Worried about legally protecting properties in other states?
Attorney · Austin, TX · Member since 2019 · 128 posts · 98 votes
Buying property as an investment far from where you live may seem like more trouble than its worth for many reasons. One of the most concerning factors is the question of how you can protect yourself from lawsuits stemming from properties you may never step foot on. Certain legal structures can help securely and cost effectively own property in numerous states though.
Please share here if you have any concerns about how to deal with potential legal liability in multiple jurisdictions.
Why would the liability of an investment property in another state be more concerning than one in your own back yard? Unless you are investing an a highly litigious state (e.g. California) the risk profile isn't that much different.
The next question is, do you really need an entity? If you don't have many assets to protect, you really aren't much of a target for a lawyer. Also, if you have good insurance, they are going to attack that primarily. If you are really concerned, get an umbrella policy for additional coverage.
If you really want to put things in an LLC, multiple jurisdictions are not a problem at all. You can either form a new local LLC or register your out-of-state LLC as a foreign entity. The on-going costs for a registered agent and annual filing is insignificant, roughly $200/yr.
Not a big deal at all.
Hello Greg, insurance is great, but I don't think it can supplant using entities to insult yourself, especially given it's relatively cheap to use them and they provide substantially more protection. To answer you question of why protecting yourself from liability in another state vs your backyard may be more concerning is just that you would have to familiarize yourself with the laws of the other state and potentially pay significantly more to form protective entities(Texas LLC's are free once created for example whereas CA one's are $800 annually to maintain). Also, for those that like to closely supervise, it may seem daunting ensuring legal claims don't develop against you when you can't physically check on the property yourself. The right legal strategy can simplify and deal with those concerns though, no matter how many properties or jurisdictions you invest in.
When I sit down with clients I will always discuss (1) their personal assets, (2) what their current investments portfolio and other business ventures are, and (3) their future goals. Each of these variables will dramatically change the advice I give the individual asking me this question. I often 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 - 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 they can't touch you or the other properties. There are several ways to achieve this though, and you can check out this article to learn more.
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 what you own, then they are less likely to sue. People don't sue people that qualify for food stamps. This anonymity can be accomplished for free by using 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 still, it doesn't matter because you are not the owner. The trust and the LLC are the owner of the asset/real estate, so even in the scenario that they guess, they guess wrong.
Now of course, when you're just starting out, it may not be ideal to abide by all these pillars of asset protection because they do cost some money to put in place, but as your real estate portfolio grows, the value of these principles goes through the roof. You could spend 10+ years building a 30 property portfolio for example and lose half of the properties in one lawsuit if they're not structures appropriately. It's also important to keep in mind that every additional rental property you own is another potential source for legal trouble, so if you grow to a certain size, it's almost inevitable that some tenant will get a valid reason(such as falling through a porch you didn't know was recently termite infested) to sue you over a 10 year period.