rental income from the LLC property for the remainder of your life, that will need to be spelled out in the Operating Agreement.

Now here’s where things get complicated: your Dad said you were entitled to the rental income, but he did not specify how other tax benefits of the LLC (profits, losses, depreciation of the property, etc.) were to be allocated between the three of you. If you and your sisters get along well, they may allow you to receive those benefits for life as well. This will, however, cause them to have a “negative capital account balance” in the LLC which will have to be sorted out if and when you decide to sell the apartment building or shut down the LLC.

If you and your sisters do not get along well, then the three of you will have to share equally in tax benefits from the LLC other than the rental income.

You and your sisters will also have to work out who will be responsible for (1) paying taxes and operating expenses of the LLC (which will reduce your rental income) and (2) making management decisions such as dealing with tenants and service providers.

One possible solution would be to make you the “manager” of the LLC responsible for everyday management decisions, with important matters (such as selling the building or taking out a mortgage) requiring approval by all three of you. Basically, your sisters would agree to let you manage the property in exchange for getting two-thirds of the proceeds if and when the apartment building is sold.

If your sisters agree, of course . . .

Cliff Ennico (crennico@gmail.com) is a syndicated columnist, author and former host of the PBS television series “Money Hunt.” This column is no substitute for legal, tax or financial advice, which can be furnished only by a qualified professional licensed in your state. To find out more about Cliff Ennico and other Creators Syndicate writers and cartoonists, visit our Web page at www.creators.com. COPYRIGHT 2022 CLIFFORD R. ENNICO. DISTRIBUTED BY CREATORS.COM

Real estate stock photo by rawmn/Shutterstock

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