Protect Your Personal Assets From Your Real Estate Activity
The main thing holding back many would-be real estate investors is the fear of losing personal assets in a lawsuit. It’s a valid concern. There are so many potential threats arising from being a rental landlord that a lot of people choose not to invest in real estate for that reason alone. No one wants to lose their home or money due to a business liability. And nowhere is that vulnerability more acutely felt than in real estate. Any number of accidents can happen when you own a rental property. Yet, everyday millions of investors all over the world continue to invest in real estate, certain that their personal assets are secure. What makes them so confident? Here’s what you need to do to protect your personal assets from your real estate activity.
Form an LLC
Many real estate investors opt to form an LLC to protect themselves. An LLC (Limited Liability Company) is a simple entity that offers a “corporate veil.” It does exactly what the name implies; it limits your personal liability in the event of a lawsuit or legal judgement. If you own your rentals under an LLC, then if someone makes a legal claim they sue the LLC, not you personally. The LLC is the rightful owner of the property, so the LLC takes the legal hit. The beauty of this is that if their claim goes through, even if the awarded damages exceed the value of the property or your insurance coverage, the claimant still can’t get to your personal assets, no matter what. That corporate veil cannot be pierced as long as you maintain the LLC according to the laws in your state where the LLC is registered. To be fully recognized as an LLC, you’ll need to maintain separate bank accounts and keep annual minutes, among other things. For details about forming an LLC and what steps you need to do to maintain the LLC, we recommend NOLO.com
The Downside of Forming an LLC
Naturally, protecting your personal assets while owning rentals isn’t as plain and simple as just forming an LLC. There are some drawbacks to this approach; the primary one being that you can’t get conventional financing for future rental property purchases as an LLC. Conventional loans like Fannie Mae approved loans are only available to individuals. And since those Fannie Mae approved loans (as well as other conventional loans) have such attractive terms, it would be a shame to turn your back on that opportunity. For that reason, lots of investors decide not to form an LLC. They choose a different option.
The Best of Both Worlds
One way that rental property investors skirt the LLC and loan access problem is by buying the rental properties in their own name and then transferring them to an LLC after the fact with a quit claim deed. That way they get to enjoy the attractive Fannie Mae terms and still bask under the protection of the corporate veil. This is obviously a complicated process that involves time, money and professional assistance. For the casual investor, it’s probably not worth the hassle. But you still want to—need to—protect your personal assets from your real estate activities, so what’s the alternative?
Cover Up With Insurance
Insurance protection is a must whether or not you decide to form an LLC. But insurance is especially essential if you decide to forego the LLC. You’ll really want to cover all the bases with insurance in order to protect your personal assets from real estate activities. There are several types of insurance policies you should consider:
If you have a mortgage on your property, you’ll be required to carry property insurance anyway. But did you realize that having property insurance helps protect your personal assets? Property insurance covers things like a tree falling on property or an exploding furnace; but having property management in place also does two other things. One, it demonstrates that you’re a responsible landlord. If someone is trying to claim you’re a negligent landlord, they’ll have a tougher time of proving it. Second, it helps you financially to keep your property in good repair for your tenant, which in turn reduces the threat of accidents. So even after you pay off a rental property, be sure to keep that property insurance in place.
Liability insurance can add a layer of protection for your personal assets in the event of a lawsuit. The liability insurance will pay out the claim for medical care, legal fees and other things so you don’t have to pay out of your personal resources. Your insurance broker will be able to advise you as to how much liability insurance you should carry based on your individual circumstances.
There’s also an insurance product called landlord insurance that helps to pay for property damage among other things. This type of insurance is more about protecting you and your property and not specifically about protecting your personal assets against claims. However, when you consider that landlord insurance could pay for a broken railing or a chipped cement step, it does indirectly help prevent accidents and injury, thereby protecting you against lawsuits.
The bottom line is that protecting your personal assets from real estate activities is a valid concern that should be addressed from the very beginning. You don’t want to own even one rental property without setting up proper insurance or forming a legal entity. At MartelTurnkey, we are very experienced with the risks associated with owning a rental property. If you have questions, we’d be more than happy to help you to get answers. Contact MartelTurnkey anytime.
Good article. I was wondering if you buy a house cash and put it in an LLC, can you have insurance under the llc or does it have to be in a manager’s member’s name? I have heard conflicting answers on this. Thanks keep up the good articles
Hey there, thank for your comment. You can get property insurance and liability insurance even if you buy in their LLC all cash.
This is a great article. Which states would you recommend forming an LLC in for a California investor?
Thanks Eva! We would recommend Wyoming.