A lot of my students have questions along the following lines:

I have several properties that have Freddie or Fannie mortgages on them. Can I move them to separate legal entities in order to get some asset protection? What will this do to the mortgages?

Holding properties in separate legal entities is a good idea for asset protection purposes. The common scenario is to hold them in various land trusts. It doesn’t matter who the beneficiaries of the land trusts are, if they are the standard revocable land trusts that everybody uses, they will not give you any asset protection. There is the possibility that you can get some anonymity out of using the land trusts. That is a very small advantage, in my thinking. Your tenants, contractors, and everyone associated with the properties know who you are already. The only thing you are hiding is property from a general search for property ownership in the recorder’s office. The fact that you don’t show up as owning a bunch of properties might save you from a frivolous lawsuit, but most lawyers don’t check the county records before they file a suit.

The other option is to put the properties into separate LLCs (Limited Liability Companies) or possibly separate S corporations, or even limited partnerships. You will probably want to use the LLC in preference to the other two options. There are a number of accounting advantages and their maintenance is much easier. Some states let you have “series” LLCs which will cut the cost, because you basically set up one LLC, and then it can establish separate legal divisions without incurring additional charges at the state offices. If you are in California or a state where the cost of the LLC is high, then just use one or two LLCs and divide the properties between them in some logical manner. You should have a management company to “manage” your properties, but that’s another story.

The asset protection value of holding properties can be expounded on for a long time. Assuming you set up the LLC and want to transfer property into it, what happens to the mortgage? Almost all mortgages have “due on sale clauses.” Technically moving the property to an LLC, corporation, or limited partnership is a “sale.” As soon as the mortgage company knows that you have transferred the property, technically they have the right to call the loan. In your mortgage note, there is a section called “changes of title.” These clauses are usually very vague. They say that you have to get permission from the mortgage company “prior to any changes in title.” Of course, if you march down and ask permission, you will be opening up a can of worms. Trust me; the mortgage company wants money every time you sneeze, even if they give permission. Most people just make the transfer and don’t tell the bank. That doesn’t mean they did it right, but that’s what happens.

The mortgage company figures out you have moved the property, because the tax notices aren’t in your name anymore. They will be in the LLC’s name. Additionally, the insurance will have to be changed, and the mortgage company will see that change. Make sure that the insurance will still be good when you change the property ownership to the LLC. The last thing you want is to have a fire and figure out that the property isn’t covered, because they insured your property, and it isn’t your property any more. NO COVERAGE!

Moving property to a living revocable trust is not a sale, by federal law. Provided you are the grantor (guy who makes the trust), the trustee (guy who manages the trust) and the beneficiary (guy who gets the benefit of the trust), federal law says the mortgage company can’t consider the transfer of a property from you to such a trust as a “sale.” A trust that meets these criteria is called a “grantor trust.” No bank, mortgage guy, property tax guy, casualty insurance or anyone else can upset the apple cart if you have a true grantor trust. (California and a few states require “notice” that you are using a grantor trust, otherwise they will assume you are not using a grantor trust, and they will try to up the property taxes on the transfer of ownership.) Note that the land trust doesn’t qualify for this special treatment, because in most cases you are not filling all three positions (grantor, trustee, and beneficiary), and it is therefore not a grantor trust. Companies like LLCs, corporations, or limited partnerships, don’t get the special treatment. The mortgage company can call the loan.

Having said that, Fannie and Freddie have always taken the position that if you move the property to a company you are basically the owner of, then they have “let it slide.” Fannie and Freddie are changing, so who knows what they will do in the future. Assuming the loan isn’t “called,” when you put property into a company for asset protection, you need to know that you can’t cash out or refinance through Freddie or Fannie. You have to remove the property back to your own name “prior to application date.” The prior to application is ok right now if the bank can show you were the owner of the LLC. That’s a little loose though. Freddie has proposed transfer at least 6 months prior to applying for the loan. Just be aware that refinance may be a problem.

Even when the property is transferred to a company, the loan is still just as it always was. You are still liable. Your name is still on the bottom line. The loan still shows on your credit. You are still only entitled to 10 properties under Freddie and Fannie rules.

Freddie and Fannie cut the number to 4, and in recent press releases they have said that they would go back to the 10 properties. But the official ruling isn’t out yet, and technically it is still 4 today. They are rethinking that real estate investors actually buy real estate, and the problem is nobody is buying right now. Maybe if they let investors invest real estate might move. In the future, you will have a lot harder time “qualifying” for multiple property loans. You will have to have tax returns, not leases to qualify. You have got to watch your losses very closely!

If you try to buy a property directly in the name of an existing LLC, it is possible that you could get them to title it directly in the name of the LLC, but you are still going to be signing personally for the loan. That’s a given.

There is no question that the mortgage industry doesn’t make asset protection easy, but there is usually a “work around” or a way to “bend the rules” and achieve the asset protection you want.