Almost every successful investor I know owns his rentals or operates his selling business through a nested system of corporations, LLCs, Limited Partnerships, and trusts. The seeming complexity of all of this (and, by the way, it's not is complex as it sounds) is not meant to "hide" assets from taxing authorities (although it does serve the secondary function of legally minimizing income taxes), nor is it to avoid payment to legitimate creditors or complainants. The attention that real estate investors pay to asset protection is in response to a very real threat in this country today: the threat of losing everything you own to a nuisance lawsuit, a jackpot jury verdict, or some other legal "lightning strike" that they can neither predict nor control.

Lest you think that this is paranoia run rampant, consider these facts:

• When you own investment real estate, many people automatically think that you 're rich. Your tenants for instance, aren't aware that their rental home is mortgaged to the hilt; all they know is that you own at least 2 houses, and they don't own any. Therefore, you must be rolling in money. And, unfortunately, there is a small but growing part of the population that finds filing lawsuits against "rich" people to be an easy and profitable way making a living.


• Unlike "soft" assets like bank accounts, cash, stocks, antiques, etc, real estate ownership is public record. Anytime someone takes it into their mind to sue you for slights or damages, real or imagined, the first thing that they do is contact an attorney. Attorneys decide to take cases, in part, based on whether the defendant is likely to be able to pay a judgment or a settlement. A quick and simple search of the public tax rolls will reveal everything that you own in the way of real estate. If it appears that you have quite a bit of equity that can be used to pay a judgement, the attorney is much more likely to accept a case on contingency (meaning that the plaintiff doesn't have to pay unless he wins the case), and is much more likely to take cases that are marginal. On the other hand, if his search turns up nothing or relatively few assets, he's likely to ask the plaintiff for a retainer-which stops most nuisance suits dead in their tracks


• The US graduates more new lawyers each year than the rest of the world combined. And all these well-scrubbed, enthusiastic new lawyers need to find a way to make a living. So they actively market to potential plaintiffs asking them to think really, really hard about who in their lives might have treated them wrong and therefore need to be sued. One enterprising firm in Pennsylvania has, in recent years, engaged in a multi-state mailing campaign to tenants in older neighborhoods explaining that if their children are doing poorly in school, are acting up, or ever get sick to their stomachs or seem listless that the problem is probably lead paint in their rental homes. They then offer a free medical consultation and a toll free number to call in case the tenant would like to get one of the multi-million dollar settlements this firm has gotten from landlords all over the country. This is, of course, at no cost to the tenant unless the firm achieves a settlement. If you'd like to get a taste of the amount of sheer volume of these sorts of pitches, go to any internet search engine and type in "landlord+sue" or "property+owner+lawsuit".


• Insurance does not cover many of the risks associated with real estate ownership. If you've been thinking, "Let 'em sue! I have great insurance!", think again. Your insurance policy, no matter how good, does not cover lead poisoning, toxic mold, radon, asbestos, fair housing claims, nor most of the other environmental and regulatory issues you can find
yourself embroiled in-no matter how careful you are. And insurance policies have limits anyway-will your policy pay a multi-million dollar jury verdict against you?

• The list of liabilities for which you are at risk is long and growing. In addition to those listed above, it's common for landlords and investors to be sued or brought before a housing court for personal injury, unfair eviction, problems with a property that appear months or years after the sale has been consummated, illegal flipping, predatory lending, failing to obtain occupancy permits, dog bites (by dogs owned by tenants), and a hundred other injuries and violations of regulation. Even the most upright, ethical, careful investor in the world is subject to these claims, and even if they are unfounded, going to court to have the case dismissed can cost you tens of thousands of dollars in legal fees.

• As the "rich", successful landlord or investor, you are always the bad guy. Whether in front of a jury, a housing court, or a regulating agency such as the local building department or neighborhood association, the assumption is always made that, as a landlord, you have a vested interest in making money at any cost. Don't believe me? Ask any ten of your non-investor friends what they think of landlords in general. Then imagine them as ten of your peers, sitting in a jury box, and think of what you'll have to overcome if you're ever sued.

The point of all of this is simply to show you that owning investment properties carries risks that can cost you a lot more than the money you have invested in the properties themselves. In fact, a single million-plus dollar judgement can wipe out not only your entire real estate portfolio, but also your own home, banks and investment accounts, as well.

Luckily, there are ways to legally separate your assets from one another, so that even if something unexpected happens, only part of what you've built will be at risk. When properly set up and maintained, each entity is effectively a separate "artificial person" that owns its own set of properties. If something goes wrong with one of the properties that this "person" owns, only the other properties and assets owned by that entity are at risk.

For instance, let's imagine that you own 30 properties in your own name, representing $3 million in assets. In one property, a tenant's guest falls down the stairs and breaks his back. After a long, stressful trial, the guest is awarded a $4 million judgement-$3 million more than the cap on your liability policy. The opposing attorney certified the judgement, then proceeds to foreclose on and auction off your entire empire. End of story.

On the other hand, if your 30 properties are divided among 3 Limited Liability Companies (LLCs), each of which has $1 million in net assets, the tale ends a bit differently. Although the plaintiff’s attorney will try to name you personally in the case, he will probably fail; therefore, only the actual owner-your LLC-will be a defendant. Again, the jury awards a $4 million verdict. But this time, there is only $1 million in assets to satisfy the judgement, leaving you with $2 million to start over with. And if the 30 properties are divided among 10 LLCs with just $300,000 in assets each...you get the picture.

Incidentally, placing your properties in LLCs, Limited Partnerships, Corporations, and Trusts that you, in turn, own serves a second purpose-it hides your overall financial picture and makes you a less attractive target. An attorney debating whether or not to take a weak case will always look into the public record to see how much equity is available to satisfy a potential judgement. If he sees that you are the owner of 30 properties, he's likely to go forward; if he sees that the owner is a trust with only one other property, he's likely to give it a pass.

Source: www.regoddess.com

 

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