In the July/August issue of DBusiness Magazine, Kerr Russell real estate attorneys Brandy Mathie and Anna Valk contribute to the Q&A section: “Expert Advice Can Help You Protect Your Property Investment.”
The most common ownership vehicle for real property is a limited liability company. LLCs are easy to set up and offer liability protection and tax flexibility.
In some instances, a real estate transaction involves a transfer of membership interest of the LLC which owns the real property instead of an outright transfer of the real property itself.
This intersection of business and real estate law presents interesting and important considerations for purchasers and sellers and their respective counsel.
Q: How does the due diligence process for a transfer of membership interest in a real estate LLC differ from a transaction in which the real property is conveyed to a purchaser?
A: In some ways, it does not. The most common ownership vehicle for real property is a limited liability company (LLC). In some instances, a real estate transaction involves a transfer of membership interest of the LLC, which owns the real property, instead of an outright transfer of the real property itself. As a purchaser (or someone representing a purchaser), you should insist on performing the same due diligence investigations that you would have performed if you were purchasing the property instead of acquiring the membership interests. This includes title and survey review, environmental investigations, property inspections, appraisal, and review of leases, contracts, and other agreements applicable to the property. With regard to the existing title policy, you should contact the title company to obtain the appropriate non-imputation endorsement(s). Also, keep in mind that certain environmental liability protections may not be available when purchasing membership interests, because the purchaser is only entitled to the protection previously obtained by the LLC.
In other ways, due diligence in a membership interest transfer transaction will be more complicated, as a purchaser should also perform due diligence with respect to the LLC in which the purchaser is acquiring membership interests. This includes review of the LLC’s formation documents, operating agreement, fi nancial records, contracts, tax returns, and an accounting of all members of the LLC.
Q: Are there any nuances under Michigan law that must be considered when transferring the membership interests in a real estate LLC?
A: Limited liability companies in Michigan are governed by the Michigan Limited Liability Act, MCL 450.4101 et seq. Pursuant to the LLC act, unless otherwise provided in the LLC’s operating agreement, the membership interests of an LLC are fully assignable (see Section 505(1)). Assignment of membership interests does not, in itself, entitle the assignee to participate in the management of the LLC or exercise any other rights of a member (see Section 505(2)). Instead, the assignment by itself only conveys a right to receive income generated by the LLC and attributable to the assigned interests (also known as a “profits interest”).
In most instances, the parties intend to transfer both the profits interest and the membership rights, including voting; however, this isn’t accomplished by the assignment alone. Assignment of the membership rights requires admission of the purchaser as a member of the LLC, which unless otherwise provided in the LLC’s operating agreement, requires unanimous consent of members (see Section 506(1)). As a result, careful attention must be paid to ensure that the assignment documents include language appropriate to convey both the profits interest and membership rights. In addition, as a condition of purchase, the purchaser should insist on documentation that proves the existing members of the LLC will admit the purchaser as a full member of the LLC.
Q: Does the transfer of real estate membership interests in an LLC trigger Michigan transfer tax obligations?
A: Sometimes. It depends on the percentage of ownership transferred and the assets held by the LLC. Michigan’s State Real Estate Transfer Act, MCL 207.521 et seq., imposes a transfer tax on the transfer of a controlling interest in an entity that holds real estate as its primary asset (see Section 523(c)). For an LLC, a “controlling interest” means more than 80 percent of the total interest in capital and profits of the LLC (see Section 522(a)). If 90 percent or more of the fair market value of the LLC’s assets is real property, the LLC is considered an entity that holds real estate as its primary asset (see Section 523(c)).
The state transfer tax is imposed on the total consideration of the real property in the amount of $3.75 for every $500 in value. The Michigan Department of Treasury updated the Real Estate Transfer Tax Valuation Affidavit form to include a mechanism by which a seller is obligated to pay the state transfer tax upon the transfer of a controlling interest. Once completed, the form must be filed with the register of deeds for the county where the property is located. Despite the updated form, at least one register of deeds has taken the position that the transfer tax wasn’t payable because there was no document to record — and, consequently, that individual refused to take the payment.