The Membership Interest Transfer is a method of taking title to properties, commercial, or residential, in a way other than a fee simple real estate transaction; through a securities transaction through the purchase of an LLC which owns the underlying property, but not the fee simple interest in the property.
What is an Membership Interest Transfer?
Simply put, an Membership Interest Transfer is a method of acquiring a property, free and clear or with a loan, through which the value of the property is shielded from the general public and is not a matter of public record, like a fee simple transfer is a matter of public record. It is a specific tax exempt transaction outlined by the Ohio Revised Code. Instead of the property being directly transferred to the buyer, the seller’s membership interest in the property is transferred into a new LLC formed by the buyer.
Who should use the Membership Interest Transfer?
Real estate investors wishing to shield the purchase price of a property from anyone who might be interested in knowing what was paid for the property should use the Membership Interest Transfer.
Investors who like to buy and flip should seriously consider this method of acquiring the property because if they are looking to get into a deal, add some value, (through renovations, management or simply being in the right place at the right time) and then turn around in a short period of time and push it back out to the market will find this beneficial. Typically when a property is listed, the first thing a buyer does is go to the county auditor’s website to see how much it was purchased for. This then becomes their basis for evaluation, and makes the quick fix-and-flip a difficult proposition, because everyone and their mother knows how much they paid for it, and for how long they have owned the property; this is none of their business what the property was purchased for, only what it is being offered for.
Another class of investors who should seriously consider the Membership Interest Transfer is those who wish to preserve the current tax valuation of a property upon acquisition. Typically, when a property is purchased above its current tax valuation, the auditor will shortly after the purchase mark the valuation of the property, for tax purposes, to the value of the transaction. When the property is purchased for a below tax valuation price there are a few more steps that must be followed to get the county to modify its valuation, like appealing the value and showing that it was a fee simple transaction at a below valuation price; this should remedy the problem fairly quickly because the auditor and the board of revision cannot argue with an arm’s length transaction. However, when a property transacts at an above valuation price – say in the case of a property which was purchased in an extremely distressed state, was turned around through management and physical curing of deferred maintenance and through numerous upgrades – the seller in this case deserves his upside. The buyer may be willing to pay for this upside; however a barrier to transaction at the seller’s desired purchase price is the tax valuation basis. Upon the sale, in a fee simple real estate transaction, the auditor and the board of revision will immediately jump the tax valuation of the property from its lower taxation basis, to its new, higher basis, because of the fact that it was an arm’s length transaction.
The problem here is that it may appraise for the higher price, but when it comes time to transact the property, a new buyer is going to look at the purchase price taxable valuation, instead of the current taxation basis, thus eroding the higher potential sale price.
When should an Membership Interest Transfer be used?
The best time to use the Membership Interest Transfer are when an investors wishes to keep the price which was paid for a property confidential. Further, if the purchase price of the property is above the taxable value, and the buyer wishes to shield the purchase price, they may elect to use the Membership Interest Transfer.
Where can an Membership Interest Transfer be used?
An Membership Interest Transfer can be used in any real estate transaction where the strike price is higher than the current taxable value.
To my knowledge the method is legal in all 50 states; but I am not an attorney; nor do I claim any formal legal training. I would consult your attorney in the state in which you intend to affect this sort of transaction.
Why is an Membership Interest Transfer used?
The Membership Interest Transfer is used to shield the transfer value of a piece, or pieces, of real property (real estate).
In the case of the above avoidance of an increased tax valuation base, the effect is by no means permanent. Typically, counties reassess value every three years, when they see a transfer in ownership status (change in the name on title as well as the tax mailing address) that is usually an indication that a change in ownership has taken place; not always, an owner could have split with partners and moved offices, thereby dictating the need for a new entity name and a new mailing address; but more often than not this is not the case.
However, when the tax man does come calling demanding that you pay more for the property than you are currently paying for it because he thinks its worth a certain value, he will not have the fee simple transfer of the property as evidence of the value, rather he will have to dig deeper to prove why he thinks the property is worth a certain amount, using an appraisal or other valuation methods, typically sales comps.
How is an Membership Interest Transfer used?
The Membership Interest Transfer purchase occurs as follows:
1. A contract addendum is drafted outlining that the purchase between buyer and seller will now be conducted as a membership interest transfer between the respective parties. The entity being sold is a newly created LLC with a name chosen by the buyer that will be formed in the Secretary of State's Office with the seller’s LLC as the sole member of the entity. This formation must occur before the closing, and the sooner the better.
2. An operating agreement for the newly formed entity will then be signed and executed by the seller’s LLC, by and through its authorized member(s), prior to closing establishing the new entity's governance.
3. A deed and affidavit in support of tax exempt transfer will also be executed at the same time as the operating agreement by the seller’s LLC transferring the property into the newly formed entity (which, along with any personal property associated with the property that is currently included with the sale will be the new entity's sole asset). The deed will be recorded with the recorder's office prior to closing. The affidavit will tell the auditor the transfer is not taxable as it is a transfer to a entity solely owned by the granting entity. This is a specific tax exempt transaction outlined by the Ohio Revised Code.
By recording this deed in advance and transferring the membership interest and not the property itself at closing the seller will save on conveyance tax that the county would have charged if the transfer of the property had been made to a third party.
3. A membership interest transfer agreement, resolutions, bill of sale, and any and all other documents necessary to transfer the membership interest held by the seller’s LLC in the newly formed LLC over to new LLC will be executed on the day of closing. Disbursement of funds will follow the normal closing process for a sale of real estate, but the property being sold on the settlement statement will be referred to as the 100% membership interest in the entity.
4. The buyer’s LLC will become the sole owner of the newly formed entity via the membership interest transfer, and will execute a mortgage and any other required documents to its lender securing the purchase in the newly formed entity's name.
5. The County will simply have made a transfer for no consideration on its books, and barring any meddling from outside entities, will continue to value the property at its current appraised value for taxation purposes. The purchase price for the membership interest will not increase the taxable valuation of the property in the auditor's records. Future tax savings are not possible to calculate, but future savings are possible.
6. The costs of the membership transfer agreement documentation and filing is $1200-$1500.
7. No liability will be assumed by the buyer for the seller's current entity’s potential liabilities, nor will the seller’s current LLC retain any liabilities for the newly formed entity.
Common Questions:
Would the new buyer take on the original basis of the previous owner? For instance, if a property is sold for $12,000,000 to a new buyer, but the seller took title to it at a valuation of $2,000,000; would the new buyer, the one who bought it for $12,000,000; would his basis be for $2,000,000?
No, the new buyer’s basis, as far as the IRS and State are concerned, when it comes to capital gains, own the asset for $12,000,000. If they acquired the property via a 1031 exchange then their basis would be based on the chain of transactions in the 1031 exchange, not the previous owner’s taxable basis, for capital gains purposes.
The main reason to use an Membership Interest Transfer is to shield the transfer value from entities who want to tax a property on an ongoing basis based on the sales price; OR to shield the price at which an asset is owned from potential buyers when at a future date the property is put up for sale.
What is an Membership Interest Transfer?
Simply put, an Membership Interest Transfer is a method of acquiring a property, free and clear or with a loan, through which the value of the property is shielded from the general public and is not a matter of public record, like a fee simple transfer is a matter of public record. It is a specific tax exempt transaction outlined by the Ohio Revised Code. Instead of the property being directly transferred to the buyer, the seller’s membership interest in the property is transferred into a new LLC formed by the buyer.
Who should use the Membership Interest Transfer?
Real estate investors wishing to shield the purchase price of a property from anyone who might be interested in knowing what was paid for the property should use the Membership Interest Transfer.
Investors who like to buy and flip should seriously consider this method of acquiring the property because if they are looking to get into a deal, add some value, (through renovations, management or simply being in the right place at the right time) and then turn around in a short period of time and push it back out to the market will find this beneficial. Typically when a property is listed, the first thing a buyer does is go to the county auditor’s website to see how much it was purchased for. This then becomes their basis for evaluation, and makes the quick fix-and-flip a difficult proposition, because everyone and their mother knows how much they paid for it, and for how long they have owned the property; this is none of their business what the property was purchased for, only what it is being offered for.
Another class of investors who should seriously consider the Membership Interest Transfer is those who wish to preserve the current tax valuation of a property upon acquisition. Typically, when a property is purchased above its current tax valuation, the auditor will shortly after the purchase mark the valuation of the property, for tax purposes, to the value of the transaction. When the property is purchased for a below tax valuation price there are a few more steps that must be followed to get the county to modify its valuation, like appealing the value and showing that it was a fee simple transaction at a below valuation price; this should remedy the problem fairly quickly because the auditor and the board of revision cannot argue with an arm’s length transaction. However, when a property transacts at an above valuation price – say in the case of a property which was purchased in an extremely distressed state, was turned around through management and physical curing of deferred maintenance and through numerous upgrades – the seller in this case deserves his upside. The buyer may be willing to pay for this upside; however a barrier to transaction at the seller’s desired purchase price is the tax valuation basis. Upon the sale, in a fee simple real estate transaction, the auditor and the board of revision will immediately jump the tax valuation of the property from its lower taxation basis, to its new, higher basis, because of the fact that it was an arm’s length transaction.
The problem here is that it may appraise for the higher price, but when it comes time to transact the property, a new buyer is going to look at the purchase price taxable valuation, instead of the current taxation basis, thus eroding the higher potential sale price.
When should an Membership Interest Transfer be used?
The best time to use the Membership Interest Transfer are when an investors wishes to keep the price which was paid for a property confidential. Further, if the purchase price of the property is above the taxable value, and the buyer wishes to shield the purchase price, they may elect to use the Membership Interest Transfer.
Where can an Membership Interest Transfer be used?
An Membership Interest Transfer can be used in any real estate transaction where the strike price is higher than the current taxable value.
To my knowledge the method is legal in all 50 states; but I am not an attorney; nor do I claim any formal legal training. I would consult your attorney in the state in which you intend to affect this sort of transaction.
Why is an Membership Interest Transfer used?
The Membership Interest Transfer is used to shield the transfer value of a piece, or pieces, of real property (real estate).
In the case of the above avoidance of an increased tax valuation base, the effect is by no means permanent. Typically, counties reassess value every three years, when they see a transfer in ownership status (change in the name on title as well as the tax mailing address) that is usually an indication that a change in ownership has taken place; not always, an owner could have split with partners and moved offices, thereby dictating the need for a new entity name and a new mailing address; but more often than not this is not the case.
However, when the tax man does come calling demanding that you pay more for the property than you are currently paying for it because he thinks its worth a certain value, he will not have the fee simple transfer of the property as evidence of the value, rather he will have to dig deeper to prove why he thinks the property is worth a certain amount, using an appraisal or other valuation methods, typically sales comps.
How is an Membership Interest Transfer used?
The Membership Interest Transfer purchase occurs as follows:
1. A contract addendum is drafted outlining that the purchase between buyer and seller will now be conducted as a membership interest transfer between the respective parties. The entity being sold is a newly created LLC with a name chosen by the buyer that will be formed in the Secretary of State's Office with the seller’s LLC as the sole member of the entity. This formation must occur before the closing, and the sooner the better.
2. An operating agreement for the newly formed entity will then be signed and executed by the seller’s LLC, by and through its authorized member(s), prior to closing establishing the new entity's governance.
3. A deed and affidavit in support of tax exempt transfer will also be executed at the same time as the operating agreement by the seller’s LLC transferring the property into the newly formed entity (which, along with any personal property associated with the property that is currently included with the sale will be the new entity's sole asset). The deed will be recorded with the recorder's office prior to closing. The affidavit will tell the auditor the transfer is not taxable as it is a transfer to a entity solely owned by the granting entity. This is a specific tax exempt transaction outlined by the Ohio Revised Code.
By recording this deed in advance and transferring the membership interest and not the property itself at closing the seller will save on conveyance tax that the county would have charged if the transfer of the property had been made to a third party.
3. A membership interest transfer agreement, resolutions, bill of sale, and any and all other documents necessary to transfer the membership interest held by the seller’s LLC in the newly formed LLC over to new LLC will be executed on the day of closing. Disbursement of funds will follow the normal closing process for a sale of real estate, but the property being sold on the settlement statement will be referred to as the 100% membership interest in the entity.
4. The buyer’s LLC will become the sole owner of the newly formed entity via the membership interest transfer, and will execute a mortgage and any other required documents to its lender securing the purchase in the newly formed entity's name.
5. The County will simply have made a transfer for no consideration on its books, and barring any meddling from outside entities, will continue to value the property at its current appraised value for taxation purposes. The purchase price for the membership interest will not increase the taxable valuation of the property in the auditor's records. Future tax savings are not possible to calculate, but future savings are possible.
6. The costs of the membership transfer agreement documentation and filing is $1200-$1500.
7. No liability will be assumed by the buyer for the seller's current entity’s potential liabilities, nor will the seller’s current LLC retain any liabilities for the newly formed entity.
Common Questions:
Would the new buyer take on the original basis of the previous owner? For instance, if a property is sold for $12,000,000 to a new buyer, but the seller took title to it at a valuation of $2,000,000; would the new buyer, the one who bought it for $12,000,000; would his basis be for $2,000,000?
No, the new buyer’s basis, as far as the IRS and State are concerned, when it comes to capital gains, own the asset for $12,000,000. If they acquired the property via a 1031 exchange then their basis would be based on the chain of transactions in the 1031 exchange, not the previous owner’s taxable basis, for capital gains purposes.
The main reason to use an Membership Interest Transfer is to shield the transfer value from entities who want to tax a property on an ongoing basis based on the sales price; OR to shield the price at which an asset is owned from potential buyers when at a future date the property is put up for sale.