SUB30kCLUB: tips to protect yourself legally

29 Replies

Today's topic is a springboard off of @Lisa Phillips a Phillips Phillips Phillips excellent blog series, episode 2 on incorporating.

We will be doing business in NY and, with the advice of our attorney and accountant, have started an LLC which will act as a legal buffer from law suits. If anyone wants to sue us related to our rental property, they will have to sue the LLC not us personally. Theoretically, that will protect our personal assets.

Another idea people have shared, is to NOT use an LLC but simply to have enough liability insurance on yourself that if you get sued, you'd have the coverage to protect yourself from losing everything. Usually this would be in the form of liability umbrella coverage on your homeowners policy. Personally, I think that's too risky but I know others who do it, have been used and have lived to tell the tale.

I'm also learning more about the option to require tenants to have proof of renters insurance prior to signing the lease. I have been told that this can provide peace of mind for the tenant and has benefit for the landlord too. The tenant is protect in case of theft, fire, etc. Also, there is a liability insurance portion in the policy which will protect the tenant from liability if someone is hurt because of his negligence, for example, while visiting the apartment. That's good news for the tenant AND the landlord. Because now, the injured party has another later of insurance to go after before trying to come after the landlord directly. Also, if the tenant maliciously damages your property in excess of normal wear and tear, the landlord can sue the tenant for damages and the rental insurance would likely pay or settle. I don't have personal experience here but I'd like to know if anyone else does.

I've also learned that business credit cards do not offer the same consumer protection that traditional personal lines of credit do. If someone steals your business credit card and runs up a balance, YOU are on the hook! Yup, it's true. Check it out. We will be establishing a new personal credit card which will only be used for business. As a normal consumer card, we will still get the personal consumer protection.

I'd also recommend making sure that you are meeting the legal requirements for your business entity in your state. For example, if you need to have an operating agreement or partnership agreement, regular meeting with recorded minutes, etc., having all your paperwork in good order will help to prove in court that you are running your business AS a business, not just a sham legal covering. It's a matter of legitimacy.

Another issue is one of PIERCING THE CORPORATE VEIL, which Lisa Phillips discusses in her blog. She explains that in some states, single party LLCs are vulnerable when compared to multiparty entities. She recommends learning about the laws in your state and adding members to your LLC if needed to protect yourself. You can do this and still retain control of the LLC. It's more of a paperwork issue than it is about having contributing partners. It might be good to look into if you're flying solo. Renee and I are partners so that seem like it'll protect us.

Any other ideas you have, please share them with the group! How do YOU structure your business so that you are maximally protected against frivolous suits?

I also wonder what level of legal protection the landlord has if he or she uses a property manager. Does the PM have any sort of liability insurance or responsibility if the tenant they place damages the property?

Thanks Douglas!

You know, you hit the main features on the head on the different LAYERS of protection you can put on. Liability (I have this threw my property insurance) and LLC (Which does depend on your state): I like this NOLO source of data, its fantastic:

Some gems from this article

"All states allow personal creditors of an LLC owner to obtain a charging order against the debtor's LLC interest. Some states specify that the charging order is the creditor's exclusive remedy with regards to the debtor's LLC interest. These states are the most "debtor friendly;" they provide the greatest protection for LLC owners against personal creditors."

And then it lists each state and their policies. I think its a nice concise resource, and I do have faith in NOLO's legal accuracy.

I have liability, but I will ask my PMs today what kind of protections they have in case someone sues, and get back to you. And, its also knowledge: My PMs in MD send me updates on court cases. That type of information is valuable, and doesn't have to come from a PM. For Instance, in MD, my PMs informed me of a courtcase that makes OWNERS liable for pitbull attacks, even if they did not approve the animal being in their homes. Its crazy, but true. Being aware of those items are just as important, and can come from the local REIA or other trade groups.

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It would be nice to have a group on here that people can subscribe to, especially if they are interested in this subject.

that NOLO article was excellent. It also more specifically addresses the issue of multimember LLCs vs single member LLCs. (Apparently, it's very important that the extra members be more than just token members).

My attorney today recommended we proceed with simply our homeowners insurance policy plus a 1million umbrella liability policy with the same company. She also liked our idea about us providing renters insurance for our renters (and building the cost into the rent) vs "requiring" our tenants to have it (concerns of discrimination).

I'm stil striking out getting dog coverage--as many of my tenants have dogs. Offering renters insurance is a nice idea, but for $800-$900/m properties, it may be asking a lot.

Any ideas on dog bite insurance?

LLC's are turning out to be more and more irrelevant in the landlording business, as far as I'm concerned. The reasons for having them when they first came into "fashion" about ten years ago were:

1. Protect your assets from a law suit.

2. Hide your identity from a tenant, making them less likely to sue you.

3. More tax write offs.

Well, unless you have a very high net worth, you can accomplish #1 by having an umbrella policy, as noted above. These are very inexpensive to get, much more so compared to the cost of setting up an LLC, maintaining it, and filing taxes for it, which your CPA charges you extra for. Also, I'm not so worried about protecting my assets from creditors as a landlord, because I pay all my bills. If there ever came a time where I couldn't, I would certainly understand if the creditor wanted to come after me, but more than likely, I would take the bull by the horns and explain to them my situation and work something out (that's the former business owner in me that spent way too many hours chasing down deadbeat clients).

For #2, you can accomplish the same by getting a DBA. Again, much cheaper but achieves the same desired effect. And with your DBA, you can open a bank account to keep your rental business expenditures separate, which makes tax time much easier.

For #3, this turned out to be untrue. According to Amanda Han, BP blogger and podcast guest, an LLC affords you no more write offs than you can get as an individual. I have been finding this to be true the last few years.

The only time I think an LLC is still very prudent would be in partnership situations. Just my 2 cents, but I'm not worried about not having my rentals in a LLC any more, unlike ten years ago when entity attorneys made me believe I was putting my financial life at risk if I didn't.

I'm not sure exactly how the liability protection works, but I'll be looking into it now. @Sharon Tzib brings up an excellent point: what happens if you're sued: does an LLC protect your personal assets, such as your personal bank account, investments, or home? Maybe someone out there knows the answer. If so, please chime in. Otherwise, I'll be researching and I'll be back with an answer ASAP.

My wife and I decided to partner and form an LLC. My attorney recommended it for our situation to "protect our personal assets". However, she also advised against landlord style liability/ property insurance and simply recommended we get an umbrella policy on our personal home insurance. Without the LLC, I wonder what would happen if we were sued in excess of the value of our insurance limits.

Ok, I found the answer. It's all here in the article entitled

LLCs and Limited Liability Protection: A 50-State Guide

I cannot verify the accuracy of the information within, but I'm inclined to believe it. I'll summarize the key points:

1. An LLC does protect my personal assets if my partner or an employee is negligent and/or causes the LLC to be named in a suit. Essentially, it protects me from my partners and employees negligent actions.

2. The LLC DOESNT protect my assets if I personally am found negligent and the LLC is sued. This part is important and is the part I didn't know. It is my understanding that if I fail to maintain a property and a tenant falls and is injured, it could be established that I was negligent and therefore I could be held personally liable for damages paid to the injured party. Basically, if I do anything negligent or illegal, the LLC won't protect me. That makes sense, but I guess I always thought (incorrectly) that even if I somehow unintentionally ended up being negligent that the most I could be on the hook for is the max value of my position in the LLC. I was wrong.

So, for a smaller scale investor like myself, it seems like an LLC doesn't protect me very well at all. I guess it's a small amount of protection if my partner were to do something wrong, but for me, personably, it doesn't seem like there's much difference whether I'm in an LLC or not. That might change someday if we end up having employees. Then the LLC protection would become instantly immensely valuable.

For single member owners, it almost seems like you'd have no protections unless you have employees.

there's also the issue of personally secured debts. If you own an LLC but personally guarantee a loan, the LLC will not protect you. You personally owe the money or debt.

Now, there's a whole other angle to LLCs beyond liability. There's the tax angle. It is my understanding that owning the LLC provides tax benefits that would not be available if I just owned properties personally. This is slightly tangential to the main discussion but is a form of asset protection (tax exposure).

@Joe Gore , I still think an LLC is important if you have partners or employees. I will likely have both. Plus, the benefits of corporate tax write offs seems good. I don't know what type of investing you do personally, but for me, I think the LLC is the right move. The key now is for me to be a good landlord and not be found liable for ...anything. Notice I didn't say anything about being sued. I probably will be. I'll just it really hard to find me negligent because we will run a tight ship.

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I used to work as a tax accountant and saw lots of real estate partnerships and LLCs. We had a high wealth individual (>$1M) who had 100s of LLCs. He was in commercial real estate and every property had it's own LLC and one "master" LLC. It was quite a setup. He had multiple partners though and each property was pretty expensive. His accounting fees from us were through the roof, but he made so much money, and his situation was so complex that it made sense for him (imagine doing his personal tax return when he gets money from 100s of LLC.. what a nightmare).

I'm investing in SFHs and choosing not to do an LLC. I don't want to go through the hassle of doing LLC tax returns, filing annual reports, getting things switched over, etc.. It's easy, especially since I have experience, but I don't see the benefit of it currently.

Question for the people who choose not to go through an LLC. Do you still have/use a "business name"? One nice thing about LLCs is that it feels official. I feel like having a business name makes it legitmate to a certain extent.

@Douglas Brundin,

I hope you never get sued but if someone trips and falls on your property, you will get sued and just because you have employees the owner of the property is the one that will get sued. Be careful when you give a deposition and the question is asked to do you own the property you don't need to lie...

Joe Gore

@Douglas B. please see my first comment - you need to listen to Amanda Han's podcast about the tax benefits of a LLC vs. an individual- basically, there are none.

I agree, for partnerships a LLC is very necessary. First because the Operating Agreement spells out the terms of the relationship. Second, because it will keep my partner's creditors away from the asset. Beyond that, I won't delude myself that it will do much more than that, but that can be very state specific.

In regards to employees, you would never want a LLC that you run your REI business out of to include your properties. Having an LLC as a business structure is a totally different conversation than having one for your investment properties. Make sense?

Now thinking that you can avoid a lawsuit by running a tight ship is a bit unrealistic. It's like saying you'll never get in a car accident because you're a great driver. There's too much in life that's out of our control. That's what insurance is for.

@Sharon Tzib I think your car example is excellent. I drive regularly but I'm Licenced, insured, vehicle is inspected and well maintained. I drive safely and obey traffic laws. I don't drink and drive or text and drive. I have snow tires. I've done all the things I can think of to reduce my liability as a driver. That's what I mean by running a tight ship.

I know that many landlords do the absolute bare minimum required to keep generating rent. Those guys are running fast and loose. And they also don't have a leg to stand on if they get sued.

I'm not saying I won't get sued. I very likely will. But that person will have to make a very strong case because I'm going to be following the letter and spirit of the law as well as running safe and well maintained properties.

My day job is in the medical field. It's the same here too. Some nurses and doctors play by the book and follow the rules. Others don't. I'm sure it's the same in every field. So, each person must decide what level of risk he or she is comfortable with. I'm very conservative regarding risk. I don't take risks very often at all. I do make decisions that others consider "risky" sometimes: take real estate for example. I view it as a calculated risk. I have a lot of personal control and I can mitigate a great amount of the risk. At that point it seems like an obviously excellent investment option. I'm surprised that my "risky" friends are so against real estate investing!

What do they say, @Douglas B. - the best offense is a good defense :) I totally hear what you're saying, just don't over think it too much. Set up your systems, purchase your insurance, and then live your life. That's my philosophy.

In regards to risk - I know!!! I'm amazed at how many people are convinced real estate is risky, yet they'll turn over $30K to a Bernie Madoff???

1. Ensure properties are safe, in good condition and meet code requirements

2. Insure your properties and yourself

3. Conduct yourself in a business like manner, understand the laws and regulations you need to operate under.

4. Treat tenants fairly and in a consistent manner.

Follow these carefully and you won't need entities that give you a sense of false security. :)

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