Posted on Feb 10, 2015 in Real Estate

Transfer taxes are not the only concern for investors who transfer property directly into a LLC; lenders can create problems as well. Recently a client, Sandy, contacted me over a letter she received from her lender informing her of the lender’s intention to call her note due and payable in 30 days. Sandy was told to come up with $432,000 or the lender would initiate a foreclosure action.

Sandy’s lender was accelerating her note. Why? It is quite simple, her lender discovered, as did I, that Sandy transferred her mortgaged rental property into a LLC without obtaining approval from her lender. The lender was not happy with Sandy’s actions.

Sandy had set up her own LLC and attempted to play attorney not fully understanding all of the legal ramifications of transferring encumbered property into a LLC. Because her property was encumbered by a mortgage, the lender reserved the right to accelerate the note if Sandy transferred title to the property.

This is commonly referred to as a violation of the “due on sale clause” which is included in most mortgages. Unfortunately for Sandy, the market is operating under a new set of rules and Sandy thought she could continue to operate the way she did in the mid 2000s. Direct transfers of mortgaged property into LLCs are now scrutinized and prior strategies must be re-evaluated.

With the implosion of the housing market, the use of land trusts has risen dramatically. Prior to 2009, many investors held little fear of transferring their mortgaged real estate directly into a LLC. If you recall, between 2003 and 2008, banks gave out loans like your local ice cream parlor hands out samples; all you had to do is ask. How you held title after the loan closed was of no consequence to the lender or the subsequent purchaser of your mortgage.

To the lenders, the game was about loaning money then securitizing to fully monetize the investment. After an investor acquired a house he could turn around and sell it subject to the existing loan the very next day with relative confidence the original lender, or even a subsequent purchaser of the mortgage, would never check title. The same can be said for investors seeking asset protection. Set up your LLC and deed your mortgaged property to the LLC for asset protection and move on to your next deal.

When the wheels fell off in 2009, many cavalier investors eventually received calls from their lender or note holder inquiring about ownership. More than a few of these inquires were precipitated by mortgage insurers who were trying to evaluate their overall risk on a pool of mortgages. During the insurers inspection of random mortgages they would often find that the borrower did not match the title holder. The property was held by a LLC or had been transferred to another individual. The mortgage insurers placed pressure upon the lenders to get their loans in order and the lenders jumped on the borrowers.

So what did the savvy investor learn from this mess? If your property is encumbered you’d better find a way to move your mortgaged property under the protection of a LLC without alerting the lender to the transfer. The solution is to construct a land trust.

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