A married couple, residents of Florida, form1 a Florida limited liability company (“LLC”) and they own their membership interest in the LLC as tenants by the entireties with right of survivorship, a special joint tenancy between spouses that provides some added asset protection in Florida (explained below). The LLC will acquire or hold title to the Florida real property to be rented (either residential or commercial real property for rent). If the property is owned by the couple before forming the LLC, then they can deed the property to the LLC (please consult your attorney in this regard). If the property is subject to a mortgage, there may be some substantial transfer tax (doc stamps) to pay on this transfer based at a minimum on the value of the principal balance of the mortgage note outstanding. In such case, and the mortgage financing contains a “Due On Sale Clause” which might allow the lender to call the entire loan as immediately due and payable, then the couple must also notify the lender and obtain the lender’s written permission to make the proposed property transfer from the couple to the LLC. Written consent to this transfer is needed to prevent triggering any “Due On Sale Clause” contained in the mortgage, note or financing documents. If the property is not subject to any mortgage or equity line, then a transfer by deed to the LLC should be just fine. The couple should probably use a general warranty deed or special warranty deed when transferring the property to the LLC, which might help to keep the previous title insurance policy liable for any prior defects in title to the property. (The title company would likely remain obligated under the title policy if this is the first transfer after the purchase of the property at which time title insurance was acquired by the couple to insure good title of their purchased realty). In theory, the LLC would assert liability for breach of warranty of good title against its members and/or bring suit against its members (who warranted title with their warranty deed given to the LLC), and the members would promptly notify their title insurance company that there is a problem with the title and that the title insurance company needs to defend and make good on its obligation of insurance.
Having the LLC own the rental property adds a layer of liability protection for the LLC Members (owners). The real estate and any other assets invested in and owned by the LLC would still be placed at risk attributable to any liability of the LLC let’s say to the tenant or its invitees, or for example, a slip and fall by a guest or customer on the leased property that is not adequately insured by the LLC or by the tenant in accordance with the lease, or the LLC is not adequately indemnified by tenant under the terms of the Lease. However, the LLC Members have “some” level of personal protection from liability if, for example, they maintain all the requisite formalities of the LLC, and they don’t comingle or pay personal expenses with LLC funds, and they ensure that the LLC pays the rental activity expenses from LLC bank accounts, etc., etc., a topic well beyond the scope of this article.
If the married couple owns its membership interest as tenants by the entirety, then the LLC membership interest (owned by the married couple) as well as the underlying assets owned and held by the LLC, have some added level of liability protection . A judgement creditor of either spouse should not be able to attach the membership interest unless the creditor’s judgement is obtained against both spouses.
Additionally, if a court would determine that the LLC is a multi-member LLC (rather than single member) and/or that the ownership by the entireties is somehow defective, then the creditor might only be entitled to obtain a statutory-based “charging order” against the membership interest of the one spouse who is the debtor; and, in such case, the creditor availing itself of the charging order should only have an economic interest in that one debtor’s transferrable interest, but not any rights of a member, and no right to reach the underlying LLC assets in order to satisfy the creditor’s judgement. It would still seem better to rely on upholding the protection afforded with ownership of a single membership interest as tenancy by the entireties.
In Rev Proc. 2002-69 the IRS stated that an entity owned solely by a married couple as community property, under applicable local law, can be treated as disregarded for federal tax purposes. Florida is not a community property state, and the IRS has not specifically addressed the issue as to whether a membership interest owned by a married couple as tenants by the entireties can also be treated as a single member LLC that is an entity disregarded apart from its member for federal tax purposes. Under the laws of States that recognize community property, assets are deemed to be owned equally by the husband and wife and neither spouse has a full interest in the assets. Similarly under Florida common law regarding tenancy by the entirety each spouse is deemed to have an equal and undivided interest in the property. Some commentators argue that a membership interest by a married couple as tenants by the entirety should be treated as a single member.
Interestingly, an apparent purpose for an LLC that operates a business (and thus not solely producing rental receipts) to be treated as a partnership for federal tax purposes is so that each spouse will receive a partnership schedule K-1 having an equal share of earned income subject to reporting and paying self employment tax on schedule SE Form 1040 (so each spouse can build up social security benefits for retirement). However, an LLC that strictly has only rental revenues does not generate earned income for which either spouse must report and pay any self employment tax.
For the following discussion, please assume that the Members and/or the LLC are merely investors in the real property acquired and held for Rental, and they are (a) NOT real estate professionals or (b) NOT persons who each materially participate more than 750 hours a year in the real estate ‘business.’
See: 26 CFR § 301.7701-3 – Classification of certain business entities. (U.S. Treasury Regulations – Printed / provided online / at law.cornell.edu – by Legal Information Institute [LII]). For our purposes, in general, this pertains to classification of entities, such as limited liability companies, for federal tax purposes.
The LLC will either be treated as a partnership or as a disregarded entity for federal income tax purposes (under the default classifications absent elections), unless the Members timely file IRS form 8832 (entity classification election) to elect to be treated as an association taxable as a “C-corporation” for federal income tax purposes, or unless the Members timely file IRS form 2553 electing to be an “S-Corporation” for federal income tax purposes. Neither of these two elections is deemed advisable because: (1) a C corporation and its shareholders could be double taxed, once on the corporation’s and secondly on any non-deductible dividends paid to the members / shareholders. (2) the real estate and assets of the C Corp or S Corp are not part of a taxable transaction when they are deemed to be contributed to the corporate entity. However, these assets may be subject to tax on their appreciation in value or on recapture of depreciation if the C Corp or S Corp is liquidated and the assets are distributed in kind to the member / shareholders. (3) If the Members are treated as 1 Member (owing a single membership interest as tenants by the entirety), then the LLC is treated as an entity disregarded apart from its member and the LLC’s net rental income is reported on Schedule E of the annual Form 1040 joint federal individual income tax return of the couple, without the need for filing a partnership return for the LLC. (4) If the LLC is considered to be a multimember LLC, and thus is treated as a partnership for federal income tax purposes, then the LLC will file an IRS Form 1065 Partnership Return, and attach IRS Form 8825 to report the rental income and deductible rental expenses. Net rental income from Form 8825 is reported on Line 2 of Schedule K of the Form 1065 partnership return.
Most importantly, the LLC and its Members should enter into a well-drafted written operating agreement and a take all steps to ensure that the married Members will be deemed to own their LLC membership interest as Tenants by the Entirety. To these ends, Tenants by the Entirety ownership in Florida requires these six “Unities” which should be established. These six unities must exist for the asset (that is, the membership interest) to be treated as owned by Tenants by the Entireties:
- Unity of Possession (joint ownership and control);
- Unity of Interest (the interests in the membership or account must be identical);
- Unity of Title (the interests must have originated in the same instrument, such as issuing a single membership certificate and establishing the membership interest of couple via the LLC operating agreement);
- Unity of Time (the interests must have commenced simultaneously, via the operating agreement and simultaneous issuance of the single membership certificate);
- Survivorship; and
- Unity of Marriage (parties must be married at the time the property became titled in their joint names).
If one of these six unities is not present, then Tenants by the Entireties ownership would likely fail and the asset (i.e. the membership interest) could be subject to a spouse’s creditors. However, keep in mind the ‘charging order.’ See Florida Statutes, Section 605.0503 – Charging Order.
Let’s look at the unity of Joint Ownership and Joint Control. Should the LLC be a member-managed LLC or a manager-managed LLC? If there are no other members, the married couple should have equal management / voting rights attributable to their membership interest in a “member-managed” LLC, regardless of whether they are treated as a single member (casting one vote together) or as two members (each having one vote). The single vote by consensus of the tenants by entireties in a “member-managed” company would seem to display better evidence of having a single member LLC (disregarded entity) without the need to file a separate Form 1065 partnership tax return each year. If the couple insists on having a manager-managed LLC (for example, to avoid listing the Members on pubic record at www.sunbiz.org), the articles of organization or operating agreement should provided for exactly two managers, and each spouse should be named as an initial “manager” in the articles of organization and in each annual report thereafter. Thus, having a manager-managed company would seem to provide identical “control” rights, with each having a single vote. Neither can proceed with a certain action unless they both affirmatively vote to approve it. Although, again, having the member-managed LLC would likely be better to bolster the “unity of control,” and better ensure the benefits of some asset protection of the membership interest and underlying assets via ownership as tenants by the entirety.
See: What is Tenants by the Entireties in Florida? Posted April 13, 2021 by Bishop L. Toups, of Daily Montfort and Toups.
See: Owning Rentals in an S Corporation Might Be a Costly Mistake. Posted November 2020, by Amanda Han.
See: A Practitioner’s Guide to Limited Liability Companies. January 6, 2016, By Domenick R. Lioce, Esquire — Florida Institute of Certified Public Accountants (FICPA).
1 Formation involves preparing an LLC operating agreement and then submitting articles of organization to the Florida Department of State for filing of record.
Disclaimer:
Yes, I am an attorney, but I do not become your attorney until you hire me by signing a written agreement containing the terms of representation. This article does not create an attorney-client relationship. This article should not be seen as providing legal advice. You should consult with an attorney before you rely on this information.