Asset Protection – Part 2
Asset Protection – Part 2
In Asset Protection – Part 1 we discussed the basics of limited liability entities and some specifics related to the one best suited for most rental properties owners. In this article we will discuss further issues related specifically to limited liability entities, using the term Limited Liability Companies (LLCs) because that is the limited liability entity most appropriate for most rental property owners.
Multiple Entities Essential
It is usually best to have a separate LLC for each property. The reason for this is that a large judgment against an LLC resulting from a claim against one property owned by the LLC would result in all other properties owned by that LLC being available for satisfaction of the judgment.
For example, assume that an LLC owns 5 separate rental properties and assume for simplicity that each property has an equity of $200,000. Assume further that a serious injury or a death occurs on one property, the Court finds the owner
liable, the jury awards the plaintiff $5,000,000, and the LLC has insurance of $2,000,000 that covers the matter. The defendant landlord (the LLC) will now be handing the 5 properties to the plaintiff plus anything else owned by that LLC,
unless the owner has other liquid assets with which to pay the $3,000,000 not covered by insurance. The equity lost may be even significantly greater than the original $1,000,000 because of loan principal pay-down and appreciation
during the years of litigation. While other assets of the defendant may be safe (assuming the LLC was set up and operated properly), the defendant lost $1,000,000 (plus principal pay-down and appreciation) rather than $200,000 as would have been the case if each property were in a separate LLC.
Although one might at first think that maintaining a number of separate LLCs would be costly and otherwise burdensome, that need not be the case. Once one creates the first LLC documentation and sets up accounting for it, or pays an attorney to do so, it is simple to edit the previous documentation and accounting when purchasing another property. The cost of setting up a new LLC is nominal and the annual cost of maintaining each LLC is only $50 to $100 in most states. Each LLC requires the same tax forms, again a simple matter for even a novice computer user and of little extra cost even when having an accountant prepared tax returns.
The bottom line is that maintaining a number of separate LLCs is not really very costly or troublesome considering the degree of protection afforded and considered the potential risks of not doing so.
While we feel that this article is based on correct fundamental law, we strongly advise that readers consult competent professionals regarding the basic strategy, as there may be specific circumstances under which this is not the best approach
to asset protection.
Finally, one must always keep in mind that there are times when one must accept liability even though rental properties are properly protected by being vested in LLCs. One instance is when obtaining financing. Unless your limited liability entity is a Microsoft or Google, you will usually find that grantors of credit will require financially qualified individuals (and usually also their spouses) to personally guarantee the credit.
Not Just For Rentals
It should be kept in mind that a person may also have risks associated with his/her personal and/or business life other than ownership of rental properties. Ownership of operating businesses, investment venture interests, as well as
participation in various sports and other activities all offer the potential for risk to your financial condition.
A personal residence and personal property such as motor vehicles, boats, and aircraft can also represent potential risks.
Putting all rental properties into multiple separate entities while retaining ownership of non-rental properties, businesses, and/or certain other assets that represent the potential for significant risk does little good if the large judgment results from one of these other assets. This can be even worse than you might first think because the LLCs that held the rental properties are very often owned by the individuals and may therefore be subject to loss if one of the non-rental properties owned by individuals was the subject of a large judgment.
For example, the serious injury or death of a child by your dog when the child wandered into your yard could have serious ramifications, particularly if your homeowner insurance policy is one that excludes coverage of the particular
breed of dog that was involved. As another example, a motor vehicle accident where your teenage son is at fault in the death of other vehicle passengers could result in serious ramifications if it resulted in dollar judgments far exceeding liability insurance coverage limits.
For various reasons, the risks associated with such personally utilized properties are usually considered to be less than those associated with rentals. This is mostly because the owner of non-rental properties generally has more control of
use of the properties compared to properties occupied by a tenant. However, depending on circumstances related to particular owners, one might give thought to considering the need for vesting of some personally used assets in an LLC or
other limited liability entity.
One should also take many of the issues discussed in this article into account if and when considering being involved in an operating business or when investing in any project with one or more other parties. Even if a passive investor, with no personal liability beyond your invested capital, you will want to consider how those in control of the group’s investment are planning to manage risks. Having limited liability does not prevent one from having to defend oneself against a lawsuit.
Although you may know the risks of being a general partner and avoid joining a partnership as such, there can theoretically be a risk to an individual investor who thought he/she had limited liability. An assumed limited liability entity could turn out to provide no protection because it was improperly created or operated. Accordingly, cautious investors may want to consider only investing in a group via their own limited liability entities created specifically for membership in that group.