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

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[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.

Investors: How do YOU protect your assets?

Leave a comment below, and let’s talk!

About Author

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

25 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.

  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?

  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!

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