ASSET PROTECTION FOR REAL ESTATE OWNERS
James C. Mulder
attorney at law
Regarding 1 above, if one tenant has a claim against the Landlord, if it is Mr. Smith on the lease, even though he transferred the property to his LLC, he may have some “splaining” to do and could be held personally liable. Furthermore, should the claim be large enough to exceed his insurance coverage, if the insurance company decides it is an insured claim, or if the claim is not covered, the equity in all 7 properties are at risk to satisfy this one claimant. The property that gave rise to the claim may have a large mortgage against it, but maybe one or more of the other 6 properties have little mortgages, thereby making them a prime target to pay off the claim, not the one in which the claim arose.
Regarding 2 above, once the LLC became the owner of the property, Mr. Smith should have notified his Tenants that the new landlord is the LLC and all rent checks should be made out to it.
Regarding 3 above, if his insurance company does not have the LLC as a listed insured, there will be no coverage. I see many clients that try to get by with adding other properties to them personally and think that they will save premiums, but if the insurance company does not show the LLC as owner, there is no coverage.
What should Mr. Smith do? Well, he could set up a Series LLC as a holding company and create a Series LLC for each property each to be owned by the holding company. By doing this he can use the holding LLC as a private bank and let it get a second lien on all of the properties by lending money to each series LLC to take care of expenses and even mortgage payments. What this will do is eventually make the holding LLC as the first lien holder on all properties. Now if a claim occurs, only one property and its equity will be at stake and that equity can be very minimal with proper planning and time.
Practical Problems in Asset Protection
Now that you have your asset protection plan, what do you do? Effective asset protection involves three aspects, planning, implementation, and maintaining. We have discussed many times the planning and implementation aspects of asset protection planning, but haven’t really focused on the maintaining of your asset protection plan. It is not difficult, but involves monitoring and consistency. Some of the common issues that need to be addressed and maintained are discussed below.
Insurance covers two aspects,(1) one making sure you have casualty coverage for assets that you used to own personally, but that are now owned by an entity and (2) making sure you do not drop your liability coverage, now that you think you are “bullet proof”.
We advise our clients to notify in writing their casualty insurance carriers as to ownership changes on property. In fact, we advise our clients to check with their casualty agents during the planning process so that the client will know of any rate or coverage changes because that rent house is now going to be in an LLC, for instance. Business assets that once were owned by the operating company, but now are going to be owned by a leasing company, need to be covered by the operating company still, but the leasing company needs to be listed as an additional insured on the policy.
Don’t drop your liability coverage. Just because you are asset protected doesn’t mean that you should not have liability coverage. Liability coverage provides an attorney for you should you be sued and have a defense. Liability coverage provides recompense to an injured party who really deserves it. You may want to consider the liability limits you currently have and see what cost savings you can make by lowering the coverage, but you should still maintain some liability coverage.
In order for you to get the asset protection you desire, you must transfer the asset into your entity (LLC or Limited partnership). If it is a piece of real property, you need to record the transfer in the real property records, otherwise a creditor can ignore the transfer. Mortgage companies generally have a right to demand you pay off your mortgage should you transfer the property on which the mortgage company has a lien. This is often called a “due on sale” clause. It is not limited to a sale though and will apply to a transfer to your LLC, for instance. So, you need to either (1) notify the mortgage company before transferring and get their consent and be prepared to get other financing should they not give consent, or (2) transfer it and hope they don’t object and if they do, be prepared to get alternate financing then.
Accounting and Contracts
Because you are forming new entities that have substance, you must treat them as a separate “business” and consequently account for them separately. Many times these structures won’t require a separate income tax return, but they do need to be accounted for separately. What I mean by this is the following:
Suppose you have formed a limited partnership or LLC holding company that acts as your own private “bank” and owns all of your liquid assets as well as your subsidiary LLCs that own pieces of real property that are leased out. The tenants in the properties need to be leasing from the subsidiary LLC, not you and you need to be collecting rents under the name of the subsidiary LLC that actually owns the property or have a contract with another LLC that handles all property management for all LLCs. You should have a set of books for each LLC and account for all expenses and income. The net result is reported for federal income tax purposes on the holding company’s partnership return.
This is not as cumbersome as it may seem. Most of this can be kept in Quick Books or simply on a spreadsheet. You should have been accounting for all of this prior to the planning implementation anyway. It really is easy to do, but absolutely needs to be done.
Part of ensuring the business relationship is to have contracts between your entities and your tenants that show the new relationship between landlord and tenant. The tenants need to make their rent checks out to the LLC owner or LLC management company. As stated above, your liability and casualty insurance companies need to show the new owner LLC as the insured.
For more information on the basics of asset protection for your business or family, contact WealthKeepers today at 713.461.9699 or info@WealthKeepers.net