Operating LLC used as asset protection

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Operating LLC used as asset protection

Lee Liberman
Investor · Baltimore, MD · Member since 2013 · 31 posts · 3 votes

Does this structure add any protection?

Properties are purchased in my and my partners individual names (tenants in common) for the purpose of renting.

We use an LLC (owned by both of us) to move money around for income/expenses of the process of renting these properties. If we have a property manager, they will send net rent checks to this account and we pay would pay them out of this account. The property management agreement is between the LLC and the property manager. The entity is used for all aspects of the business.

Mortgages are in the personal names of me and my partner (no LLC).

Insurance is maintained on the properties themselves and with the LLC as a named insured.

If a lawsuit were to occur, would we be personally liable? What if we accidentally at one point use our personal checking account to pay for something as opposed to running it through the operating LLC? Does that pierce the vail of the LLC if it provided any protection to begin with.

Please respond only if you are a lawyer or consulted a lawyer in thinking through your structure and feel confident in the response.

Thanks,

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Keith JacobsonPro Member
Investor · Chicago, IL · Member since 2011 · 12 posts · 5 votes
8y

As a former personal injury attorney, I can tell you that if your name is in any way related to the property (on the deed, rent checks etc..), you will be named as a Defendant.  Plaintiffs don't have any information early on as to your business structure, so they will "shotgun" and name everyone who could potentially be involved to make sure they file against the correct entity before the statute of limitations expires.

I am not YOUR lawyer, but it seems to me your bigger problem is that your insurance policy does not have you (the property owner) as a named insured.  Insurance companies margins are income (premiums and investments with premiums) - expenses (claims).  If they can avoid paying a claim, they will.  They have no loyalty to you, so if they can deny coverage because you weren't named in the policy, they will.

Piercing the corporate veil is a complicated topic, and this is a long reply already. The short answer is if you "disregard the corporate form" (i.e. don't treat the LLC as it's own "person") they could potentially ignore the corporate veil. One "accidental" payment probably wouldn't do it, but a bunch of them would become a problem.

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  • Brian Schmelzlen
    Accountant · La Mesa, CA · Member since 2017 · 477 posts · 476 votes
    8y

    Hi @Lee Liberman,

    I am unclear; does the LLC hold title to the properties? If it doesn't, then I don't see it offering much if any liability protection.

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  • Lee Liberman
    OP
    Investor · Baltimore, MD · Member since 2013 · 31 posts · 3 votes
    8y

    @Brian Schmelzlen that is correct. The properties are held in personal name

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  • Mike S.
    Investor · Broward County, FL · Member since 2018 · 1k+ posts · 938 votes
    8y
    First I’m not a lawyer and this answer is based on my own training and experience only. The fact that your llc is collecting rent without having any relation with the property (no consideration) will make it easy to pierce its veil and bring back all the liability to you personally.
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  • Keith JacobsonPro Member
    Investor · Chicago, IL · Member since 2011 · 12 posts · 5 votes
    8y

    As a former personal injury attorney, I can tell you that if your name is in any way related to the property (on the deed, rent checks etc..), you will be named as a Defendant.  Plaintiffs don't have any information early on as to your business structure, so they will "shotgun" and name everyone who could potentially be involved to make sure they file against the correct entity before the statute of limitations expires.

    I am not YOUR lawyer, but it seems to me your bigger problem is that your insurance policy does not have you (the property owner) as a named insured.  Insurance companies margins are income (premiums and investments with premiums) - expenses (claims).  If they can avoid paying a claim, they will.  They have no loyalty to you, so if they can deny coverage because you weren't named in the policy, they will.

    Piercing the corporate veil is a complicated topic, and this is a long reply already. The short answer is if you "disregard the corporate form" (i.e. don't treat the LLC as it's own "person") they could potentially ignore the corporate veil. One "accidental" payment probably wouldn't do it, but a bunch of them would become a problem.

    1Reply
  • Joe SplitrockPro Member
    Moderator
    Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
    8y

    @Lee Liberman if the LLC doesn't own the property or manage the property, it is a pointless LLC. The attorney who set it up should be fired. (Sorry to be the bearer of bad news). Even if you transfer title into the LLC, the loan is still in your personal name, so there is a hole in the LLC.

    The attorney is going to go after the money, so they will name you personally. The LLC currently holds no assets, so is unlikely to even be named.

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  • Costin I.
    Rental Property Investor · Round Rock, TX · Member since 2016 · 1k+ posts · 971 votes
    8y

    Not a lawyer so take this with due diligence. The LLC you have is pretty much useless in the current configuration, as is not holding the property, nor is doing the property management - it's just an entity you use.

    The properties are not protected whatsoever, beyond the insurance you have (which offers protection against claims covered by insurance, but not against litigation and other problems not covered by insurance, and yes, insurance doesn't cover you completely) and the mortgages you have (yes, the mortgage note itself is a form of insurance, but you still need to worry about protecting your equity).

    And you better have a good partnership agreement with your partners (what happens if one of them hits someone with his car and he's getting sued? Hint: you all lose).

    So, that's the bad news. Good news: you can correct the problems, if you need. 

    Normally you want to separate passive from active operations: a holding(s) LLC for asset(s) (or a Series-LLC, if available to you) and an operations entity for property management (an LLC that doesn't have any assets, but is the one interfacing with the public, doing property management, hiring of contractors, dealing with tenants, etc.). Eventually, with an extra layer of anonymity through land trusts (at the top between you and the LLCs and at the bottom between assets and holding entity).

    Here is a diagram to help you:

    And in your case, with partners, I would have each one form an LLC and have the LLC partner - that way problems coming from one of the partners is not jeopardizing all the other partners and assets.

    I can send you my notes on the whole asset protection question (dealing with structures, transfer, insurance, DOS, etc.). Ultimately, you'll need specialized help - watch podcast 109 and talk with @Scott Smith.

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  • Lee Liberman
    OP
    Investor · Baltimore, MD · Member since 2013 · 31 posts · 3 votes
    8y

    i didnt want to deal with commercial loans so i have the properties in my name and not an llc. With rates rising i dont feel comfortable with quit claiming as they may have more incentive to call them. Some people dont think llcs matter and you can just get a ton of insurance in its place. Others think llc is the only way to go. If fannie lent to llcs it wouldnt matter but this causes people to prioritize different things.  Im balancing the small likelihood of huge interest rate rises causing refinancing to crush us vs the small likelihood of a non insurance covered tenant lawsuit that crushes us. Both are bad and impossible to quantify. 

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