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LLCs and Real Estate Investing — Beware of the “Due on Sale” Clause

LLC’s are great for owning investment real estate! Be careful, however, if that real estate has bank financing in your individual name.

Most attorneys would agree that a limited liability company (LLC) is the preferred entity in which to own investment real estate. An LLC is relatively easy to set up and provides flexibility in ownership structure, management, and taxation.

An LLC protects a real estate investor’s personal assets because the LLC is considered to be separate from the investor personally. In fact, keeping the investor’s personal assets separate and apart from the LLC’s assets is a fundamental requirement to maintaining limited liability protection.

Although it is typically a good idea for investors to transfer ownership from themselves, personally, to the LLC, investors need to be mindful about banking requirements if the real estate is encumbered by a mortgage or deed of trust. When an individual purchases real estate subject to a mortgage, the bank usually provides personal financing, often with relatively low interest rates and amortization periods up to 30 years. Banks are able to do this because they perceive relatively low risk when an individual is going to occupy a piece of real estate as the primary residence.

On the other hand, bankers tend to see rental real estate as a higher risk investment. This is why most banks require commercial mortgages on such properties, which typically have higher interest rates and shorter amortization periods.

Investors need to be careful when transferring by deed property from themselves, personally, to an LLC. Doing so may trigger the “due on sale“ clause in the applicable mortgage or deed of trust between the bank and the individual. Triggering this clause may allow the bank to accelerate the note and force the investor to refinance the mortgage to one with commercial terms. This is especially true in a rising interest rate environment!

So, before you retitle a piece of real estate from yourself, as an individual, to your LLC, seek out the advice of a good attorney or trusted banker to ensure that you won’t run into trouble with your mortgage loan.

Case results depend upon a variety of factors unique to each case. Case results do not guarantee or predict a similar result in any future cases. Also, nothing in this website creates an attorney/client relationship, and you should not leave anything of a confidential nature on this website.

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