As a rental property owner, you are accustomed to solving many different kinds of problems. Ensuring you are protected in case something goes wrong is one of the problems. So we're going to talk about the benefits of having a limited liability company (LLC) for rental property investing.
This is where many owners will say, “I have asset protection insurance, so I am protected if something bad happens” It is true that insurance covers accidents, but you'll start to understand the benefits of using an LLC for rental property ownership if you watch this video:
Insurance will not protect you from most lawsuits regarding the buying and selling of real estate. Every time that you're entering into a contract, selling a piece of property, or leasing property to a new tenant, insurance doesn't give you the asset protection strategy you need.
This happened to one of my clients after the sale of a property: After the sale took place the buyer emailed asking if my client had replaced the plumbing under the house. My client simply replied via email that he had replaced, “all of it.” In the context that would be understood as all the plumbing under the house. However, the buyer misinterpreted that email as referring to all the plumbing in the house.
These types of miscommunications happen all the time. Especially now that texting is more and more common between renters and their landlords! This is only one example of an issue that insurance may not cover. This is where the LLC comes in to save you.
Real estate LLCs are powerful entities that separate the liability of your asset from your personal name. When there is a lawsuit against your rental property, it cannot impact your personal assets. It also means that if you are personally sued, your LLC assets will be protected. In addition, when a lawsuit occurs against the LLC, it will not impact your personal credit score.
Operating an LLC is quite simple, but must be done properly in order to reap its benefits. Forming an LLC is quite straightforward, but needs to be done correctly the first time. To create an LLC you need to select a name for the LLC that the state approves. After that, you choose a registered agent. You will need to file the Certificate of Formation and create an Operating Agreement. Finally, the state will assign you an Employer Identification Number (EIN.)
An LLC is a great entity, but your rental property still holds a lot of liability. No investor likes having the possibility of losing an entire property to a lawsuit. Because of this, many will create additional layers of defense. The first of these layers is a secondary LLC. This LLC carries out the operations of the company. People refer to this LLC as a “shell company.”
The operations LLC doesn’t own any property. It simply functions similarly to a property management company for your “asset holding LLC.” That means it collects rent, pays contractors, and carries out the operations of that property. This tag-team duo is called a two-company structure. The operating LLC holds most of the liability and is most likely to be sued. However, you only risk the money in THAT LLC. The asset-holding LLC is not involved, and thus the rental property is still legally separated.
Have more than one rental property? You can scale your asset holding LLC up to a Series LLC. This entity scales infinitely with your portfolio. In this case, you can still be using the operating LLC to carry out the activities for all these different rentals without risking any of your properties directly.
An insurance claim usually results from a "slip and fall" on a property or something else you would normally characterize as an accident. Typically this is what your insurance is willing to cover. But your insurance doesn't cover you for any intentional acts that might occur.
What's considered an intentional act? Well, that depends on what you consider to be intentional. And that's where the law comes in!
In the example above, my client was hit with a lawsuit alleging intentional fraud, an incident that insurance doesn't cover. Yet even after this simple misunderstanding, my client walked away from that lawsuit without paying a dime. This was all because she had a proper asset protection strategy in place.
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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