Structuring Real Estate Investment Properties
Ask the Real Estate Lawyer: Real Estate Law Q&A
REM #LAW 689
By Ilyce R. Glink and Samuel J. Tamkin
Summary: A reader has created an LLC to invest
in real estate. They are still having trouble financing due to an increase debt
to income ratio. Sam and Ilyce give advise on how to invest in real estate and
retain a strong personal financial base.
Q: My husband and I have rental properties with mortgages under our name.
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We set up a limited liability company to separate our personal and business
real estate properties. I'm the manager of the company and my husband is the
Our mortgages have prepayment penalties and having the mortgages has affected
our debt-to-income ratios. We were recently turned down for a mortgage for another
real estate acquisition.
How can we transfer the debts from our name to the limited liability company?
If we refinance our loans under the limited liability company’s name,
will refinancing satisfy the "soft" prepayment clause in the mortgage?
Can we avoid the prepayment penalty?
A: You may have entered a black hole of real estate ownership. While you probably
have good cash flow from the homes or buildings you own, your income is probably
reduced by the depreciation you take in owning these properties.
This depreciation – the tax benefits you get from owning a property that
allow you to reduce you tax liabilities each year – causes your income
to go down. The more real estate you own, the bigger the effect on your tax
return. Thus if you own a couple of single family homes, you will see some impact
on your income taxes, but if you own large commercial properties or dozens of
residential properties, the impact can be quite large. You can even live quite
well but show a loss on your income taxes.
If a large part of your income is from your real estate business or you have
enough buildings to affect your income, many residential lenders will have difficulty
giving you financing. You should try to find a commercial lender or a residential
lender that has extensive experience with people that own many rental properties
to help you out in your future deals.
As far as transferring title of the properties from your name to the name of
a limited liability company, your efforts will be in vain if the lenders still
require you to personally sign the loans.
If the limited liability company were able to secure financing without your
personal guarantees, that would assist you in your ability to obtain loans for
other properties you may wish to own and live in. But, if the company’s
structure is such that the losses and gains flow directly to you and your income
tax return, you may end up in the same place. Your tax return will show you
with little income to justify new loans.
While you may find a residential lender willing to lend you money, it is more
likely that residential mortgage lenders that keep the loans in-house –
that is, they do not sell the loan in the secondary market – or a commercial
lender will be a greater source of financing for you in the future.
Whether you’ll be able to avoid the repayment of the prepayment penalty
will depend on the terms of the prepayment penalty. If the terms of the prepayment
penalty state that you do not have to pay the penalty if you sell the home,
your transfer of title may not satisfy this requirement. The lender would be
looking for a true sale of the property and not a transfer of title from your
name to an entity you control. You need to review the terms of the prepayment
penalty and have a discussion with your lender to determine if the prepayment
penalty can be waived under your circumstances.
Overall, you need to figure out how to structure your real estate transactions
going forward. You should sit down with a good accountant that has a fair amount
of experience with real estate investments to strategize what you should do.
Once you figure out the game plan, you should look for a lender that can be
a partner in financing your real estate transactions going forward.
Samuel J. Tamkin is a Chicago-based real estate attorney. Ilyce
R. Glink’s latest book is 50 Simple Steps You Can Take To Sell Your
Home Faster and For More Money In Any Market. If you have questions for
them, write: Real Estate Matters Syndicate, PO Box 366, Glencoe, IL 60022
or contact them through Ilyce’s website www.thinkglink.com