Transferring Real Property to an LLC, Friend or Family Member? You May Be Accidentally Invalidating
When you buy real property, you want to make sure you get what you paid for. That’s why title insurance exists. Imagine you are buying a piece of land to build on which you plan to build a new home. You’re told by the seller that no other party has an interest in the property, but after closing, a developer knocks on your door and shows you an agreement in which a prior owner granted the developer the right to build a road on your property. If the developer tries to enforce that agreement, a title insurance company will defend against the lawsuit on your behalf or will reimburse you for the monetary loss incurred, if any.
Property often gets transferred outside of the purchase and sale context, however. For example, family members may deed property to one another, an individual may decide to put a piece of property into a closely-held LLC for asset protection, or property may be awarded to one party or another in a divorce proceeding, to name a few.
When making these types of “off the books” transfers, people rarely involve a title company, and seldom think about the effect any transfer will have on the existing title-insurance policy. Many times, such transfers are made by quit claim deed, in which the grantor does not warrant what interest he, she, or it has in the property, or even that the grantor has any interest at all, but simply transfers any interest the grantor may have. Such transfers will compromise a property owner’s ability to make a claim under its title insurance policy.
For example, you decide you want to transfer an investment property you hold in your name to an LLC for asset protection. If you transfer title out of your own name and into the LLC via a quit claim deed, the LLC will have no warranty from you regarding the property. An issue involving title then arises. You cannot make a claim under your title insurance policy directly, because you no longer own the property.
Your LLC can’t make a claim under the title insurance policy, because you are the named insured, not the LLC, and the title insurance company has no duty to indemnify the LLC for its loss. You’re out of luck, and the LLC may end up with significantly reduced property rights, exorbitant legal fees, or both.
If you instead transfer the property to the LLC via a deed in which you warrant the title against defects occurring during your ownership of the property, the LLC then has an ability to maintain an action against you for the later-discovered defect. While the concept of suing yourself may seem odd, this allows you, as an insured under the title insurance policy, to make a claim with the title insurance policy for your losses, allowing you to reimburse your LLC. While slightly convoluted, the benefit is obvious: indirectly, you still have the benefit of insurance coverage for title defects with respect to your property.
It is highly recommended that you hire an attorney to help you with any transfer of title to real property. If you are in the process of estate planning, asset management, or familial gifting, speak with an attorney prior to any transfers to ensure that the effects of executing your plans will meet your expectations.
By Sean M. Stewart