Let’s say you worked your tail off to save up some money to invest in a piece of real estate.
Or maybe you’re more experienced, having studied real estate investments and networked with others in the industry, and now you’re starting to acquire a small portfolio of rental properties.
Either way, you’ve worked hard to get where you are.
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So, How Do You Plan to Protect All of Your Real Estate?
Over the years, I’ve taken several “asset protection” courses. From these, I’ve implemented some strategies, but others have been much harder to implement. The first thing we should do is to take a look at our own situations and assess our risks (divorces, autos, tenants, employees, creditors, etc.).
The first step on the asset protection pyramid is probably insurance. I could write an entire article on this topic, but I think we all understand the importance and cost-effectiveness of insurance. Obviously, we need it on our primary residence, as well as our rentals.
As we build larger portfolios, it may make sense to increase our liability insurance coverage and to eventually have an umbrella policy for a few million dollars, too. Some folks insure for catastrophic things like floods and earthquakes. I even know some investors who insure against maintenance by keeping home warranties on their properties.
Titling and Entity Selection
This is probably the next area of decision-making one has to encounter, and there’s a variety and degree of protections to combat almost any exposure. For example, some forms of title or strategies are low or no cost.
You’ll see many folks start out by titling real estate in their own names and then later in entities or trusts. Sometimes having multiple buckets of assets makes a lot of sense. In my state of Pennsylvania, for example, you can own real estate as a married couple (tenants by the entirety), and creditors can’t force the sale if there’s a judgment that’s only against one spouse.
Many people prefer using LLCs (Limited Liability Companies) to hold real estate rentals in because these pass-through entities can work fairly well at relieving one from being personally liable. They do cost a little to set up and maintain, and you are in the public record. A better option may be to own fewer properties in your name and just control them instead.
Recently, I got to see my good buddy Jack Shea teach a course on lease options and trusts in Philadelphia. Jack thinks one of the best strategies one can employ is trusts, especially land trusts. Not only does it give you anonymity, but it keeps you out of the public record, as well as probate.
Asset Protection by Debt
The concept of asset protection by debt may be one of the cheapest forms of asset protection there is. If there’s little equity, there’s not too much for anyone to take, especially if one doesn’t have a large amount of earned income.
Once I knew an investor whose strategy was to put the maximum amount of debt against his real estate for this very reason, and he would keep pulling the equity out of his properties at every chance he could. He would then use that money (tax-free since it was a loan) by reinvesting it in more real estate with little or no money down for as many mortgages as he could get. He often invested in notes with some of that excess cash as well.
He said he didn’t care if some assets were in his name, his wife’s name, and/or some entities because he had enough buckets of investments, especially when factoring in things like his other business, his personal IRA, his life insurance, etc. Since he liked the write-offs from the real state debt, he maintained liquidity through his other investments.
Now, I’m not saying he’s right. But he didn’t care when he paid off his rentals because he had a couple million dollars in life insurance that would pay off all of his properties for his family if he died. Besides, they would get a step-up in basis on the inherited real estate.
Larger Real Estate Portfolios: Trusts, Entity Structures, Etc.
As your portfolio grows to over a million dollars in equity, obviously you need more protections. Utilizing trusts, entity structures, debt, and even a combination of onshore and offshore accounts may start to make more sense.
For example, a pretty airtight way to protect real estate would be to take title in a trust with the beneficiary being an LLC that’s owned by your living trust. If there’s any excess equity in the property, you could have another LLC give you a mortgage to protect the excess equity.
Another strategy that Jack Shea recently taught was to record a defense option (for a low value) against the property to deter creditors.
As you can see, asset protection can be a complex strategy that’s not a one-size-fits-all type of thing, especially when so many other things can come into play.
Another common idea is to build in some estate planning strategies into your current asset protection plan.
One of my good friend’s family has done this by utilizing the family limited partnership, which can help reduce estate and income taxes. It gives you the ability to manage your assets, while denying creditors access to them, and it has a built-in tax penalty for any creditor who receives a charging order against it, providing a substantial deterrent.
So, let me ask my fellow BP members: How do you like to protect your real estate?
Let me know with a comment!