In a landscape that continually evolves, the U.S. Department of Housing and Urban Development (HUD) has once again brought to light an important regulation by reinstating the Discriminatory Effects Rule. This development holds far-reaching implications for those who navigate the property management sector. It not only applies to public housing providers but ALL housing providers.
This article seeks to illuminate the intricacies of this recent move by HUD, charting its trajectory and the
subsequent effects it may cast upon property management professionals.
UNDERSTANDING THE DISCRIMINATORY EFFECTS RULE
Central to the ongoing battle against housing discrimination, the Discriminatory Effects Rule emerges as a paramount framework. Its primary objective is to clarify the concept of disparate impact in the context of the Fair Housing Act. Under the purview of this rule, a policy, even when neutral on its face, can be flagged if it disproportionately hampers or affects any protected group.
In layman’s terms, the Discriminatory Effects Rule is a key tool in the fight against housing discrimination. It helps explain the idea of “disparate impact” related to the Fair Housing Act.
Basically, this rule says that even if a housing policy seems fair at first glance, it can still be considered discriminatory if it ends up hurting a specific group more than others.
According to HUD’s press release, “[The Discriminatory Effects Rule] has long been used to challenge policies that unnecessarily exclude people from housing opportunities, including zoning requirements, lending and property insurance policies, and criminal records policies.”
For example, a blanket rule that excludes anyone with a criminal record from living onsite seems fair in light of resident safety. However, this rule can have a discriminatory effect based on race, national origin, and disability. Although it is not unlawful to have a rule about criminal history, there are other ways to achieve resident safety without discriminatory effects.
For example, reviewing how long ago the crime occurred, the nature of the crime, and efforts to rehabilitate should be considered, instead of simply using a “no felons” policy.
The Discriminatory Effects Rule was initially adopted by HUD in 2013. With the turn of a new administration, the rule was recalibrated in 2020, which left some feeling that the new stance was more amenable or helpful to landlords and not so much of a protection for residents.
The new stance added new pleading requirements, new proof requirements, and new defenses that would have made it more difficult for a protected class plaintiff to start and win a disparate impact case.
So, what catalyzed the recent return to the 2013 understanding? Following the 2020 alterations, a series of litigations emerged, championed by various advocacy groups. Additionally, a federal judicial intervention halted the execution of the 2020 modifications, prompting discussions about their alignment with the foundational court case that set the initial standards.
This evaluative process subsequently led HUD to reinstate the 2013 version of the rule, deeming it more
in line with established precedents.
Navigating the maze of housing laws can be a formidable challenge. A critical takeaway is the absolute necessity for property management professionals to insulate themselves from disparate impact claims.
This demands an acute awareness and meticulous evaluation of occupancy policies and criminal history screening practices given their susceptibility to challenges.
The revival of the Discriminatory Effects Rule serves as a poignant reminder of the commitment required to eliminate housing discrimination.
With this reinstatement, property management professionals bear the onus of ensuring their operations align seamlessly with the stipulations of the rule. By recognizing the intricate dynamics of disparate impact and proactively amending any unintentional biases, they can foster an inclusive housing environment.
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CHARTING THE PATH AHEAD
As we step into the future, the onus remains squarely on property management experts to stay abreast of fair housing legislation. Periodic training and continued education become non-negotiable, ensuring preparedness and adherence. With knowledge as the guiding compass, property managers can adeptly steer clear of complaints, ensuring a compliant and inclusive housing landscape for all.
In conclusion, as housing regulations evolve, professionals in the field must remain vigilant, informed, and proactive in their approach, ensuring fairness and equality in housing opportunities.
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It seems like there are stories published every day about how expensive multifamily insurance premiums are getting. With such large increases, it might be tempting to put off updating your existing policies or even cancelling them.
But the question remains, do you want to risk not having enough coverage should there be a devastating natural disaster or massive damage to your property? Do you not want to recover losses due to theft and injury? What if an employee sues you for wrongful termination or sexual harassment?
Although it is not required by law, insurance is your protection from such catastrophes. Nothing beats excellent coverage by a reputable company when you need it the most.
But it’s getting so expensive!
One of the primary threats to multifamily investment returns is rising insurance costs. Insurance premiums for this industry have significantly increased over the last two years, dating back to early 2021 and intensifying in 2022. And the trend will continue into 2024.
Multifamily investors have reported 40-50% increases in premiums and in certain cases, insurance premiums have doubled. In addition, apartment owners are also faced with increased deductibles and self-insurance limits.
Not only are apartment owners realizing a lower net operating income, but they may also face the inability to secure financing for new investments. Higher deductibles will require larger capital reserves, forcing some property owners to sell.
What is Multifamily Insurance and why is it so important?
When buying insurance, any residence larger than a single-family home and which can accommodate more than one family is considered multifamily. Multifamily rentals often have individualized standards for risk and coverage, which can be covered with multifamily property insurance.
Multifamily insurance, sometimes known as apartment insurance, should protect you from potential liability claims, such as lawsuits, and cover you for lost rent income that you may experience after a loss covered by your insurance.
Such losses may include:
- Vandalism
- Theft
- Natural disasters, such as fires and storms
- Loss of income from rentals
- Advertising liability claims
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There are several different types of multifamily insurance:
Property Insurance
Property insurance protects against damage to the physical structure of the property.
Coverage can be obtained per building if there are multiple structures on the property where each building has its own separate coverages and deductible(s). This can be helpful for big-ticket items like mold.
Or, coverage can be obtained under a whole property policy that covers everything, regardless of the number of buildings. In either case, the actual face value of the policy will depend on the size and value of the property.
General Liability Insurance
General Liability insurance protects against claims for bodily injury and third-party property damage. For example, if a tenant is injured due to your negligence, you will be covered for damages, including medical expenses, lawyer’s fees and lost wages.
Umbrella Liability Policy
An Umbrella Liability policy is one that provides additional coverage over the stated business owner limits in order to ensure that there are no gaps in the General Liability coverage. For instance, this policy will provide coverage for acts of terrorism that may not be covered in a General Liability policy.
Business Income Coverage
When a property suffers damage that causes an interruption in the flow of normal business income, this coverage can provide protection. It can help you recover lost revenue and pay your expenses during the time it takes to repair your property and prepare it for the return of your tenants.
Based on various considerations, such as business income, sustained loss, waiting period and payroll limit, the amount of the policy may vary significantly from one property to another.
Employment Practices Liability Insurance (EPLI)
EPLI provides coverage to employers against claims made by employees alleging discrimination based on sex, race, age or disability as well as wrongful termination.
Flood Insurance
Depending on your property’s location, flood insurance may be a necessary type of coverage to consider. Standard property insurance policies typically do not cover damage caused by flooding, which can be a significant risk for multifamily properties located in flood-prone areas.
Workers’ Compensation Insurance
If you have employees working on your multifamily property, workers’ compensation insurance may be required by law in your state. This type of coverage can provide compensation for medical bills and lost wages if an employee is injured or becomes ill while on the job.
What is a small multifamily investor to do?
The small investor needs to have multifamily insurance almost more than the larger property owners who may have greater access to funds should a disaster occur. “Mom and Pop” landlords should work with their accountants to find the means to cover the needed insurance premiums.
There are economies you can take to lower your operating costs that will not affect your bottom line, such as carefully screening your potential tenants with an AAOA tenant credit check. Bad tenants will cost you in the long run with rental property damage, late rent payment, evictions, and vacancies.
The value of excellent insurance cannot be over-emphasized. This is one area where you should not shop by price. You want to choose a company that will respond quickly and work with you to get your building back to operating condition as quickly as possible.
As emphasized in Forbes, “Insurance is a must for commercial multifamily properties. The amounts and types needed are unique to the property and the market in which it is located…You should work closely with an experienced agent to determine coverages and deductibles.”
To learn more about rental property insurance for all residential types, check out our podcast, The Nuts and Bolts of Residential Rental Property Insurance.
Thank you to Spark Rental for writing this informative article
If you’re new to real estate investing—and especially as you grow your portfolio of rental properties—sooner or later you’ll be faced with a choice about how to structure your business. As an individual you can own a rental property and operate the real estate business out of your personal checking account, but that gets messy in a hurry.
Many experienced real estate investors in the United States use a limited liability company (LLC) to hold their properties and operate their businesses. Holding your real estate assets this way helps protect you from potential lawsuits from tenants and offers favorable tax treatment on your rental income.
Forming an LLC is deceptively simple, and transferring property into one takes only a few steps. But they must be done correctly and in full view of your mortgage lender, insurance provider, and of course the tax man.
Let’s review the benefits, tax implications, and pros and cons of transferring rental property to an LLC. Then, we’ll run through the step-by-step process.
- Why Real Estate Investors Love LLCs
- Tax Implications
- Federal Income Taxes
- State Business Taxes
- Transfer Taxes & Transaction Fees
- Potential Cost Triggers
- Deducting Business Expenses
- Pros and Cons of Holding Property in an LLC
- Pros of Transferring Rental Property to an LLC
- Cons of Transferring Rental Property to an LLC
- How Many Rental Properties Should I Put in 1 LLC?
- Steps to Transfer Rental Property to an LLC
- Step 1: Do Your Homework
- Step 2: Contact Your Mortgage Lender
- Step 3: Form the LLC
- Step 4: Transfer Ownership
- Step 5: Update Insurance Policies and Lease Agreements
- Final Thoughts
Why Real Estate Investors Love LLCs
A limited liability company (LLC) is a business structure that effectively creates a private business entity. This structure protects the business’ owners from personal responsibility for its debts and other liabilities.
Many small business owners and freelancers choose to form LLCs through which to conduct their business’ operations and finances. That way, if the business falls into debt or faces a legal settlement, creditors can’t come after your personal assets such as your home, car, and financial accounts. Hence the “limited liability” in limited liability company.
For real estate investors, transferring rental property to an LLC bestows some notable advantages.
To begin with, holding your rental property within an LLC shields your other personal assets from potential lawsuits or legal claims arising from your property. A litigious tenant who decides to sue the property owner will end up coming after the LLC’s assets, but your personal assets remain completely separate if you’ve set things up correctly. Yes, your LLC owns the property—maybe several properties—that could be targeted by a lawsuit seeking damages, but it won’t include your family’s home, your car, or your retirement account.
Holding rental property in an LLC also gives you tax flexibility and pass-through taxation—one of the primary benefits of an LLC over other business structures. The IRS does not recognize LLCs as separate tax entities, so income and losses pass through to your personal income tax returns. This allows real estate investors to avoid double taxation (once on the business’ income and then again on the personal income the business pays out to you). You can also write off many ordinary business expenses as deductions, while still taking the standard deduction on your personal income tax return.
Operating rental properties through an LLC ensures a clear distinction between your personal finances and the property’s financial dealings, enhancing transparency and reducing potential confusion during tax season. If you work with partners or co-owners, an LLC can formally define your property’s ownership structure and streamline ownership transitions as well.
Tax Implications
Before you jump headfirst into transferring your rental property to an LLC, you must understand the significant tax implications of the move—some good, others not so much.
Federal Income Taxes
Good news! The IRS treats LLCs as pass-through entities, meaning the income and losses from LLCs pass through to the members’ personal tax returns. Unlike with a corporation, with an LLC you don’t pay a separate federal corporate tax rate on your business profits and then get taxed again on any income you draw from the business. In other words, you pay federal income taxes on your profits as though it was direct personal income. Clean. Simple.
State Business Taxes
At the state level, the tax picture gets muddier. Like, “consult an attorney or accountant” muddier. You’ll hear this mantra a lot in the paragraphs ahead.
For starters, every state taxes businesses at a different tax rate. Because your LLC is a business, in most states you’ll pay the state’s business tax rate on your profits. It’s still generally the same or better than the personal income tax rate you’d pay to the state, but some states are much friendlier to small businesses than others. Find your state’s current marginal corporate tax rates to see what you’ll be expected to pay.
Transfer Taxes & Transaction Fees
Because LLCs are formed at the state level, each state carries its own rules and regulations for transferring property into these business structures. Many states find ways to charge upfront or ongoing fees or levy special taxes on real estate investors trying to take advantage of the benefits LLCs offer.
For example, New York imposes a real estate transfer tax of 0.4% for properties valued up to $3 million and 0.65% for properties above $3 million. Florida imposes a documentary stamp tax of $0.70 per $100 in property value when you file certain documents during this process.
Oof. When you’re talking about a piece of rental property, these small percentages can add up to a sizable expense. Make sure you know what to expect in your state.
Once again, consult an attorney or tax professional familiar with real estate regulations in your state to get a full sense of the taxes, fees, and other charges that might affect you when you transfer your property to an LLC.
Potential Cost Triggers
Transferring real estate to an LLC may trigger potential costs associated with the property technically changing hands from you (the individual) to you (the LLC member).
Transferring property to an LLC may trigger capital gains tax if the property’s value has appreciated since acquisition. And if you have claimed depreciation deductions on the property, transferring it to an LLC may result in recapturing some of those deductions.
If you plan to do a 1031 exchange in the future, transferring the property to an LLC may impact your eligibility for this strategy. Put simply, the law excludes LLC ownership interests from eligibility for 1031 exchanges.
If you’ve used other tax-saving strategies with the property in the past or you think you might want to in the future—you guessed it—consult a real estate attorney or tax professional in your state to help you fully understand the implications of moving the property into an LLC.
Deducting Business Expenses
The news isn’t all bad, though. Owning your rental property and conducting your business through an LLC allows you to deduct property expenses and ordinary business expenses from your taxable income.
It’s hard to overstate the power of being able to write off business expenses as tax deductions, especially when your business periodically involves five-figure repairs to your property. These deductions can make a huge impact on the amount of taxable income you report, and thus the taxes you owe.
For example, if you earn $50,000 of income from your rental property but have to pay $20,000 to replace a roof, your taxable income from the business for the year becomes $30,000—and your tax bill drops by thousands of dollars.
Pros and Cons of Holding Property in an LLC
Transferring rental property to an LLC has its pluses and minuses. Many real estate investors find that the benefits outweigh the headaches for them, but your mileage may vary, especially depending on your state’s tax laws.
Pros of Transferring Rental Property to an LLC
1. Personal Liability Protection: Transferring rental property to an LLC can safeguard your personal assets from potential lawsuits and claims related to the property. You never know what can happen, so holding your rental property in an LLC limits the amount of damage a potential lawsuit could do to you and the assets you’ve worked your whole life to accrue.
2. Tax Flexibility and Pass-through Taxation: LLCs offer pass-through taxation, allowing you to avoid double taxation and report rental income and expenses directly on your personal tax return. You’ll typically enjoy a more favorable tax rate on business income and have the option to deduct many everyday business expenses, lowering your overall tax burden.
3. Simplified Ownership Structure: LLCs allow for multiple owners and facilitates transfers of ownership interests if you work with co-owners or wish to sell shares of your rental business. It’s also helpful if you decide to bring on employees, such as a property manager, because the LLC can pay them rather than you paying them personally.
Cons of Transferring Rental Property to an LLC
Despite these advantages, transferring property to an LLC carries a few trade-offs and considerations worth noting before you pull the trigger.
1. Initial Costs and Taxes: Setting up an LLC involves formation costs, including state filing fees and legal expenses. The cost to file an LLC with the state is often negligible, but plan to also engage the services of a real estate attorney or accountant to help you execute a property transfer correctly. Additionally, many states charge taxes in one form or another whenever you transfer property.
2. May Invalidate Your Current Loan and Insurance Policies: Transferring your property to an LLC can invalidate the mortgage loan and owner’s title insurance policy you signed in your name. Many mortgages include a “due on sale” clause that can force you to pay the full mortgage amount immediately if you transfer the property incorrectly, so make sure you involve your lender in the process before you initiate the transfer. You’ll also need a new insurance policy in the LLC’s name. And because your brand new LLC doesn’t have the credit history you do, you may not be offered the same rates on new loans or insurance.
3. Difficulty Refinancing: Fannie Mae and Freddie Mac, the federally backed mortgage institutions, only guarantee loans issued to individuals, not to business entities. That discourages most residential mortgage lenders from working with you. You have options for financing LLC-owned rental properties, including refinancing with a commercial or portfolio lender, but these providers tend to offer less favorable rates and shorter terms lengths compared to residential mortgage lenders. Additionally, lenders may require a personal guarantee, which puts you personally on the hook to repay the loan in case of a default.
How Many Rental Properties Should I Put in 1 LLC?
There’s no one right answer to that question. You have to find a balance between liability protection versus cost and inconvenience.
You could create a new LLC for every single rental property. But those costs add up quickly, and you have to open separate bank accounts for each LLC, complete tax returns for each LLC, and so forth.
On the opposite extreme, you could create just one LLC to hold a dozen or more properties.
To strike a balance, I’ve known some real estate investors to put two to four properties in each LLC. That segments the risk to small portfolios — if you get hit with a nasty lawsuit, theoretically you contain the risk to just that small portfolio of properties.
How many properties you put into a single LLC also depends on the size of the property. If you buy inexpensive single-family rental properties, you might put a handful into a single LLC. If you buy a 20-unit apartment building, you probably want a separate LLC for it.
Find your own balance between protection, hassle, and cost.
Steps to Transfer Rental Property to an LLC
If you’ve decided this approach is right for you, great! Next we’ll walk you through how to move your investment properties into an LLC. Transferring a rental property to an LLC must be executed correctly to avoid any costly surprises. Follow these steps to make sure you don’t miss anything.
Step 1: Do Your Homework
At the risk of sounding like a broken record, before you make any decisions about how and where to establish your LLC, you should consult with a local real estate attorney and/or tax professional to understand the tax implications and for legal advice specific to your situation.
Seek professional advice to review your existing mortgages, loans, and contracts to decide whether moving your property to an LLC is the best approach for your situation and, if so, to ensure a smooth transfer to the LLC.
When choosing a state in which to form your LLC, consider factors like corporate tax rates, filing fees, and ongoing compliance requirements.
Step 2: Contact Your Mortgage Lender
Avoid the risk of tripping a due on sale clause by contacting your mortgage lender and discussing your intention to transfer the property to an LLC. They’ll let you know whether you can transfer the property title under your existing mortgage and what fees or interest rate adjustments, if any, you’ll incur.
While I’m not saying it’s a good idea, I’ve known real estate investors to create an LLC named after themselves, such as “Jim Cirigliano LLC,” in hopes that the mortgage lender simply won’t notice the subtle change in ownership. While I’ve seen it work, there’s no guarantee, and you risk the mortgage company calling the loan.
Step 3: Form the LLC
Register your LLC with the state government, usually with the Secretary of State’s office. During this process you’ll choose a unique name for your LLC and register it with the state by filling out some forms and paying a registration fee, often around $100.
Upon completion, your new LLC will receive an employee identification number (EIN), a unique ID akin to a Social Security number you’ll use to file your LLC’s taxes and open a bank account.
Remember, once you create this new business entity, you have to keep your LLC compliant by maintaining separate bank accounts from your personal finances and keeping detailed records of your business income and expenses to protect your limited liability status.
Step 4: Transfer Ownership
To move your property into your shiny new LLC, you need to obtain a deed form, which you can find online.
In most cases, if you’re transferring property you already own to an LLC you also own, you can get by with a quitclaim deed, which simply transfers ownership without making any guarantee that the title is free and clear and that you rightly own the property. If you’re working alongside partners or co-owners who might need to verify this information, you can use a warranty deed instead.
Complete these forms using your legal name and your LLC’s information exactly as registered with the state. If you have questions, a local title company can help you through any of the specifics that apply to you in your state. In some cases you might need to have a third party, such as a registered agent, sign on behalf of the LLC, and you may need to sign the paperwork in the presence of a notary.
File the paperwork with the county clerk or county recorder’s office to transfer the title and record the new deed. Congratulations, it’s official!
Step 5: Update Insurance Policies and Lease Agreements
Once the property belongs to the LLC, you need to update several stakeholders to whom this change matters.
For example, you’ll have to notify your insurance company about the transfer to the LLC and ensure that the property is adequately insured under the new legal entity. You should also update any contracts or utility accounts you have in your name to that of the LLC.
Finally, make sure to notify your tenants about the ownership change and have them sign updated lease agreements under the LLC’s name.
Final Thoughts
Transferring rental property to an LLC offers real estate investors protection for their personal property, tax flexibility, and organizational clarity. The drawbacks include potential costs and less flexibility when it comes to financing and selling the property. Unfortunately the rules vary so much from state to state that it’s impossible to cover them all here to provide a one-size-fits-all recommendation, other than to consult with a real estate attorney or accounting professional in your state who understands the tax laws that apply to you.
That said, as long as you play by the right rules, investors who successfully transition their real estate assets to an LLC enjoy many benefits that will serve you well in the long run.
We published a podcast ALL about how to determine if holding your rental property in an LLC is right for you.
Check out episode 16 to listen!