Legally Speaking: LLC Anonymity in Real Estate Transactions Is No More
On September 13, 2019, limited liability companies (LLCs) lost the ability to offer anonymity of their owners in residential real estate deals throughout the State of New York. Now, real property transfer tax returns, relating to residential property, sold or purchased by a limited liability company, must offer transparency by including ownership information about any LLC transacting in the deal. Residential property refers to one-to-four-family dwelling units. The ownership information required to be included on the return is the identification, by names and business addresses, of all of the members, managers, and any other authorized persons of the company. If there are no such members, managers and other authorized persons, the return should identify the shareholders, directors, officers, members, managers and partners of any other business entity that is a member, manager or authorized person of the limited liability company.
Before sellers and buyers start freaking out that their identity will now become readily available, it’s important to note that this practice has been successfully implemented in New York City since 2015 and the real estate market has remained vibrant ever since. Beyond the market’s continued success, LLCs have remained an important tool in real estate transactions in the city. The reason that LLCs have remained an important tool in the city for real estate transactions goes to their true purpose, which is not anonymity. The true purpose of an LLC, as the name says, is to limit liability of the owners.
An LLC limits the liability of its owners by capping liability at the LLC’s asset level and does not expose the owner’s other assets to such liability. To illustrate, imagine a rental house that is owned by an LLC, “Don’t Sue Me, LLC,” which, in turn, is owned by Wanda and Jake Smith. The rental house has a fair market value of $1 million and no mortgage. Wanda and Jake Smith have a combined net worth of $5 million ($4 million in assets outside of the house). The Smiths’ tenant, Sally, has a wild party at the house and her friend Tom, sadly, is seriously injured when he falls off of the deck because the railing was not secure and it gave way when he leaned on it. The injury was so serious that Tom’s back required a fusion surgery and he has been unable to return to work ever since, being rendered permanently disabled. In response to his injuries, Tom sues both Don’t Sue Me, LLC and Wanda and Jake Smith seeking damages for their negligence (premises liability) in the amount of $5 million. In response, Wanda and Jake Smith move the court to dismiss Tom’s case against them personally, because they are shielded from such case through their ownership of the property in an LLC. As required, this motion is granted by the court and the Smiths are personally out of the lawsuit.
After the dismissal against the Smiths, Tom persists in the case and ultimately prevails while obtaining a $3 million judgment against Don’t Sue Me, LLC, which carried a $1 million general liability policy. Because the insurance policy fell short of the judgment amount, Tom is able to take ownership of the rental house. But, thanks to the LLC’s protection, Wanda and Jake Smith maintain a net worth of $4 million. The Smiths owe a lot to their LLC ownership because without it, Wanda and Jake Smith would have been down to $3 million ([$5 million net worth + $1 million insurance] – $3 million judgment). This is why, irrespective of anonymity, an LLC is necessary when owning rental property.
Would the situation have resulted differently if, even with owning the real estate in an LLC, Wanda Smith had personally, but negligently, constructed the deck and railing, which was the situs of the injury? Yes. An LLC does not protect an owner from personal acts of negligence. So an LLC should hire licensed and insured home improvement contractors and not play handyman if such LLC wants to enjoy the full protections of the ownership structuring.
Would the situation have resulted differently if, even with owning the real estate in an LLC, Wanda and Jake Smith never filled out their corporate book, never drafted an operating agreement, never assigned the membership interests of the LLC, never established a corporate checking account, commingled assets with their other entities and personal accounts, and failed to observe all other corporate formalities like annual meetings, voting and the like? Yes. An LLC alone does almost nothing. To obtain protection from an LLC, an owner must observe many rules of the game rather than exercising complete dominion and control over the entity. Filing for ownership online does almost nothing for a real estate owner. Instead, being guided on corporate formalities is the name of the game when seeking counsel on business entities.
Would the situation have resulted differently if rather than owning the real estate in an LLC, it was owned by a corporation? Nope. An LLC and a corporation are both viable ownership options to limit liability. However, an LLC doesn’t have to file a Form 1120 for the business or report the profit and loss of the individuals on a K-1, so it’s typically the preferred ownership structure where the owners aren’t self-employed by the entity (LLCs, unlike S-Corporations, have to pay self-employment tax of 15.3%).
In all, the LLC remains quite useful for real estate ownership and should continue to enjoy its day in the sun with respect to rental property ownership. However, anonymity is no longer one of those advantages and only through the maintenance of requisite corporate formalities does ownership in an LLC make sense.
As you can see, it’s a good thing to know a little something called the law.
Andrew M. Lieb, Esq., MPH, is the managing attorney of Lieb at Law P.C. and a contributing writer for Behind the Hedges.