When protecting your assets, build a castle not a fence. You've made the effort to make your money, now keep it. You've built a fence to protect your assets by using an LLC, now learn how using the awesome power of Irrevocable Trusts will build you a castle.
Protecting your assets is about building legal walls to keep out a litigation attorney after a successful lawsuit. Using Trusts builds a strong, high wall to defend against an attacking litigation attorney. The properly structured Trust strategy isolates your assets where if the attorney wins a lawsuit against you or your LLC, they can't get at your prized assets. Poor guys, all that work for nothing.
Think you’re protected with an LLC? Think again…
Assuming you're a real estate investor with 10 properties held in an LLC, you're vulnerable. There are many tricky ways litigators are able to break into an LLC and get access to all your assets even though the lawsuit only pertained to a single property.
LLC protection is limited. The LLC will protect the properties from suits against you individually, but a lawsuit relating to the sale or lease of property will go against the owner, the LLC. In a landlord/tenant dispute or a dispute relating to the sale of a property, the LLC will be liable as the owner of the property. If the opposing party is successful in the lawsuit, they will be able to collect on their judgment against the assets of the entire LLC, all of your properties, not just the property or sale they based their lawsuit on. They will be able to foreclose and auction off your properties at a discount until they have collected enough money to satisfy their judgment.
Poof, there went your years of hard work into the pocket of an attorney.
A Trust stops the fight over your assets before it starts…
The more walls you have, the harder it is for the other side to recover and the more likely it is that they will not even bother filing suit. Lawsuits are a three legged stool, and a Trust destroys one of the legs and the lawsuit crumbles.
The three stool legs which support a successful lawsuit are: (1) legal liability, (2) injuries, and (3) recovery. In layman terms it translates respectively to: (1) the law recognizes liability either by common law or statute, (2) the facts show that the party suffered money damages because of the defendants conduct, and (3) assuming that previous two are true, there are assets which we can take from the defendant to satisfy the judgment. An attorney won’t file a lawsuit without all three legs being in place.
Using a Trust cripples litigation because it makes the pool of assets for recovery, the third leg of our stool, unattractive. Ten properties held in an LLC makes me slobber worse than Saint Bernard because there is likely lots of money for me to go after. A single property doesn't even get me to the keyboard to type a petition unless there is a hefty chunk of equity in the property. Without multiple properties, usually there just isn't enough equity to recover against.
A Trust is the individual stone that builds a castle around your assets
You have all your property held in an LLC and it's time to transfer each of those properties into individual Trusts. You have 10 properties, you'll need 10 Irrevocable Trusts.
A Trust isolates the assets. By establishing an irrevocable Trust, the property is not held in your name or in the name of the LLC, but in the name of the Trust. Since the Trust is the owner of the property, neither you nor the LLC own the property. You or the LLC are merely a beneficiary of the Trust, which entitles you to the income from the property. In effect, you get all the benefits of owning the property without the liability. In a dispute regarding the property, the opposing party will only be able to collect against the asset of the Trust, the Trust property, which hopefully has limited equity.
Why do I hope that the Trust property have limited equity? The lawsuit that is filed against the Trust is limited to recovery against the Trust property. If the mortgage on the property is close to the value of the property, then there isn’t enough equity in the property to justify a lawsuit. Remember, the litigation attorney only gets paid after he auctions off the property and pays off all the liens including the mortgage. The fees for the auction and the costs in litigation to get it to auction are also subtracted from the equity. In the end, there is hopefully little that he and his client will get paid out of. If the attorney can’t make money, they won’t file suit.
THE LAW FAVORS THE PROACTIVE. Set up your Trusts today and rest easy knowing you’re protected.
@Scott Smith What do you think about a Texas Series LLC for asset protection?
For those who do not know, a Series LLC has the overall company (for instance, ABC Properties, LLC) and individual cells or series for each property (for instance, ABC Properties, LLC - Series A, ABC Properties, LLC - Series B, ABC Properties, LLC - Series C, etc.
Great information @Scott Smith I've been curious as to how trusts help protect you and you helped explain it perfectly. Awesome post. Definitely going to use this information in the future!
A Series LLC is great tool and I haven't seen any Texas Law that would show that it is vulnerable; however, I also haven't seen anything that convinces me that the Court's strictly uphold the Series as separate entities. In fact, the series is not technically their own legal entities, at least technically. Tex. Bus. & Com. Code §101.622.
Also with Series you're accounting has to be impeccable, or you risk commingling funds and destroying your protections in whole or in part. In fact, series insulation is preserved only so long as "records maintained for that particular series account for the assets associated with that series separated from the other assets of the company or any other series." Tex. Bus. Orgs. Code § 101.601(b)(1). In other words, records must be maintained "in a manner so that the assets of the series can be reasonably identified by specific listing, category, type, quantity, or computational or allocational formula or procedure." Tex. Bus. Orgs. Code § 101.603(b). Implicit in the statute is the idea that assets and liabilities of a series can and should be separate both from the assets and liabilities of other series and those of the company at large.
A Trust structure may be more beneficial since there is a judicial history of upholding them and you don't have the same concerns and liabilities regarding commingling of assets.
1. Why irrevocable?
2. Is it necessary to have a third party as trustee, or can a married couple have an LLC and also act as trustee for each property's trust?
3. Does this only apply to Texas?
4. Is there any point to this if all the RE is owned outright (100% equity)?
5. Would you still form a trust for each property if the value is relatively low - <$50K each - or would you group them?
Great post @Scott Smith Thanks for sharing with this group.
The trust is a very secure way to purchase / hold real estate because the trustor doesn't have the fiduciary responsibilities. That's the job of the trustee. How does one go about finding a trustee to do all of the work on behalf of the beneficiary? Do you hire a new trustee for each property? Should you take the position of the trustee? It's a 3 prong plug make no mistake about it. Its not as easy to set up as its often portrayed. If it were there would be more Trusts than LLCs in this business. My coin.
@Mary. Those are good questions. I can tell you're thinking thoroughly about all the legal necessities of establishing a proper trust. I agree with you that you want to make sure the Trust is properly structured, and you will want to get legal advice on that topic. I can tell you though that I believe a Trust is more cost effective than an LLC. Trusts do not have to be registered with the state in the State of Texas, and they do not have any fees from the State of Texas associated with their establishment. This can make a Trust cheaper to establish than an LLC. They are also quicker to establish because they can be created without any delay in processing from the State. If you have any questions about how Trusts can help you as a wholesaler please let me know and I'll consider writing an article about it.
Yes, great post, @Scott Smith thanks for the info. I wasn't aware about trusts. Will look into it further
Scott, good post, are you an attorney?
I sense you are in the trust business?
I use an irrevocable trust, however there are some down sides. Additionally, a Charitable Remainder Trust and a Revocable Trust all work together in the family estate management game.
A few aspects;
One is that you had better trust those you put in the driver's seat, of an irrevocable trust as it's very hard to remove a trustee and you are not in control of the assets, the kids better love you.
Secondly, real estate can be a real pain in a trust, the trust must be valued annually, many trust companies will not hold RE due to annual valuations (appraisals) and management, but some do and administration is higher than holding liquid assets.
If you're sued and you lose, collectors may not attack the trust, but rather the income from the trust as it disburses income to you.
Next, if you have an LLC managing trust property, check your real estate license laws as the property is not owned by the LLC, it's managing property "for others".
Same with legal proceedings, you can't represent your trust or in many areas your LLC as they are separate entities.
Trust accounting is more expensive than general accounting, the responsibilities are greater as to compliance and therefore it will generally cost more.
A much better method to protect your assets, once accumulated or even while you're trying to accumulate your riches, is a good insurance policy and great management. As Scott pointed out those three legs, you won't have negligent issues if your management is exceptional and that's much easier to control and costs very little.If you follow some plan of placing liens against a property as an asset reducing management ploy, it will cost you, some are nothing more than equity stripping ploys and can end up being filing false liens. Such ploys can be attacked as well. You can refinance, say every five years or so, where the purpose of the loan is for other business purposes, but be careful in just trying to suck equity out as a ploy to be too broke to be sued.
Irrevocable trusts are best suited for higher asset individuals, not saying the average person can't benefit, but the costs of administration can eat up a lower asset account, the income should be looked at from a perspective of your yield after taxes and administration.
But, with an IT, they can't get it if you don't own it. A Trust can help make you bullet proof but nothing is bomb proof.
All good info to look into. Thanks to all!
This is a good thread and a topic we should all think about a little more often than we probably do now. When I spoke with my attorney about my LLC he told me that an LLC was simply a waste of time if I was doing it for asset protection. And that I should be looking into Umbrella Insurance. The Umbrella was going to cost much less in the long run and give me better protection in a worst cast scenario.
Keeping your assets leveraged also helps, especially now with the ridiculous interest rates. But when interest rates rise this strategy can become costly and kill cash flow of a rental.
I'm not an attorney, nor have I stayed at a Holiday Inn recently. But like @Bill Gulley said I think an Umbrella is much more cost effective for the average to mid level investor.
Chris, I'm not an attorney.
It was in my insurances days that I worked with an estate attorney, using trusts for estate planning and asset protection, asset preservation. For 75-80% or so, good management and insurance does the trick for RE investors. The risk exposure of owning SFDs or small multi family is really pretty low, it's the horrific cases that are used to scare you into buying your attorney's home. :)
Really Really good information!
Thank you for sharing Mr @Bill G.
I have a specific question regarding opening the LLC.
Someone advised me to open a LLC in Nevada, instead of opening it in Texas. I was wondering if you advise the same option.
Do you have any recomendation of lawer and price wise that I can reach out and try to organize either one?
This post has been removed.
There is a Nevada style LLC, available in most states, it was the first I believe to adopt the limited liability company corporate entity.
No, I don't suggest you form an entity out of state as you will have a foreign corporation, more money and headaches.
First find out if you need an LLC, is there a business reason to form an entity?
The best defense to liability is 1. good management, don't be negligent and 2. INSURANCE! Lots of it.
Many, if not most who form LLCs have no clue as to the proper management required (I'm speaking of the DIYer's) the corporate veil can be pierced easily if you fail in your management duties, so don't rely on an entity to protect you, it is a secondary line of defense.
The Operating Agreement should be given some thought as to the business to be conducted, you don't want any boiler plate agreement. Contact a local RE attorney and first see if you really have a need, if so, the design your company and operations first and then address filing your entity. You should see and attorney and an accountant.
Scott may be able to help you being in Texas, btw, consider the Series LLC, much can be accomplished using a Series LLC, it's my understanding that Texas has past rulings concerning these entities, which is a good thing. :)
Updated about 4 years ago
LOL, I cam here from Val's mention and then answered, I didn't see all the posts above, so the Series had already been mentioned! :)
I agree with you 100% Bill that we shouldn't rely on boilerplate anything in the legal world. If legal protection is like armor, a boilerplate document is akin to wearing a piece cardboard.
The heart of this matter is an asset protection strategy. The more protected you want to become legally often correlates to complexity and costs. You have to weigh the extent of your assets against what it will cost to establish and properly manage the entities. I can help you look at what will make sense given your asset portfolio.
If you have relatively few assets, it may not make sense to establish an LLC at all. In some scenarios, you can run a well protected business inside of a Trust alone.
Is an Asset Protection Attorney versed in tax law? When this topic of trusts and LLCs come up, someone always says, talk to your Tax Attorney. How many attorneys do you need to set this up? Wouldn't part of Asset Protection include not losing it all to taxes? ;)
Also, diagrams help a ton in these types of discussions. Does this diagram, posted by @Bryan Otteson look correct? https://www.biggerpockets.com/forums/311/topics/175437-land-trusts-and-llcs-for-asset-protection
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