In the last issue, we took a look at the general advantages of using a limited liability company (“LLC”) as part of a broader estate planning strategy, with a specific focus on the potential impact of valuation discounts on transfers of LLC interests. In this installment, we will continue to look at the roles that an LLC can play, looking particularly at using an LLC to hold out-of-state real property.
Why Use an LLC to Hold Out-of-State Real Property?
To understand the utility of an LLC in this arena, a basic understanding of probate is required. Probate is the process by which a court supervises the transfer of a decedent’s assets at death. Because real property is subject to the jurisdiction of the state in which it is located, real property must generally be probated in that state. Going through this probate process in a state that wasn’t the decedent’s state of residence is often called “ancillary probate.”
This can pose a major inconvenience for people who own real property in multiple states, and there are several ways of circumventing the need for ancillary probate. One common way is to create a revocable (“living”) trust; another way is to create an LLC and transfer ownership of the out-of-state property into that LLC.
How It Works
Creating an LLC and transferring real property located in multiple states to that entity sidesteps the need for an ancillary probate in each state in which the LLC holds property. After the decedent’s death, the LLC will continue to hold the real property, and therefore there is no need for a court-supervised transfer. The decedent’s membership interest in the LLC will pass to his or her heirs, but this will require a probate only in the decedent’s state of residence, and not in every state in which the LLC holds property.
Considerations Beyond Avoiding Probate
While the process described above does circumvent the need for ancillary probate, avoiding probate is not necessarily the only consideration at play. One major consideration that varies by state is the estate tax consequences of holding property in an LLC versus holding it outright.
A state in which real property is located will have the authority to tax the transfer of that real property upon the decedent’s death. For example, if a Washington resident owns real property in another state, that other state will likely levy a tax on the value of the real property at the decedent’s death. If that real property is held in a Washington LLC, however, the state in which the property is located will not have the right to impose state estate tax on the transfer of those LLC interests at the decedent’s death.
In Washington, out-of-state real estate is not subject to Washington State estate tax. Therefore, any out-of-state property owned by a Washington resident at death will not be taxed as part of that resident’s estate for Washington estate tax purposes (it will be subject to federal estate tax). Because LLC membership interest is classified as “personal property” for tax purposes, however, moving real estate into an LLC means that the value of the real estate (expressed as membership interest in the LLC) would be included in a Washington resident’s taxable estate, even if the property held by the LLC is out of state.
The same is true in Oregon, but the value of out-of-state property will be used to calculate the rate at which Oregon estate tax is imposed (meaning that those owning out-of-state property will be taxed at a higher rate than they would have been if such property was not part of their estate, though the out-of-state property itself will not be subject to tax).
Using an LLC to hold out-of-state property can have many advantages—it can avoid ancillary probate as discussed above, and it can facilitate the transfer of one parcel to multiple heirs without dividing the property, as discussed in our prior column on this topic. As with any estate planning strategy, however, the usefulness of LLCs should be carefully weighed with the potential disadvantages in order to produce the best result.
Related Files: Estate Planning Advisor - Fall 2013