Are your kids eyeing that expensive out-of-state college?
Do you want to see a larger return on your individual retirement account (IRA) investments?
Or do you want to quit working your 9-to-5 and start earning a profit on your own?
Whatever the reason, if you are looking to diversify your investment portfolio, real estate is a great start. However, this is a business that can bring you serious legal and financial headaches. That's why asset protection for real estate investors is so important!
Think about it: A simple slip on your property can lead to a court ruling that bankrupts you. A typical judgment will take into account medical damages, pain and suffering compensation, as well as other necessary expenses the injured party faced.
Your overall net worth will also be examined under the microscope.
Below, we take a look at the best ways to protect yourself and your real estate assets from court rulings and expensive judgments.
When it comes to investing in real estate, your liability can land you in court. Regardless of the root cause, if you are found to be liable for damages or injuries – a lawsuit will likely follow. This is because, per the legal definition, liability means that you are responsible, or answerable, to the law.
Most lawsuits end with a settlement or judgment. In other words, the majority of lawsuits will result in you having to pay for whatever damages have occurred. When it comes to real estate, most of liability lawsuits result from accidents. (Of course, other lawsuits, such as fraud, do exist as well.)
By definition, accidents are something you typically do not anticipate. Unfortunately, that does not clear you of your liability. However, you can protect yourself and your assets from such lawsuits in several ways. This includes:
To figure out which protective actions you should take, let’s examine each of these individually. After all, every piece is unique and deserves a careful evaluation when you are building a real estate empire.
Consider insurance to be supplemental to the other ways to protect your assets we'll look at.
Insurance is your first line of defense when it comes to protecting yourself. There are limitations and benefits to the various insurance plans, so make sure you find one that works for you. Basics typically include accidents, like slips and falls. (If the accident is questionable, your insurance company may debate it with you. In most cases, the insurance company wins! So make sure you understand the scope of your policy!)
Typically, insurance providers will refuse to cover several different scenarios. Gross negligence is a big one. If the insurance company believes the accident was caused by something you “should” have known was an issue and did not fix, the fault is yours. Insurances also come with different coverage amounts. The majority of large judgments or claims, for example, will not be covered by the standard insurance plan. Financial disputes between contractors, venders or other such suppliers are not often covered by your insurance either. Oh, and a tenant dispute that involves things like liability, discrimination, rent or evictions? The majority of insurance companies will deny you coverage.
Example: In an ideal world, your insurance will cover damages before a lawsuit is even thought of. For example, a short-term injury caused by a slip and fall has an average settlement of $10,000 to $15,000. While a check for $15,000 seems like a lot, your insurance likely has a much higher ceiling. If this is the case, they will likely pay this amount and the case is closed. However, should a tenant fall from a balcony on your property and suffer serious, long-term injuries, the settlement will likely be much higher. Your insurance company will then investigate the fall, including the railing, regulations, and reason for the fall. If they feel the rail was not properly secured, or it was an inch below new state regulations, they will deem you negligent and refuse to pay the settlement. It will not matter if your tenant was inebriated or sleep walking once your insurance company finds you negligent.
At the end of the day, insurance is a proactive asset protection supplement. It can help mitigate some of the damages financially so long as they fall within your insurance coverage. However, because of the loopholes, it should not be your only means of protection.
Compartmentalization means that you separate your real estate assets from risks and liabilities that can cost you money. One of the best ways to do this is to establish a limited liability company (LLC) for each asset. These are called Series LLCs. They provide boundaries between assets and prevent lawsuits or judgments against one LLC from being able to take from another.
To understand how a LLC helps protect your real estate assets, let us first look at the benefits of the LLC itself. If you were to directly invest in a property, you and your personal finances would be subject to any court judgments. That means you could lose your home, car, bank savings, and other investments. In contrast, if you use a LLC to invest in a property, only the assets owned by that LLC would be subjected to any judgments. (In this sense, let us think of a LLC as a barrier wall. Anything outside the wall is considered off limits to the court.) Other advantages of forming an LLC for your real estate investments include less paperwork, less meetings, pass-through taxes, and flexible management and profit distribution.
Example: You’re a conqueror. You see potential in each of your real estate investments. As you invest in each property, you expand your real estate kingdom. Some you purchase in pristine condition. Others, well – they need a bit of work. Buying property is risky business. After all, there are inspections to pass, repairs to be made, and regulations to comply with. To help protect your assets from legal actions, you purchase each with a different Series LLC. Like the battle mounts around a castle, your Series LLC builds a wall around each of your investments. One of your tenants falls from a balcony on Property A (owned by Series LLC A). As the tenant, their lawyer, and court wages war against your kingdom, the walls protecting your other properties are impenetrable. Whatever the lob at the walls around Property B, C and D, you can rest assured nothing will get through. The only course of action they have is to go back to Property A and assess the worth of everything contained within the walls.
Limited liability. That is the magic phrase here. Because you cannot plan for every accident, investing through a LLC helps to limit your overall liability. Forming Series LLCs to isolate each asset from each other further protects your net worth. Why? Because each LLC builds a wall around the assets it owns. If a tenant slips on ice on one property, a Series LLC will ensure the courts can only gauge that specific LLC’s worth when establishing a judgment.
A shell company is the face of your business. It owns nothing, but legally appears to operate everything. Consider the traditional LLC to be an example of a shell company when it is owned by an Anonymous Trust. (We’ll talk most about these trusts in a moment.) As with a Series LLC, the traditional LLC allows you to keep your personal and business assets separate. This legally obscures your net worth. Additionally, it helps to insulate you from having your personal finances garnished if your business must declare bankruptcy or defaults on a loan.
Example: You’re still a conqueror. However, you build your wall around the entirety of your real estate kingdom this time. After your tenant falls, their legal team rides from village to village, pillaging your assets and reaping the benefits of your total real estate worth. If you have one property, however, they remain contained within a smaller area, unable to touch your personal assets outside of the wall.
If you only plan on investing in a single asset, the traditional LLC provides ample asset protection. It offers the same advantages of a Series LLC, however it provides you with only one barrier that contains all of your investment assets. This means, if an incident on one of your properties lands you in court, all of your business assets may be in trouble.
Anonymity is another layer of protection that can help you sleep better at night. To achieve true anonymity, we often advise clients to establish an Anonymous Trust before creating any type of LLC. Why?
An Anonymous Trust, also called a Land Trust, is made up of three parts. These are the grantor, trustee and beneficiary.
When you decide to establish an Anonymous Trust with my company (Royal Legal), we become your designated “nominee trustee” and file the required paperwork for you, thus eliminating your name from the records. Once filed, we resign as the trustee and you become the designated sole trustee.
This means that your name is never filed with the clerk. This makes it incredibly hard for lawyers to connect your Trust to the LLC, and thus, to the property.
Because your Anonymous Trust can then create a traditional or Series LLC, your name continues to be obscured. (An LLC will need to disclose the names of its members when it files its Articles of Incorporation with the state clerk. However, when an Anonymous Trust owns the LLC, only the name of the trust is listed in this document.) By adding this important layer to your asset protection plan, you can shut a lawsuit down before it is even filed.
Example: An anonymous conqueror makes the most of their kingdom. After all, who can the tenant and their legal party attack when they cannot figure out who is running the show? However, you decide to operate your kingdom, whether through a single wall or many, your crown sits securely in your safe, where no one knows to look.
In 2001, DreamWorks’ Shrek told us, “There’s a lot more to ogres than people think. Ogres are like onions…Onions have layers. Ogres have layers.” As a real estate investor, you should too. We recommend a three-layer approach to real estate investing.
The problem with using only one level of protection with real estate investing is because of the dynamic nature of real estate itself. After all, most real estate lawsuits stem from accidents. Because you cannot plan for every potential accident, having layers ensures you remain protected no matter what happens. From lawsuit prevention, like acquiring insurance, to creating a legal obstacle course, like an Anonymous Trust, to help discourage lawyers from picking up a case – layers help stop a lawsuit before it starts. However, should a lawsuit actually occur, establishing boundaries through a traditional or Series LLC can help to minimize any judgments and protect your personal and business assets.
We want your real estate investments to be successful. To do this, you have to look at the bigger picture. This includes figuring out the best way to protect your real estate investments, your personal assets, and your name. Through years of experience helping our clients avoid lawsuits, our three-layer approach to asset protection has proven itself to be invaluable. Best yet, our experts streamline the process to ensure everything flows smoothly. We can help you set up an Anonymous Trust and establish your desired LLC structure. Alternatively, if you already have an LLC, we can assist you with rolling over your direct ownership to an Anonymous Trust to give you another layer of protection. If you would like to learn more about how we can help you keep your real estate assets protected, contact us today.
Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.
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