An often promoted “secret” of buying investment real estate with the intention of “selling” the property is not, as usual, a secret at all. However, it’s worth checking out here so you don’t end up in a relationship you don’t want. Many real estate investment enthusiasts promote the concept of buying real estate under the name of an organized legal entity rather than their own name. One of the objectives of this structure is to facilitate the resale of the property. This goal is reportedly achieved by selling the owning entity (LLC, Corporation, or Trust) and thereby transferring the property you own as well without the traditional process of searching for titles, title insurance, filings, etc. Sounds good, but is it really? I well understand the desire to make life easier for a buyer. However, there are elements involved in a typical “entity sale” that can make it problematic at best.
The first question is the probable sale of the entity. Unless this is done correctly, the seller may be selling a security. The securities law is what governs people who sell securities. The stocks, bonds, and stocks of an LLC are generally considered securities. In a case like the one we are discussing, the seller must comply with the securities law. The penalties for breaking these laws are far more punitive than for breaking most real estate laws. In addition to the value ramifications, there are liability issues.
In order for all available real estate property benefits to be enjoyed (transferred) to the owners, they must have personal liability for the debt. This means that new owners will need to sign any underlying debt, assuming current lenders will allow it, which is not a given. Also, it will be difficult for sellers to obtain authorization from lenders. It is important to note that this type of sale can still trigger a “due on sale” clause on the mortgage. This would allow the lender to recover 100% of the balance owed and payable on the loan. Read these clauses carefully.
There is also the issue of the entity’s operating liabilities. Simply put, if you buy an operating entity, you will inherit all of its operating liabilities. If the entity owes a debt when you buy it, you owe the debt. That is true even if the debt does not belong directly to the property you want to own. This may be the case with loans such as lines of credit, credit cards, and accounts opened with suppliers. In most cases, it is difficult to know all the debts that an entity has and therefore, if you buy an operating company, be careful to identify and document all the debts that you take on and have the sellers compensate you for any other .
As with many things in real estate, this concept is presented as a safe and easy-to-use tactic to facilitate business. In the real world, it usually isn’t. But it is used with a certain degree of frequency. The reason you don’t hear more about this is that the parties involved usually never get to the point of litigating any of the issues. In most cases, things are just going well according to Hoyle. If money is made, everyone will be happy. If money is lost, most people take the hit and get on with their lives. However, the fact that you are never caught does not mean that it is correct to use this concept with impunity.
As with all elements of real estate, you have an obligation to yourself and the people you do business with to be honest, open and direct. You must understand as much as possible about a transaction and make your decisions wisely. If you are thinking of buying or selling an entity and therefore a property, be careful. The more you know the better. This tool is not as safe as some would have you believe, neither for the buyer nor for the seller. If we can help, we will be happy to do so. Good luck.