LLCs vs. Umbrella Insurance for first rental

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LLCs vs. Umbrella Insurance for first rental

Joseph Gambino
Rental Property Investor · Mobile, AL · Member since 2018 · 54 posts · 19 votes

From everything that I've read so far on BP and abroad it seems like there is a questionable argument for LLCs vs Umbrella Insurance. 

So, let me start by saying I have my first rental property and am looking for the most effective way to cover my tail should the need arise. 

From what I understand so far and have picked up on both is that for an LLC if someone were to sue you that would protect your personal assets and investments and the only items that could be in danger is what is under the LLC. On the other hand, Umbrella Insurance fills the gaps for home owners insurance, auto insurance, and protects your personal value. The Umbrella Insurance would be the first to be eaten up before any of your assets or investments could be harmed. Am I wrong or is that the gist of it?

First time investment what would you recommend? Pros and Cons for an LLC? Pros and Cons for Umbrella Insurance? Or would you get both? Would Umbrella Insurance be applicable over an LLC? Many more questions but I'll let these start the discussion.

Thanks in advance to all that supply their input.

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

You'll need regular insurance and you'll want to supplement that with umbrella insurance. Regardless, you'll need proper maintenance, property management, hiring, etc. Just know insurance will not cover you in all cases (fraud, negligence, mold) and for whatever amounts. Therefore, depending on your situation and risk threshold, you'll also need litigation insurance - aka asset protection structures and strategies, aka LLC.

Here is a diagram to help you navigate this question:

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  • Aaron K.
    Specialist · Riverside, CA · Member since 2015 · 6k+ posts · 3k+ votes
    8y

    It is hard to say without knowing the circumstance.  What are you protecting? What are you protecting against?

    0Reply
  • Michael Pepe
    New Haven, CT · Member since 2017 · 30 posts · 17 votes
    8y
    @Joseph Gambino Creating an LLC and buying insurance are accomplishing two different things. Insurance does not limit liability, It just shifts the responsilIty to pay for that liability to the insurer. When you create an LLC you are creating a separate legal entity. The LLC will have liability for its actions and omissions, but you cannot be held personally liable for the LLCs acts or omissions (except in certain circumstances).
    3Reply
  • Mike S.
    Investor · Broward County, FL · Member since 2018 · 1k+ posts · 938 votes
    8y

    When you create an LLC, basically you are creating a box. If something inside the box creates liability, you can loose the whole box content, but nothing outside the box.

    If you are sued personnaly, you can loose all the asset that you own, but not what is in the box (if the State where you organized your LLC offer the charging order as only remedy).

    The gold standard in asset protection is to put each dangerous asset (ie the one that gives you liability; real estate being a good example of it) in its own box, while you can put all the non dangerous assets (bank and brokerage accounts) in another single box.

    In practice, you will have to decide what is the size of the box that you would accept to loose vs the price of establishing and maintening these box. Some will tell you that they don't need an LLC, some will tell you that they would need one per property. What you need, only you can tell. It's what will make you feel better at night based on your specific circumstances.
    Even when using this structuring strategy to the fullest extend, liability insurance is a must but not a replacement.

    9Reply
  • Costin I.
    Rental Property Investor · Round Rock, TX · Member since 2016 · 1k+ posts · 971 votes
    8y

    You'll need regular insurance and you'll want to supplement that with umbrella insurance. Regardless, you'll need proper maintenance, property management, hiring, etc. Just know insurance will not cover you in all cases (fraud, negligence, mold) and for whatever amounts. Therefore, depending on your situation and risk threshold, you'll also need litigation insurance - aka asset protection structures and strategies, aka LLC.

    Here is a diagram to help you navigate this question:

    10Reply
  • Sam Jiang
    Investor · Windermere, FL · Member since 2016 · 11 posts · 1 vote
    8y

    I have same question about newB setting up insurance or LLC. Can someone give some details to tax paperwork as when buying one rental worth $50k, and I have to file taxes for each LLC which will be a nightmare when you have 10+?

    0Reply
  • Marc Winter
    Real Estate Broker · Northeast PA · Member since 2017 · 2k+ posts · 2k+ votes
    8y

    @Joseph Gambino, you've received lots of good advise from some very smart folks.  I'm not that smart, but I know what works for me: TRUSTS.

    Of course you need a good landlord insurance policy, and an umbrella policy is a good idea, and fairly cheap.  

    Before you make your final decision as to your title-holding entity, do your homework on the differences between LLC, S-Corp, reg Corp, and Living Revocable Trusts (aka Land trusts.)

    I'm not an attorney, but after using trusts in holding title to dozens of properties over the last 18 years, I can tell you that for me, they are hard to beat:  minimal set-up costs, no state transfer taxes, no annual state taxes, no extra accounting fees, no annual registration costs, no minutes, no separate tax returns to prepare, no due-on-sale/transfer liability with banks,  no nuttin!

    Private and secure: trustee is held harmless, beneficiaries can remain unknown, judgements against you do NOT attach to the trust; judgments against the trust property do not attach to you.  I could go on, buy my wife of 35 years might get jealous  ; )

    Have fun and check it out.

    2Reply
  • Marc Winter
    Real Estate Broker · Northeast PA · Member since 2017 · 2k+ posts · 2k+ votes
    8y

    @Mike S., one of the most succinct explanations of LLC's I've read. Good work!

    0Reply
  • Account Closed
    Rental Property Investor · Torrance, CA · Member since 2016 · 724 posts · 1k+ votes
    8y
    Costin I. That diagram is amazing!
    0Reply
  • Mike S.
    Investor · Broward County, FL · Member since 2018 · 1k+ posts · 938 votes
    8y
    Originally posted by @Marc Winter:

    @Joseph Gambino, you've received lots of good advise from some very smart folks.  I'm not that smart, but I know what works for me: TRUSTS.

    Land trust are great for anonymity and to avoid the due on sale clause, but they are not providing any asset protection (except in Florida).

    I am using Land Trust and assigning the beneficial interest to an LLC for the asset protection part.

    0Reply
  • Marc Winter
    Real Estate Broker · Northeast PA · Member since 2017 · 2k+ posts · 2k+ votes
    8y

    Umm, an LLC will limit liability, but I am not aware of how that is asset protection any more than a trust.

    It is your property and your decision. LLC as bene is smart move

    0Reply
  • Mike S.
    Investor · Broward County, FL · Member since 2018 · 1k+ posts · 938 votes
    8y
    Originally posted by @Sam Jiang:

    I have same question about newB setting up insurance or LLC. Can someone give some details to tax paperwork as when buying one rental worth $50k, and I have to file taxes for each LLC which will be a nightmare when you have 10+?

    An LLC can be taxed as a partnership, C Corp, S Corp or as a disregarded entity (only for single member LLC). You make the choice when you create the structure.


    The usual structure when you have multiple entities would be to have all your properties held in individual single member LLC. These LLCs will be disregarded entities and there will be no tax return. All the tax reporting will be on the single member tax return. If you are the member, then all of them will be on your tax return. If your individual LLCs are owned by a holding LLC, this holding LLC will do the tax return (unless it is also disregarded).

    If your LLC is multi member, the default taxation is as a partnership and you will have to file a 1065 return and issue a K1 to each member. No tax will be paid by the LLC, but each member will include the K1 in their own tax return.

    0Reply
  • Michael S.
    Huntsville, AL · Member since 2018 · 577 posts · 864 votes
    8y

    We have an LLC AND an umbrella policy for the properties in the LLC; totally worth the cost in my opinion, but everyone has to make their own choices. I don't like leaving much to chance personally.

    1Reply
  • Mike S.
    Investor · Broward County, FL · Member since 2018 · 1k+ posts · 938 votes
    8y
    Originally posted by @Marc Winter:

    Umm, an LLC will limit liability, but I am not aware of how that is asset protection any more than a trust.

    As I explained before, if you are sued personally, for anything unrelated to your property (car accident, your kid do something stupid, ...), you can loose all the asset that you own in your name. The assets owned by the LLC won't be reachable by your creditor (in States where the charging order is the only remedy).

    Same if you have multiple LLC, if you are sued for something related to one of the property (slip and fall, ...), you can loose all the asset owned in the same LLC, but your own asset and the other LLCs asset will be out of reach.

    A revocable grantor trust (living trust, personal property trust, land trust...) does not provide any asset protection at all. An irrevocable trust will, but then you loose control and benefit of the asset, because technically, it's not your asset anymore.

    2Reply
  • Ned J.Pro Member
    Investor · Manteca, CA · Member since 2017 · 1k+ posts · 2k+ votes
    8y

    The liability protection of an LLC can be easily pierced by a decent lawyer if you don't really run it like a true LLC.....comingle of income and expenses with your personal income and expenses etc . EVERYTHING needs to be separate from your personal assets.... you mix them together.....like the majority of small time REI landlords do and the protection disappears....so don't fool yourself......

    1Reply
  • Mike S.
    Investor · Broward County, FL · Member since 2018 · 1k+ posts · 938 votes
    8y
    Originally posted by @Ned J.:

    The liability protection of an LLC can be easily pierced by a decent lawyer if you don't really run it like a true LLC.....

     I agree that if you spend time and money to create the structure, you need to use them properly. If you can't do a minimum of paperwork and keep the money flowing through the proper entity, you will weaken your structure. It would be like installing a high security lock on your door, but never locking it... It may be impressive and looking nice, but that wont stop anyone to open it...

    0Reply
  • Marc Winter
    Real Estate Broker · Northeast PA · Member since 2017 · 2k+ posts · 2k+ votes
    8y

    @Mike S., sorry, but I still have to disagree with your interpretation of what is protected and what is not protected in the trust I described.  Please do your own research, and the facts will speak for themselves.  

    If you feel more comfortable with LLC's, that's your call. For me, trusts have proven to me and courts to be a great way to protect whatever is outside that trust.

    Best,

    Marc

    0Reply
  • Mike S.
    Investor · Broward County, FL · Member since 2018 · 1k+ posts · 938 votes
    8y
    Originally posted by @Marc Winter:

    @Mike S., sorry, but I still have to disagree with your interpretation of what is protected and what is not protected in the trust I described.  Please do your own research, and the facts will speak for themselves.  

    I'll be interested if you have any case law on that as all my research and cases that I have found showed that a revocable trust does not provide any legal asset protection.

    It does however creates anonymity. In that way, it would avoid any lis pendis or other generic liens as your creditor is not aware of your ownership of that property. However, if you are sued and lose the case, you will have to disclose all your asset, including the trusts that you have beneficial interest in. When disclosed, the creditor will easily obtain full access to them, including the right to foreclose.

    In an LLC or an LP structure, even when disclosed, the only judgment that could be obtain in some state is a charging order that give the creditor the right to receive any distribution from the LLC or LP if any. But if your operating agreement is properly set up, you won't have to make any distribution and your creditor will still have to pay tax on them. Its a poison pill that will deter any creditor to go against your LLC or LP.

    1Reply
  • Marc Winter
    Real Estate Broker · Northeast PA · Member since 2017 · 2k+ posts · 2k+ votes
    8y

    @Mike S., you are assuming a very critical point:  who said I own any beneficial interest?  And the beneficiaries cannot be sued; they do not own the trust.

    In any event, you go with LLC's. Have a nice day.

    0Reply
  • Mike S.
    Investor · Broward County, FL · Member since 2018 · 1k+ posts · 938 votes
    8y
    Originally posted by @Marc Winter:

    @Mike S., you are assuming a very critical point:  who said I own any beneficial interest?  And the beneficiaries cannot be sued; they do not own the trust.

    In any event, you go with LLC's. Have a nice day.

    If your trust is revocable, you have the right to revoke it, and you will be compelled to do so if you lose your law suit.

    Again, you are the only person that I have heard so far stating that a revocable trust provides asset protection. If your structure is providing you what you want for it to do, then everything is fine. However, unless I misunderstood what you described, I would strongly suggest that you get a second opinion from your lawyer, as I do maintain that a revocable trust does not provide asset protection.

    Respectfully

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

    @Marc Winter - your stance is contradictory to all I know about trusts and LLCs. If you have some more information and legal support I would appreciate if you could share it with us to give proper consideration to trusts level of protection. Till then, I stand with @Mike S. on the same position that trusts only offer anonymity, but no legal asset protection.

    1Reply
  • Jonathan Herron
    Attorney · NJ · Member since 2018 · 120 posts · 58 votes
    8y

    @Ned J. making sure that the LLC is properly set up and run to avoid piercing the corporate veil is extremely important. Typically, education is the most important tool to keep the asset protection.

    @Mike S. and @Marc Winter a lot of your discussion may be related to the different states you are located in.  Florida and Pennsylvania likely have different rules regarding how trusts operate and the protection they give.  Some of the protections Marc describes is dependant on the language of the trust itself.  Finally, it is always important to ensure that the trust, as a separate entity, files all necessary tax filings.   Income earned by a trust is taxable by the IRS and the top tax bracket is hit much earlier than for individual income. 

    Most of the asset protection in a trust is based on irrevocable trusts.  A revocable trust keeps an ownership interest in the property granted to the trust in the original owner.  i.e. Person A gives a property to a revocable trust.  Both Person A and trust have an ownership interest in the property but Person A has a better interest since they can revoke the interest of trust at any time.

    One thing I have learned about representing clients is that the right plan depends on the main goals of each person involved.  For some people, trusts are the best way to achieve their goals and for others LLCs.  The most important thing is to ensure that you are educated on the various options and that whichever option you choose you follow the laws and regulations surrounding them.

    1Reply
  • Chris K.
    Attorney · Nashville, TN · Member since 2015 · 1k+ posts · 1k+ votes
    8y

    @Jonathan Herron @Mike S. @Marc Winter @Costin I.

    In Pennsylvania, revocable trusts offer no meaningful asset protection. Maybe some mild annoyance to the creditor/plaintiff but any lawyer can deal with it if the underlying liability is large enough. 

    If the underlying liability stems from the settlor, then the creditor can revoke the trust. If the underlying liability stems from the beneficiary, then there is some benefit there. 

    The problem with most of these trusts is that the settlor and the beneficiary is the same person (or basically the same person). If so, there's basically zero protection. There are some land trust gurus that try to get around this by adopting "Matryoshka Doll" approach where you just layer on entities after entities. But all of that is just annoyance --- if the underlying liability is large enough, they will come after you. 

    Disclaimer: While I’m an attorney licensed to practice in PA, I’m not your attorney. What I wrote above does not create an attorney/client relationship between us. I wrote the above for informational purposes. Do not rely on it for legal advice. Always consult with your attorney before you rely on the above information.

    1Reply
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