Protection of your personal assets: LLC or increase insurance?

Tax, Legal Issues, Contracts, Self-Directed IRA 26 Replies

WOW, were were looking into putting our few units into an LLC to protect our personal assets in case tenants sue, and my accountant just advised me that apart from paying to FORM an LLC, there will also be an 800$ tax/year for California (we live here). The accountant expressed his disbelief in the advantage of creating LLC and recommended to increase our insurance.
How do you guys protect your personal assets?
Thank you!
Edita :)

Depends on your preference, but in my case, Indiana is pretty landlord-friendly, so a $500k insurance policy per unit, plus my $1m umbrella policy lets me sleep at night.

For me, an insurance policy on each property plus a separate umbrella policy is enough. I don't see the need (for me) for an LLC on top of that, especially considering the costs you mentioned. I actually have a friend who is lawyer who could form the LLC for me, but the $800/year tax is just something I can't see paying.

More insurance over LLC all the time.

Medium buymemphisnow stacksCurt Davis, Buy Memphis Now | [email protected] | 605‑310‑7929 | http://www.BuyMemphisNow.com | TN Agent # 00321765

I thought placing your property in an LLC discourage litigation in the 1st place? Is my logic flawed?

2 scenarios:
Say Problem Renter A slips on the stairs going up to the house gets injured and decides to consult an attorney.

Insurance Scenario:
The attorney see's it is personally owned by you and assumes you probably have an insurance policy and assets worth hundreds of thousands of dollars (insurance, umbrella policy, personal home, retirement accounts, kids college funds, other properties, etc.). He files a lawsuit for $5 million dollars. Even if they are only awarded the value of your umbrella policy or your win outright, you still lost because you had to pay your own attorney's fees and lost countless $ due to the time in litigation.

LLC Scenario:
The lawyer looks at the house and see's it is valued at ~$100k, but leveraged at 75k. If structured properly none of your personal assets are at risk. There is only 25k of equity for him to steal. He tells Problem Renter A it is not worth their time.

You can get a Wyoming LLC for only a couple hundred $/ year. Probably about the same cost as an umbrella policy and you don't have to worry about some judge telling some guy you owe him your life's worth.

I am new to real estate investing, so someone please tell me if my logic is flawed as this is how I intend to own rental properties.

@Mark Spivey Here's what my research showed:
-when u put ur property into LLC, INSURANCE RATES are HIGHER, and it's more difficult to GET insurance- loss of income
-you have to create LLC in a state you live, otherwise it will NOT be protected under the LLC, since you have to pay taxes/fees depending on your state. We have properties in CA and NV, and have to pay 800$/year tax for CA, amd 350$/year some kind of fee for NV - loss of income
-you have to transfer the property's title into the name of LLC,which will cost 300-500$ in attorney money-loss of income. And, there's no guarantee your insurance carrier will no drop you! I called mine: they will drop my policy if I wanna put it into LLC..

Overall, if you are just starting out and do not have lots in assets, you are fine having a 2mln umbrella over EVERYTHING that u have: cars, homes, etc.

Originally posted by Edita D.:

-you have to create LLC in a state you live, otherwise it will NOT be protected under the LLC, since you have to pay taxes/fees depending on your state. We have properties in CA and NV, and have to pay 800$/year tax for CA, amd 350$/year some kind of fee for NV - loss of income

That runs contrary to what Garret Sutton says. Maybe because it is CA where it's very renter friendly and easier to "pierce the veil"? I think CA LLC's are the weakest around. I don't claim to be an expert. I'll do some more reading when I get the chance and post back.


-you have to transfer the property's title into the name of LLC,which will cost 300-500$ in attorney money-loss of income. And, there's no guarantee your insurance carrier will no drop you! I called mine: they will drop my policy if I wanna put it into LLC..

I suspect that dollar figure you quote is highly dependent on many factors. I know CA fees are among the worst around, and NV's used to be cheap, but are now getting fairly expensive in their own right. So I would encourage people to check it out on their own.


Overall, if you are just starting out and do not have lots in assets, you are fine having a 2mln umbrella over EVERYTHING that u have: cars, homes, etc.


Lets take my previous example and assume I have 1 million in assets. I buy a 3 million umb policy. What if there is faulty wiring in my house and it winds up burning down several properties and I get slapped with the $5M lawsuit? I would lose EVERYTHING! Personally, I simply don't want to assume the potential risk of exposing my life's work to our judicial systems whims, just to gain an extra 1-2% ROI.

Seems to me this is a very important decision that shouldn't be taken lightly. I wouldn't trust me or anyone else. I would treat it as due diligence and research it to the last decimal.

Consider the method by which you structure the ownership of assets as your "castle walls and moat" around what you want to protect. Think of insurance as the "archer in the watchtower"...two different mechanisms that function together.

[email protected] | 888‑741‑8454 | http://www.nreinsurance.com

Mark, I think your doomsday scenarios would likely play out differently in the real world. In your first "insurance scenario", your insurer would be paying for your legal defense for a covered claim. In your "LLC Scenario" you would pay your own legal defense unless you had insurance, in which case it would be the same as your insurance scenario.

In your later post about the $5MM lawsuit with the $3MM policy limit, what would likely happen is your insurer and the plaintiff would likely settle out of court for an amount within the policy limit. If you had a ton of assets, the plaintiff might not agree, however. Lets say you are worth $10MM, the plaintiff will refuse to settle for the $3MM insurance proceeds because they think they can get the extra $2million from you. Simple solution: get a $10MM umbrella policy.

The LLC may provide you with some asset protection by discouraging lawsuits, and it may not. It all depends on how much you are worth, how much the LLCs are worth, etc. if you have a lot of various exposures (houses, apartments, medical practice, a restaurant, motel, etc) LLCs provide some separation of liability so that losses from one exposure don't wipe you out across the board. Regardless of all of that, insurance and good risk mitigation is always your first line of defense.

Medium praxis capital logo cmyk stacked 900pxBrian Burke, Praxis Capital, Inc. | [email protected] | http://www.PraxCap.com | Podcast Guest on Show #3

There are a lot of opinions on this subject.

One thing that I have run into is landlord tenant court. In my state, it is up to the court as to whether an LLC needs a lawyer. Some courts will let an LLC owner represent themselves, but other courts say that a lawyer must do it. Also, the insurance and costs are another factor.

One lawyer that I know told me that an LLC is a waste of money and paperwork. He said that in my state, the biggest judgment against a landlord ever was 1 million dollars. He suggests having that much liability insurance and everything is fine. He also told me that almost all lawyers will go after the insurance amount and nothing higher. They want the easy money and don't want to go after your assets.

If LLC is the route you choose, do you form an LLC for each property? Thought being that if you own say 10 properties outright and you are sued because of an issue at one, if you form LLCs for each property you mitigate your risk.

My CPA says that if you do have multiple LLCs you'll have to prove in court that you operate each one as a completely independent business.

My choice thus far has been to form one LLC for all of my properties and carry a 500k landlord liability policy on each one and also 2m in a personal umbrella.

Love to hear any suggestions.

To what extent can putting things into a non-revocable trust help?

Michael

Both ...

We have a $2M Umbrella, and hold our prop's in a single LLC

As for non-revocable (irrevocable) Trust's -- I don't think I'd use one for Rentals. For an estate, cash, etc.... yes. Investors tend to move in & out of rentals at a whim. Should that neighborhood go south quickly, you would NOT be able to get out because the trustmaker pretty much gives up all control.

I'd stick to insurance and entity asset protection when it comes to rentals.

As Rob K suggested, plaintiffs attorneys want to collect and settle as soon as possible. If there are adequate insurance limits they won't go to the trouble of trying to attack your personal assets. Judgements above and beyond the insurance are not easy to collect. If you have $2M or more in liability limits, the attorney will take the quick settlement and pocket their 30%.

Is this true? I live in NY but have Florida investment properties in Florida LLC's..

-you have to create LLC in a state you live, otherwise it will NOT be protected under the LLC, since you have to pay taxes/fees depending on your state. We have properties in CA and NV, and have to pay 800$/year tax for CA, amd 350$/year some kind of fee for NV - loss of income

Joe, I have a Delaware LLC for a Texas property, but I had to register the LLC as a foreign entity in TX. I also have a couple of Texas LLCs for Texas properties. I live in California. I do not have to register the LLCs as foreign entities in CA because there is no business activity in CA. If I also owned CA properties in these particular LLCs, I would have to register them in CA and pay additional fees. I hope those examples are helpful in evaluating your situation.

Medium praxis capital logo cmyk stacked 900pxBrian Burke, Praxis Capital, Inc. | [email protected] | http://www.PraxCap.com | Podcast Guest on Show #3

Originally posted by Edita D.:
WOW, were were looking into putting our few units into an LLC to protect our personal assets in case tenants sue, and my accountant just advised me that apart from paying to FORM an LLC, there will also be an 800$ tax/year for California (we live here). The accountant expressed his disbelief in the advantage of creating LLC and recommended to increase our insurance.
How do you guys protect your personal assets?
Thank you!
Edita :)

I'm not a lawyer, but IMO, if you equity stripped the properties through mortgages and liens and then put them all into one LLC that would make the annual fee affordable and provide a good degree of safety. If the properties are all free and clear you could be taking a bit of a risk by using one LLC. I wouldn't create multiple LLCs at $800/yr unless I had a lot of properties.

What I am doing is putting "high risk" properties (so far only one) in LLCs and keeping the rest in my own name under an umbrella.

Originally posted by Brian Burke:
Joe, I have a Delaware LLC for a Texas property, but I had to register the LLC as a foreign entity in TX. I also have a couple of Texas LLCs for Texas properties. I live in California. I do not have to register the LLCs as foreign entities in CA because there is no business activity in CA. If I also owned CA properties in these particular LLCs, I would have to register them in CA and pay additional fees. I hope those examples are helpful in evaluating your situation.

@Brian Burke

With a Delaware LLC, don't you still have to create a management company (LLC) in the state where the rental(s) is, with the Delaware LLC as the holding company, for it to work? This is what my attorney told me.

We did not. The property is held in a Delaware LLC (which was a requirement of our lender, go figure) and that LLC is managed by my California LLC. The property is in TX. We just had to register the DE LLC as a foreign entity in TX.

Medium praxis capital logo cmyk stacked 900pxBrian Burke, Praxis Capital, Inc. | [email protected] | http://www.PraxCap.com | Podcast Guest on Show #3

@Joe Bertolino is absolutely correct about how it works with plaintiff's lawyers. (I know because I am one, though I don't sue landlords for obvious reasons.) The only other personal observation I would offer is that getting a million dollar or even two million dollar policy will probably protect you from most claims.

I had already started a thread on this topic above before I saw this. There are a lot of posters in this thread I respect. The answer we all need the most is to know how often the “veil is pierced” in LLCs. Rob and I are in the same state of Michigan so I was glad to see his answer. Is there a way to research at a law library or a court as to the effectiveness of LLCs in protecting business owners in ACTUAL lawsuits?

Here is the website I used in my first psot that takes a negative view with LLCs. http://www.johntreed.com/entity.html

Atty's won't even attempt to pierce the corporate veil unless you have significant assets and the damages were severe. It is vary rare in liability cases. If you have significant insurance limits, they won't even bother as the ROI for their efforts is extremely low.

After getting my feet wet in investing over the last 5 years in NY and PA here is what I have come up with.

Set up your LLC(s) ahead of time, so when you purchase property you can have it titled to the LLC from the get go. It is costly (more so in PA that NY) to transfer afterwards. All that does is reduce your ROI. We're in this to make money, so get one set up and start using it. When you hit your equity threshold start another entity. For example. LLC A may hold 10 properties valued at 1MM, but which are leveraged at 90% LTV leaving 100,000 in equity that could be attacked. You can tweak that number depending on your personal risk tolerance.

I have had no problem getting landlord insurance for property titled in an LLC, the LLC members are named as additional insured.

I created an LLC to do the management and I have also created an LLC to do the repairs and maintenance. They are both multimember LLCs as opposed to single member. I give small percentages to various family members to prevent them from ever being lumped together in court. You want the companies to seem as different as possible. If they are all single member LLCs with just you, it won't really help. If they are all multimember LLCs with different people and different ownership percentages you'll be in much better shape IF anything ever happens.

The management company bills back a monthly fee to the owning entities and deals with lease ups, paper work, advertising, bill paying etc.

The construction company provides all repairs and maintenance and bills the owning entities directly.

Hope it helps!

Medium square logo final flatMark Updegraff, Updegraff Group REALTORS & Mngemnt/Const | [email protected] | (585) 314‑9790 | http://www.RochesterInvestment.com | NY Agent # 10491205428

Originally posted by Joe Bertolino:
It is vary rare in liability cases. If you have significant insurance limits, they won't even bother as the ROI for their efforts is extremely low.

Joe, if that is true I have to wonder if it is worthwhile to form the LLC. I am already insured through a landlord policy and umbrella. I would rather not do an LLC unless it will make a difference. I am hoping someone who knows their way around a law library would tell me where I could look in my home state of Michigan to research as to the frequency of LLCs being pierced. From what I have been told an attorney need only ask for it to happen. If that is true I would think every lawyer would do this regularly. If I find that LLCs do routinely protect business owners I will go forward with it. A lot of people say “it is a good idea,” and “it’s to protect you.” However I just don’t know the facts yet.

Steve Might Check out this thread from a couple weeks ago.

http://www.biggerpockets.com/forums/52/topics/78884-has-a-tenant-or-former-tenant-ever-sued-you

I asked this because everyone is so paranoid about lawsuits and afraid that they will "lose everything." While I didn't think there would be any posts of people who lost everything when their tenant drowned in the bathtub, I did expect to hear more higher dollar lawsuits. None of the lawsuits that werre mentioned would have made a difference if it was an LLC or in their own name.

Check it out. There were some interesting posts.