Tips & Tricks From an Attorney: Here’s How I’d Protect My Real Estate Assets

by | BiggerPockets.com

[Editor’s note: The following is meant for informational purposes and is not legal advice. For information pertaining to your specific legal situation, please be sure to consult your attorney.]

Real estate asset protection is a favorite strategy used by rich real estate investors. The rich don’t take the same risks you do; they use the law to their maximum advantage. It’s not sleazy, it’s using the rules available to your maximum advantage. The most underutilized tool is an effective contract. Below, I’ll show you one little used trick to create maximum leverage in a lawsuit—and the most effective way to protect yourself should one ever result.

A highly effective tool that many don’t use is a contract with terms that favor you when a deal goes sideways and litigation could result. We don’t want litigation to actually happen because it is expensive—what we do want is a contract that gives us huge amounts of leverage to get the settlement we want quickly.

To protect yourself from lawsuit—and to protect yourself even in the event you need to sue someone (YES, suing someone does put you at risk)—you will want to use an LLC. The rich use LLCs.

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Have the Remedy in the Contract

If the remedy is spelled out in the document, then you don’t have to rely on complicated legal matters for your remedy. If you’re buying real estate and the deal goes bad, do you want the property or do you want money? If you want the property, you need a provision for “specific performance.” Otherwise, what you’re left with is a suit for “damages” and money. The bad part about “damages” is you have to prove how much you have been harmed.

Related: Landlords: The 6 Best Ways to Minimize Your Chances of a Lawsuit

Unless you were getting a killing on the property compared to the comps in the area, how do you show how much money losing the deal cost you? The solution to this problem is known as “liquidated damages.” This is a clause that specifically states the amount of damages in the case of breach of the contract, i.e. the other side backs out.

For example, the contract could say if the seller refuses to execute the sale after the buyer obtains financing for the deal, then the seller is liable for a liquidated damages amount of $40,000. Note that this should be one sided to your favor so that only the buyer has these rights. This gives you leverage over the seller since they know they have much to lose instead of having hope of low damages being determined by the court.

Some people say the seller will balk at this type of clause—and they likely will. But you can counter by asking them, “Do you have any intention in backing out of this deal after I put in thousands of dollars’ worth of man hours and hard cash? No? Well, this clause is to ensure that you won’t and gives me confidence to know you’re serious about moving forward.” At the very least, this opens the door to a negotiation about what amount of liquidated damages are agreeable between you two. If litigation does result, your future attorney will kiss you.

When a Deal Goes Bad, You Should Be Prepared for the Lawsuit

Even if you don’t believe anyone would ever sue you for any reason and you are 100 percent sure, you will still want an LLC for protection. You may not be sued, but you will need to sue someone. When you sue someone else, you put yourself at risk. In the United States, the prevailing party, which may be the other party, can be awarded attorney fees. You would be surprised to find out that the damages could be only $1, but since the other side prevailed, they get $30,000 in attorney fees. If you sue someone, it could come back to bite you.

How Does the LLC Help?

The LLC acts as the plaintiff to the lawsuit instead of you personally. Since the LLC is the plaintiff, if there is an award for attorney fees or other damages, then they can only look to the LLC. The cost to file a new LLC is MUCH cheaper than the cost of paying off a judgment. Also, remember that if a judgment is ever filed against you, then it appears on your credit report, harming your score. Since we are in the borrowing business to leverage our hard dollars with those from the bank, this hurts our bottom line.

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Related: 7 Tips to Keep Landlords Free From Costly Tenant Lawsuits

What Does This Mean Practically?

You should never buy a property, hire a contractor, or talk to anyone—your operating shell LLC should. The operating shell LLC is an LLC that has no assets and is the face of your business dealings.

You can only sue someone that you interact with, either in contract or communication. So, if you want to insulate yourself from lawsuits, then you have to act through a business entity. How do you do this? Create an LLC that owns little to no assets and acts as a shell. Since that LLC made all of the communications and entered into the contracts, then that is the only entity that they can come after. So when a lawsuit happens, what do we care? Our worst case scenario is that we wind up the LLC (i.e. destroy it) and start a new one. It’s not a sketchy thing to do, it’s using the laws that exist to our advantage.

The elephant in the room usually regards when the LLC isn’t effective and the court says  you have “pierced the corporate veil.” I don’t care about piercing the corporate veil. I anticipate that as a possibility when I use an operating shell LLC. Even if the court were to “pierce the veil” of my operating shell LLC, the worst case scenarios is that they can attack me personally. Guess what? I don’t own anything; my separate asset holding LLC does.

Rich people don’t own assets, and their operating shell LLCs don’t own assets, either. Under this type of legal strategy, even if they are able to pull every legal trick, the worst thing that someone can do is harm a credit score. The reality is that nobody spends the cash to hurt you when they know they’re not getting anything in return; lawsuits are a business.

[Editor’s Note: We are republishing this article to help out our newer readers.]

Investors: How do YOU protect your assets?

Leave a comment below, and let’s talk!

About Author

scott smith

Scott Smith helps clients nationally and internationally from his office in Austin, Texas. With over 5 years experience in the litigation, Scott works on proactively building defense in anticipation of future lawsuits for real estate investors. Scott is one of the few attorneys in the nation that structures companies for maximum protection with minimum taxes. What You Want the Text to Say

45 Comments

    • scott smith

      It’s not the number of properties, it’s the amount of equity. Given how inexpensive LLC’s are in the grand scheme of things, I wouldn’t carry more than $200,000 per LLC. If you don’t live inside California, you should consider using a Series LLC formed in one of the many states that allow it, and using it in the state where your property is located.

    • scott smith

      I recommend using a shell corporation for all of the business affairs — anything that touches the world.

      The asset holding company I recommend in most circumstances is a Series LLC, usually formed in the state of Texas. Texas has very strong asset protection laws and a $300 filing fee. The big benefit is that you don’t pay franchise tax until the company makes over $1,000,000 annually, so for my real estate clients that effectively means they have no year over year expenses.

      • eric upchurch

        Unless you live in CA, right? I have a CA LLC, but if I set up a new series LLC in TX, CA will still make me pay another $800/year, correct? Basically still “doing business in CA” since I live here even though it’s a TX LLC?

  1. Denis Monahan

    “Even if the court were to “pierce the veil” of my operating shell LLC, the worst case scenarios is that they can attack me personally. Guess what? I don’t own anything; my separate asset holding LLC does”.

    And who owns the separate asset holding LLC?

    It is a somewhat common misconception that LLCs provide what I call “downstream” liability protection, i.e., if someone gets a judgment against you personally that they cannot reach assets that are in a LLC that you own or that is in your revocable living trust. If you own the LLC , it is just like any other asset. If you owned 1,000 shares of Apple or any company, and someone got a judgment against you they could reach those shares of stock. They would not get to Apple’s bank account, but they could force the sale of that stock and get the proceeds. They can do the same thing with an LLC that you own. There are other complexities such as “charging orders” etc. beyond the scope of my reply. LLCs, if properly formed and properly maintained, can provide what I call “upstream” liability protection, i.e., a judgment against that LLC can reach the assets owned by that LLC but cannot reach up hirer and get the other assets of the owner of the LLC.

    At to how many LLCs? The “Goldlocks principle” appplies. Not too many and not too few. If you have invesest properties and do fix and flips, have your investment properties in different LLCs than you fix and flipper – which is an operating entity taxed at ordinary income rates. If you have other members, do not mix members in the same LLC. If you have a higher risk asset (.e.g. a multi-unit apt in lower economic area, it gets its own LLC. Next, you diversify your real estate assets just like any other assets. How much do do what to have at risk in any one entity? Five $50k houses with 70% mortgages equals one $175K house you own free and clear. An don’t forget insurance.

    Be careful about “self-medicating” based on what you read on the Internet.

  2. Isn’t the fee for an LLC in CA taxed $800 (which includes having an LLC in any other state–as long as I reside here in CA, I have to pay $800/yr)? That seems to make a small-equity LLC not a very good business decision for buy and hold investors. If my property is cash flowing $3200/yr, just having an LLC.f or that property cuts 25% into my returns.

    One real estate accountant said that if you only own a few properties it’s much smarter to hold them in your name, and make sure you have a very strong umbrella policy. Was he wrong?

    • scott smith

      The franchise tax is $800 per year in CA, and at that rate it likely doesn’t make sense to use an LLC. However, if you have multiple properties and lots of equity it could make sense to pay that. In any event, you may want to mask your ownership using anonymous land trusts so that if someone was looking to sue you they wouldn’t be able to find out what you own. There are also trust options like the DST which may, if properly formed, avoid franchise tax and give protection.

    • scott smith

      The standard asset holding company is an LLC since it will allow for pass through tax treatment. S-Corps are better suited for the Operating Company, but in any event they provide minimal tax advantages that are usually outweighed by the cost of preparing the tax filings themselves. Consult Amanda Han, a CPA that is very active here on BP

  3. Dwyanne June

    Great information. We have an LLC, formed in the State of Utah. So far as I known, once the State of CA recognizes our property transaction, we pay $800 for the privilege of doing annual business, plus $100. Thus we can do business in Utah and CA. Lots of information for continuing education in REI, as well. Thanks!

  4. Jack Forester

    I’d like to see a flow through example of buying a property and accepting rent. Which entity does what and how does the property move between them. Maybe this is a partial bookkeeping / tax question, but it’s also a legal question.

    If the shell LLC writes the offer (and can get a loan), how does the property then transfer to the asset holding LLC without triggering the “Due on sale” clause.

    If the shell company is collecting rent, is it then paying it to the asset holding company or does it hold the rent? Seems the asset holding LLC gets all the depreciation, which I guess rolls up to the shell LLC to offset the rental income, but then, is the shell LLC holding the rents for the year?

    • scott smith

      I will attempt to address this in a few follow up posts, it is a somewhat complicated process as you have pointed out by your questions. I’m always available for a consultation if you would like to talk offline.

  5. Jason Lewis

    Here is what I currently have:
    LLC 1
    LLC 2
    LLC 3
    LLC 4

    Management LLC owns 100% of LLC 1-4.
    I own 100% of the Management Company.
    The leases are through the separate LLCs. If you live in LLC 2 your lease is with LLC 2.
    It will be on Management LLCs letter head but the landlord you are making the contract with is LLC 2.
    Management LLC is the only one with a bank account and is allowed to do all banking for the other LLCs.
    Also the other LLCs all have their own mortgages…eventually these will be non-recourse.

    So if a tenant sues me then they sue the LLC that they live in. If it’s for a ton of money I can bankrupt that LLC and they would basically get the equity in the house. But they can’t get any assets being held by the Management LLC. Is this correct Scott?

    If so how does a series LLC give you any more protection?
    Also you might want to explain how a charging works. Most people have probably never heard of one.

    Great Article

  6. Thank you for your advice. I like what you said about being prepared for a lawsuit if the deal goes sour. I agree that you need to be careful, but also aggressive at the same time. This is your property, you need to protect it. Although, like you said, even though it seems sleazy, I need to use the law to my advantage. Thanks again!

  7. Paula R.

    Is it okay for me to buy an auction property in my own name (since it’s so much easier than buying through my LLC initially), then transfer the deed to the LLC after it closes? Any downside to doing it this way? Thanks.

  8. I had no idea that it was so easy for people so sue and be sued just from a real estate deal not going as planned. I thin that it would be important to make sure that the real estate company that you go through has an attorney to defend them. If a deal doesn’t go well but you have an attorney on your side you should be able to resolve all of the confusion easily.

    • Cory Adams

      Never ever use an attorney that your Real Estate Broker or agent recommends. The reason is that you may need to name your agent’s company/broker in a law suit should you be sued during the transaction. You need this attorney to be neutral to all of the other parties.

      Also if any broker or agent ever tells you that you need an agent to avoid legal issues, just laugh in their faces. Agents will be the first to tell you, “I’m not a lawyer.” if something goes sideways.

  9. Al Johnson

    What if you have a mortgage on the property? Transferring the property title to an LLC could trigger the acceleration on sale or transfer clause. Most mortgage lenders won’t work with LLCs, and if they do, they charge significantly higher rates. Even if you keep paying the mortgage, you will have to put the property insurance in the LLC’s name and the insurance company is obligated to notify the mortgage bank as it’s the “other insured”. Thoughts?

    • Jason Lewis

      There are two types of mortgages. Residential and Commercial. Residential is for both a person looking at buying a home or a person looking to purchase an investment property. This type of loan will not be allowed to be done in an LLC and it must be done in your name which will hurt your DTI ratio and it will be reported on your personal credit report. We only have 1 more of these left and the interest rate is 4.75% with a 25% down payment. For the record that property is deeded in an LLC.

      Now is where the real fun comes in. The commercial loan is for investors. These loans are only done using a cooperate entity like an LLC. US Bank has the best commercial loan department for properties that are 4 family or below because most banks will not do a commercial loan unless it’s 5 units or more. US Bank will still make you use a DTI ratio but it’s a little bit different than normal and it’s much easier to meet than residential banks.

      When the properties get above 5 units you can start to use other commercial banks. I have a few small ones here in town that I use that lend locally. Once the loan amounts get above $1MM and $2MM you can start to use fannie and freddie to do the commercial deals.

      Thought is go get a commercial loan…you will need to talk to the business banker or a commercial loan NOT just a normal banker. Ask for those two.

  10. Jerry W.

    I have several concerns here. First when there is a lawsuit the winner does not automatically get lawyers fees. There are 2 rules, the American Rule which says you only get lawyer fees if it is in a contract, or if a statute provides for it. The second is the English rule that says the winner gets his lawyer fees paid by the loser. It is my understanding that the American rule is more common in states than the English rule.
    Next I am concerned about putting all of my assets into an LLC. If I put my house in an LLC and I don’t pay fair market rent that fact can be used to pierce the veil. If I pay buy my groceries out of the LLC then they can pierce the corporate veil. Even if you get your personal assets into an LLC and it doesn’t pierced and they only get a charging order, you can never take cash out of the LLC again until all the money from the judgement is paid in full. So how have you helped yourself? If you buy houses and collect rent through shell LLCs and leave no money in them they are under capitalized and the veil can be pierced. If you think you can hide assets using a land trust or any other scheme how do you answer questions in a deposition where they ask you to list every entity you have an ownership in, or that pays you any income? Any entity you have created in the last 5 years, any entity you list on your income tax forms, etc. It is prison time if you lie on those things. LLcs are a very good idea when you operate them as a true business and not as a scam. There are also some great exemptions to protect your personal home if it is your name that is not available if it is in an LLC. There are even better protections if you are married and own as tenants by the entireties. You lose that protection if the ownership is in an LLC. LLCs are great, but they are not the magic pill being portrayed here. Series LLCs are nice in states that allow them. Nevada has the reputation of being the place you want to file them, but Texas may have a good one also, I have just not seen it as popular with those I deal with. Saying you just collapse an LLC sounds easy, it is not. Have one pushed into a bankruptcy and watch a Trustee go through the layers like hot butter If the LLC owns several properties but gives every penny to another LLC you will see the Trustee pull the next LLC in. Someone must attend the debtor hearings for an LLC in a bankruptcy, and you should see the questions they must answer. These things are not as simple as what you are being sold. The guy who signed the legal contract is the guy who gets who deposed. If you are the only member that guy is you. Do you think you can not go to one of those by retiring from the LLC? Guess again.
    Most of these strategies are pretty complex for someone starting out. Unless you are already rich I would start with a single LLC for the first few properties. Get a good book on how LLCs must operate so you observe all of the corporate formalities.

    • Steven Schmidt

      Hi Jerry – What books would you recommend? I’ve been trying to find a good reference to compare and contrast S-corps and LLCs. So far, “LLCs for Dummies” is the only one I’ve read and it certainly whets the appetite for more info, especially on Series LLCs. Thanks.

      • Christopher Smith

        I feel your pain.

        I get the sense that LLCs are being grossly oversold. I work with establishing large corporate structures everyday and with those clients LLCs are an extremely effective tool for establishing flexible limited liability activities. The costs are negligible relative to the benefits, but this is often not so with small RE investors.

        Honestly I think a huge attraction to the novices that are getting into LLCs to in effect run a hot dog stand is that it gives them a certain “BIG SHOT” Cachet feeling that they have their own “Corporation” which is of course is silly and ridiculous. There is of course a place for intelligent and prudent liability management, but I believe a lot of this LLC promotion business is just dog and pony show stuff pushing something most who get it don’t really need. It’s often just pandering to their vanity and gullibility.

  11. Christopher Smith

    In California an LLC (including all formed within the state, and most scenarios outside it too) cost $800 per LLC just as the minimum filing fee, not counting the cost of establishing and maintaining the LLC. This is really cost prohibitive even for a sinle LLC let alone multiple LLCs.

    How do you work around that?

    • John Wielgolinski

      You don’t. The franchise tax in CA is a cost of doing business and must be considered when evaluating this strategy in CA. A strategy might make sense legally, but not financially. If you have low cash flow and low equity, this makes no sense. If cash flow OR equity are high, then the additional cost might make sense.

    • Jason Lewis

      From what I was told by my lawyer my property management company receives all rents, pays all expenses, and the monthly profit I transfer into the LLC that own the building and then into my account. It must make the trip. So yes every property should have it’s own LLC, bank account, and mortgage. I pay any bills including the mortgage through my property management company.

        • Jason Lewis

          I self manage my properties currently. I would make a property management company. It is there to allow, first and for most, as the company your renters communicate with. So if you are showing a unit and you trip up and say a lot of young professionals live here you can be sued for age discrimination. They would sue the property management company which would own nothing to there is nothing to sue for. Mine owns a $1,400 truck, that I would gladly give them, but that’s it.

          The second is the banking does get easier. It’s easier to make all of those payments out of 1 account and then just make the trip with the profits.

  12. Sarah P.

    Hi there! I love this article. A quick question regarding personal assets… what all is in your asset holding LLC? When you say you have nothing, does this also include paper assets? I know Robert Kiyosaki said his house/cars etc. are in an LLC. Just curious about other things as well.

    Additionally, if your operating LLC (the one that enters into leases and hires contractors) is to be sued, and then they pierce the veil and come after you, and then realize you don’t own anything, but they still win a judgment, how does that all work?

    Lastly, where does an umbrella policy come into play with all of this? Will it cover your LLCs as well if you put it under your name or is it smarter to just have that policy and everything under your name?

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