HOW TO TITLE REAL ESTATE:
LLC, Revocable Trust, Personal Name?
Ethan R. Okura
For many people—especially in Hawaii—real estate is the most valuable investment they own and the largest part of their estate. There is so much advice and mis-information floating around about what is the best way to own real property. Today I will talk about different entities and tenancies and how each applies to owning different types of real estate.
Your Home: First, let’s look at your personal residence. Generally, having your home owned by a revocable living trust is highly recommended. In this case, when you pass away your heirs can avoid going to court for probate. The trustee can transfer the title of your residence to your designated beneficiaries without getting a judge involved. If you own your residence in your personal name, then when you pass away, your heirs will have to go to probate court to transfer the property from your name to theirs. Anytime we get a court involved, the legal fees and time required grow exponentially. It’s much easier and cheaper to set up a trust now than to go through probate later.
You may have heard that owning the property in “joint tenancy” or with a “transfer on death deed” will do the job and avoid probate. It depends. Although we don’t expect it to happen, if you name your spouse or children as joint tenants or as beneficiaries in a transfer on death deed, it’s possible that your beneficiary (or one of them) may pass away before you, which could throw off your distribution plan. For example, in your trust you might designate that if your daughter dies before you, her children would inherit her share of your property. However, with joint tenancy, your other children would inherit instead of her kids. Also, if all your joint owners or your transfer on death beneficiaries pass away before you, then the property will still go through probate! In addition, by adding someone to the title as a joint owner, you open yourself up to lawsuits fro any of their creditors. Any liabilities of your joint tenancy owners could be satisfied from your residence, possibly kicking you out of your home!
We used to sometimes recommend that married couples (or those in Civil Unions) consider weighing the benefits of the revocable trust against owning as Tenants by the Entirety, which can provide some limited creditor protection if only one spouse gets sued. However, we can now have our property owned as Tenants by the Entirety while in a revocable living trust. Hawaii is one of only two states that I am aware of (the other is Illinois) which currently allows this unique and new twist on protecting your home from both creditors and probate. If you set up your revocable trust before July 2012 or your lawyer didn’t set up your trust to provide Tenancy by the Entirety protection, you should strongly consider updating your plan to include this protection.
Finally, if you have a lot of equity in your home, we might even recommend an asset protection trust, which can protect your home from your creditors 2 years after it has been transferred into this trust.
Rental Property: Your rental property should be owned in an LLC. An LLC is a Limited Liability Company. Rental real estate is a great tool to build wealth and generate income, but it also comes with liabilities. Tenants or their visitors can sue you (as the owner) for any injuries they sustain while on your property. If you own your rental property in an LLC instead of personally, then they must sue the LLC instead which can protect your savings, residence, and other personal assets from being lost in that law suit. If you have substantial equity in more than one rental, you might want to set up separate LLCs for each rental property that you own. If you are the only owner of the LLC, by default, the LLC will be treated as a disregarded entity by the IRS and you will not need to file a separate tax return for the LLC (for married couples filing jointly, this disregarded entity status only applies in Community Property states. Because Hawaii is not a Community Property state, the couple will be required to file a partnership tax return). When it’s a disregarded entity, you can claim the same profits and losses on your tax return as you would if you owned it directly without the LLC. We usually do not recommend that you own rental properties in a limited partnership as that can limit your tax losses and write-offs.
Vacant Land and Vacation Homes: Vacant land and vacation homes can be owned in your Revocable Trust or your Asset Protection Trust, just like your primary residence. If you are not renting them, you do not need to put them in an LLC because they’re not likely to generate any liability. For all types of real property, we never recommend that you own them in your C-Corporation or S-Corporation. Although corporations also provide liability protection like LLCs, they have different tax rules and you lose out on a lot of tax benefits by owning real property in a Corporation.
© OKURA & ASSOCIATES, 2013