Asset Protection for Novice Real Estate Investor
Rental Property Investor · Malvern, PA · Member since 2018 · 8 posts · 8 votes
Asset Protection for Novice Real Estate Investor
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Ricardo R.Pro Member
Property Manager · Michigan Ctr, MI · Member since 2016 · 663 posts · 581 votesJason , this is an age old question. With three different camps giving tree different and sometimes opposing views. And to be honest with you it's pretty hard to find someone that is qualified in all three. The Lawyers will tell you to lock it up and down as full proof as possible but, it increases your filing costs and it makes it harder to finance/refinance, harder to manage. The accountants will tell you that it increases your costs and it makes it harder to move between lenders and tell you to keep the lender involved. The insurance salesmen will vouch that all you need is to increase your coverage and get umbrella insurance. The problem with all of them although they may be really good in their perspective fields is that they don't approach it from the eyes of an investor. A you are an investor; fluid, you may need to dispose of a property now or borrow against it at the lowest rates, or pull money out or any other number of scenarios.
There are honestly so many different ways go about protecting your assets and all have their upsides and down. But, the thing with LLC's and I'm not a lawyer but have been down this road enough times to know is that if you make one mistake the whole thing can be circumvented there goes money, time and effort down the drain, also from my understanding SLLC's are relatively new and still being tested by law, so no guarantee there. @Scott Smith is right in using a mixed approach but at what cost? both actual cost and time and effort and then how 'fluid' will you be? do you have to go through hundreds of steps before you can refi? are you now going to be in a different insurance bracket and have to pay a higher premium? are you now going to have to have a lawyer represent the LLC during evictions? are you now having to use more expensive and less forgiving commercial financing? these are all costs that we as investors look at that are missed. But to be honest with you I have never seen anyone get sued for their property, sure I have heard about it, read about it; but if you think about all the properties out there you would figure it would be more common. I'm sure it happens and I'm sure one would regret it then but, a house can burn down anytime and we're not protecting ourselves by only buying homes next to fire stations. I hope this helps
9 Replies
- 7yScott SmithPro MemberAttorney · Austin, TX · Member since 2014 · 1k+ posts · 932 votes
@JASON CHOI Sure thing brother! When I sit down with clients, I always discuss (1) their personal assets, and (2) what their current investments portfolio and other business ventures are before discussing (3) their future goals. Each of these variables will dramatically change the advice I give the individual asking me this question. Generally though, I break it down into the "five pillars" of protecting your assets.
The first pillar is avoiding unnecessary and risky activities (don't drink and drive, insurance generally won’t cover your poor decisions) and take good care of your investments(maintain your property, etc) - these simple steps will help you prevent lawsuits before they even occur.
The second pillar is a good insurance policy as that cover the majority of your exposure. However, insurance is limited because it only protects you from one type of liability: accidents/negligence. Insurance doesn’t protect you from any part of the sale or acquisition of a property (e.x. Somebody wanting to sue for you backing out of a bad deal or accusing you of selling them a property with defects like unknown termite damage). Insurance also doesn’t protect you from misunderstandings, especially those made in writing and email. What happens in these misunderstandings is that something goes wrong either in the sale or after, and then they sue you for some statement you made that they “misunderstood”. That lawsuit is a claim for fraud, and that’s what fraud typically is...a misunderstanding and someone being “injured” and wanting to hold the other responsible for it. Insurance never protects you from these kinds of claims and they happen all the time.
The third pillar applies after you have good insurance You need to protect yourself from what insurance doesn't cover by compartmentalizing your assets. Compartmentalization means that if something happens to one property, people suing can't touch you or the other properties. You should use either LLC's (the old and expensive way) or a Series LLC (the new and more cost/time effective way). No matter where you live or where you own assets, I personally recommend the Series LLC to be a great tool for the individual investor who is planning to expand their operation, as it allows for you to scale infinitely for FREE. If you're interested in using an LLC, this article also further explains the advantages of a Series.
The fourth pillar is somewhat similar - you want to separate your operations from your assets. One company owns everything and does nothing (this is your SLLC a/k/a "asset holding company") and a completely separate company handles all of your operations (this is a traditional LLC a/k/a "operating company") For the operating company which serves as your face to the world and through which you do all your business, you establish a Traditional LLC to carry out the operations of your investments. The operating company takes on all of the liability that would otherwise blow back on you including: paying property management, paying contractors, collecting rent, marketing, etc.
The fifth pillar is owning everything anonymously. If people don't know that you have assets, then they are less likely to sue because there's no use in suing people that qualify for food stamps. This anonymity can be accomplished for free by using land trusts to own your companies as well as the assets. Trusts create this anonymity by removing your name from public record. Even if they can see you used to own a property, when properly transferred it will look like it was sold to investors. If they somehow guess you are the owner though, it still doesn't matter because you would not be the owner. The land trust and the LLC are the owner of the asset/real estate, so even in the scenario that potential litigants guess, they would guess wrong.
For 5+ properties my best recommendation is to do this through a Series LLC. I can discuss this more with you as needed or provide additional information. If you check out Podcast #109 you will get a good overview here.
Feel free to leave a reply of DM me if you have more questions. I am happy to help.
- Scott
- Rental Property Investor · Malvern, PA · Member since 2018 · 8 posts · 8 votes7y
@Scott Smith Thank you for sharing this information. I have never heard of SLLC before. As you suggested, I read several articles after you responded. I am very much inclined to go with your firm.
A few follow up questions for you:
1. What is the cost of creating Delaware SLLC vs conventional LLC at Royal Legal Solutions?
2. Is SLLC a widely accepted entity? Do such States like OH, IN, MI, NC or GA recognize the "internal liability shield" of SLLC? These are the areas I would like to invest in in the near future.
3. What is the actual steps in creating 'child' or "series" under SLLC? Can each Series have its own EIN?
4. I read several posts saying not many banks allow you to open a business account with SLLC. Why is that?
5. Tax perspective: Is it more costly to file taxes for SLLC compared to conventional LLC?
6. For someone like me who's just starting out, would you suggest SLLC or a Land Trust and then transfer to LLC later?
7. Do I need a LLC to deduct business expenses (i.e. travel expense, REI education expense, any other business activity expenses)?
Thank you again for your help!
- 7yRicardo R.Pro MemberProperty Manager · Michigan Ctr, MI · Member since 2016 · 663 posts · 581 votes
Jason , this is an age old question. With three different camps giving tree different and sometimes opposing views. And to be honest with you it's pretty hard to find someone that is qualified in all three. The Lawyers will tell you to lock it up and down as full proof as possible but, it increases your filing costs and it makes it harder to finance/refinance, harder to manage. The accountants will tell you that it increases your costs and it makes it harder to move between lenders and tell you to keep the lender involved. The insurance salesmen will vouch that all you need is to increase your coverage and get umbrella insurance. The problem with all of them although they may be really good in their perspective fields is that they don't approach it from the eyes of an investor. A you are an investor; fluid, you may need to dispose of a property now or borrow against it at the lowest rates, or pull money out or any other number of scenarios.
There are honestly so many different ways go about protecting your assets and all have their upsides and down. But, the thing with LLC's and I'm not a lawyer but have been down this road enough times to know is that if you make one mistake the whole thing can be circumvented there goes money, time and effort down the drain, also from my understanding SLLC's are relatively new and still being tested by law, so no guarantee there. @Scott Smith is right in using a mixed approach but at what cost? both actual cost and time and effort and then how 'fluid' will you be? do you have to go through hundreds of steps before you can refi? are you now going to be in a different insurance bracket and have to pay a higher premium? are you now going to have to have a lawyer represent the LLC during evictions? are you now having to use more expensive and less forgiving commercial financing? these are all costs that we as investors look at that are missed. But to be honest with you I have never seen anyone get sued for their property, sure I have heard about it, read about it; but if you think about all the properties out there you would figure it would be more common. I'm sure it happens and I'm sure one would regret it then but, a house can burn down anytime and we're not protecting ourselves by only buying homes next to fire stations. I hope this helps
- Rental Property Investor · Malvern, PA · Member since 2018 · 8 posts · 8 votes7y
@Ricardo R. Thank you for your comment. I like the different angle you are providing. As I learn more about "starting this out appropriately," it become harder to actually pull the trigger.
If you don't mind me asking, how did you start? Did you end up buying your first one on your own name?
The thing is I have three young girls and some personal assets that I would like to protect - that's why I'm spending so much time on asset protection topic.
I already have interested markets and some turnkey providers that I'd like to contact next: OH, MI, IN, and GA.
I would appreciate your insights here!
- 7yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
Originally posted by @JASON CHOI:
@Ricardo R. Thank you for your comment. I like the different angle you are providing. As I learn more about "starting this out appropriately," it become harder to actually pull the trigger.
If you don't mind me asking, how did you start? Did you end up buying your first one on your own name?
The thing is I have three young girls and some personal assets that I would like to protect - that's why I'm spending so much time on asset protection topic.
I already have interested markets and some turnkey providers that I'd like to contact next: OH, MI, IN, and GA.
I would appreciate your insights here!
a lot of this depends on how much TRUE cash or equity your trying to protect..
if your just putting minimum down on turn key rentals.. there is not a lot of equity to protect and would be rare to the extreme anyone would pay to go the full monty getting a judgement against a house that by the time they foreclose and pay off our secured lenders and real estate fee's etc there is not much left.
keep in mind 20% equity in the Average C class rental is really no equity.. nothing really to get.
if your worried about cash for your daughters you can set up an irrevocable trust for them right now. I think those are pretty bullet proof but again you would want to check it out..
AS stated above your going to find having advanced asset protection will make lending difficult ..
- 7yRicardo R.Pro MemberProperty Manager · Michigan Ctr, MI · Member since 2016 · 663 posts · 581 votes
@JASON CHOI I started pretty similarly as you perhaps. I left the military and moved out of state into Michigan for my wife in 2007, so I wasn't very familiar with the area. I didn't know what I was doing but, what I did know is that: 1) I wanted a property to live in that I could easily make into a rental later down the line and 2) that I didn't know enough of the area and needed a real estate agent. I really didn't know what I was doing but, to my luck (after an exhaustive search) I stumbled across an agent that did. We purchased our first property in my name and we took our time after that learning, watching, learning and learning. Eventually we turned that into the rental we planned on and off we went into purchasing additional properties - single-family homes and apartment buildings some in our name and others under an LLC.
Looking back at it there are definitely things I would have done differently and it's one of those things where you don't know what you don't know (I hadn't found BP yet), but even now I'll still consider putting a property under my own name just because financing options are just easier and cheaper. When I do use an LLC it's because it may just make sense and the personal option is off the table such as for an apartment building. I'm fully aware of the risks but, am also fully aware of the positives and that starting off, if I had wrapped myself up into LLC's and other stuff, it would have been much harder. I'm sure others here may have different experiences. Listen I'm all for protecting my family, I also have 3 little ones (a boy and 2 girls) and have kicked the LLC and insurance thing back and forth and what I found that works for me, is a mix. We of course have rental dwelling policies on all of them and also hold an umbrella policy now. If the home is backed by a lender we have it in our name without an LLC, if we buy it outright or it's an apartment building, we buy it directly as the LLC. I hope this helps, like I said there are so many different experiences from everyone and tons of articles on here about it but, I think that at the end of the day you need to find a happy medium between not having any protection at all or going overboard on protecting your assets, especially if you are a growing investor which is constantly growing and shrinking and moving pieces around. That is where I find myself now, I am a growing investor but as I get older however, and accumulate more, my mindset will change to complete asset protection so that I can fully protect what I've worked hard to acquire. Hope this helps.
- 7yScott SmithPro MemberAttorney · Austin, TX · Member since 2014 · 1k+ posts · 932 votes
@Ricardo R. and @JASON CHOI I agree with Ricardo that the strategy that you use is dependent on many factors. You don't want to get yourself in a position where you are doing more than you need to, but also not too little which would leave you unprotected, losing money on taxes, damaging credit etc. I use the same strategies as I promote for my own RE Investments and certainly appreciate a simple, streamlined approach to doing business.
I have a plethora of information on various topics from estate planning, investing, asset protection, etc. if anyone has a specific area they are looking into I am happy to point you to a few BP articles that may help.
- Scott
- 7yMike D'ArrigoPro MemberTurn key provider · San Jose, CA · Member since 2010 · 4k+ posts · 3k+ votes
@JASON CHOI the biggest problem you'll have is buying in an LLC with conventional financing. Lenders will require that you buy it in your own name. Some people will tell you that you can close in your name and then transfer it to an LLC but the lender can make you transfer it back.
- 7yScott SmithPro MemberAttorney · Austin, TX · Member since 2014 · 1k+ posts · 932 votes
Originally posted by @Mike D'Arrigo:
@JASON CHOI the biggest problem you'll have is buying in an LLC with conventional financing. Lenders will require that you buy it in your own name. Some people will tell you that you can close in your name and then transfer it to an LLC but the lender can make you transfer it back.
While a direct transfer to an LLC is risking the Due on Sale Clause being used and the lender calling the note back, you can still use a land trust to work around this issue. This article touches on the strategy. Essentially, you would purchase the property in your personal name and after transfer it to a land trust, which is a protected transfer due to land trust being considered an Inter Vivos Trust and excluded in the St Germain Act. After the transfer is complete you assign the beneficiary of the land trust as the LLC and make yourself the manager. This places the liability for the property for the land trust on the LLC while still offering your the beneficial financing options available to your personal name.
This isn't legal advice, just my opinion as a real estate investor.
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