Asset Protection for Landlords and Tenants – Part 3
Asset Protection – Part 3
In this third and final article of our series about asset protection we will discuss some additional issues related specifically to limited liability entities, using the term Limited Liability Companies (LLCs) because that is the entity most appropriate for most rental property owners.
Structuring For Continuity
It has often been said that the only things certain are death and taxes. Unfortunately, investors often worry more about and put more energy into minimizing taxes than they put into minimizing the impact on their investments in the event of their demise or their incapacity.
In Part 2 of this series we discussed the importance of having each real property, both rental and personal real estate, each operating business, and each group investment in which you have potential liability being owned by a separate limited liability entity.
What happens regarding all these different entities if you become incapable of managing them or if you die? Who will manage each entity? Will it be someone who you know, someone who has the necessary abilities, and someone who is trustworthy? Or will it be someone whose only qualification is being the brother-in-law of the clerk of the probate court?
Unfortunately, many Americans, including many real estate investors, do not have adequate estate planning in place. Even worse, some have none in place and the management and/or disposal of their assets will depend on the statutes of the particular states where they resided and/or those of the states where their properties are located. This article will not further consider the general issue of estate planning, but will briefly discuss a particular way of providing for preservation of assets and continuity of operating businesses, including rental properties.
Many estate planners and knowledgeable investors know that there are many advantages to having all assets being held in a Revocable Living Trust. Important advantages include (1) avoidance of probate in the event of death of the Trustor, (2) avoidance of conservatorship hearings in the event of incapacity of the Trustor, (3) easy succession of the Successor Trustees chosen by the Trustor, and (4) ease of distribution to beneficiaries upon death of the Trustor. Furthermore, the privacy that results from those items compared to open court hearings and publicly available records is very important to many and is a disadvantage only to the probate attorney profession and the accountants who might be chosen to join an attorney in milking the estate for a few years.
It would be advantageous to have a way of combining the estate planning and other benefits of a Revocable Living Trust with the liability protection of limited liability entities. One theoretical strategy that does this utilizes several levels of ownership.
We assume that an individual owns rental real estate, personal real estate, operating businesses, and various other assets that have risk associated with them such that they might be held by a limited liability entity.
First, we assume, for simplicity, that there are only three assets – A, B, and C.
Second, we assume that each of the three assets is transferred to ownership of a separate limited liability entity. For ease of discussion, we assume that each entity is a LLC, but keep in mind that they might be a mix of LLPs, ‘S’ Corporations, or even ‘C’ Corporations. Accordingly, the LLCs are called “Asset ‘A’ LLC,” ”Asset ‘B’ LLC,” and “Asset ‘C’ LLC.”
Third, we form a holding company called “Holding LLC” that is the sole member/owner of each of the three asset LLCs. Accordingly, Holding LLC owns the interests in the three LLCs, but does not own the real estate, business, or other asset itself. Holding LLC manages the Asset LLCs and their properties, including leasing vacancies and collecting income for each asset, paying all expenses of the Asset LLCs. Of course, each Asset LLC is kept separate, there is separate bookkeeping and accounting for each Asset LLC, and each Asset LLC has its own insurance policies as required for the asset it owns.
Fourth, the individual’s Revocable Living Trust, of which he/she is Trustor/Trustee, is made the sole member/owner of Holdings LLC which is a member managed LLC.
You should note that, in this case where we have assumed a sole Trustor for the Revocable Living Trust, no additional tax return need be filed during the life of the Trustor because the incomes of Asset LLCs flow through to Holdings LLC whose income flows through to the Revocable Living Trust and is reported on the individual’s 1040.
In addition to providing asset protection and all benefits of a Revocable Living Trust, the major benefit of the above strategy is that there is continuity of management of each asset with no requirement for Court involvement in event of incapacity or death of the Trustor. Obviously, the choice of Successor Trustee or Trustees is important, but no more so than if the assets had been held directly by the Trust.
There are other possible things that could be done as part of the above strategy for various tax or other reasons. For example, any equipment utilized by one or more of the assets (e.g., a pickup used for property maintenance) and/or real estate utilized by an operating business could be owned by another Asset LLC and leased to the other Asset LLCs as required.
The above discussion should not be construed to be advice for any reader. There may be specific circumstances under which this is not the best approach to asset protection or estate planning. Furthermore, there may be disadvantages of such an approach that overshadow any advantages. Also, court decisions and statute changes may require new or modified approaches to asset protection. Finally, it would be very important that everything be properly structured in order to avoid the strategy being considered a sham by a court if/when there is any event that might result in the strategy being challenged.
For the listed and other reasons, individual investors should consult competent estate and/or tax professionals regarding strategies discussed above or any other matters related to risk management, tax planning, and estate planning.
Some Final Thoughts
Life is full of risks to your health, safety, security, and finances. In our earlier Disaster Planning and Risk Management series we discussed some ways to avoid or minimize problems and manage financial risks. In this now completed Asset Protection series we have briefly discussed some continuity issues.
We strongly urge you to consider the issues covered in the three series and those of your personal financial advisors to see if you can improve the odds of keeping and passing on to your heirs whatever financial empire you have been able to build so far and might expand in the years ahead.
Once again, however, we advise you to seek competent professional advice regarding issues that are critical to your risk management needs and other personal and business related matters whenever it is prudent to do so.