The primary reason most people create a limited liability company, or LLC, is because it creates a shield of protection between the business owner and the corporation identified as the LLC. These days, people are prone to suing at the drop of a hat and because it’s impossible to predict how liability will be determined in even the most frivolous of cases, it’s important to protect real estate assets with an LLC.
From a legal perspective, real estate is a lawsuit magnet because the law treats you – the property owner – as the guarantor for the safety of your tenants, employs, vendors, and anyone else who walks onto your property. If anyone is injured on a property owned by your real estate investment LLC, regardless of fault, the owner will generally be held responsible and that’s a big legal burden to shoulder.
That said, the number of real estate investors today is about 28 million. The most active real estate investors are under the age of 55 and are more likely to live in the South or the West. More than a third of these active investors make more than $75,000 a year and over a third of them are likely to buy more real estate in the next 12 months. Understanding how to protect those real estate assets is critical because if a person owns real estate, that property could be seized if they wind up on the unhappy end of a lawsuit.
There are two competing principles involved with creating a real estate LLC:
The desire to encourage risk-taking by allowing liability to be legally limited. Specifically, if a person can limit their losses and control their fear of losing everything, they can handle more risk.
The responsibility to make sure an injured person is made whole again. If your property is neglected and that neglect results in harm, justice dictates it’s your responsibility to put things right.
With these principles acting against each other, the smart business owner needs to ask themselves: “Is my real estate asset protection effective enough?”
The reality is that strong asset protection is just as important as good tax planning for one simple reason: bad things that are out of your control can (and do) happen all the time. This means that any random mishap like a simple slip and fall can make a big difference in whether you retain those assets or not.
The following are the two most common myths associated with having an LLC and believing you have bullet-proof real estate asset protection.
I Have an Entity, Therefore I’m Safe
Most people start and end any discussion around asset protection with this idea and it’s the most dangerous one of all. Any aggressive (read starving) plaintiff attorney will attempt to use veil piercing – a term that means setting aside your entity to gain access to your personal assets.
The most common veil piercing factors are:
An entity that is poorly capitalized when compared to the industry standards
Lack of annual reports
More complete asset protection means getting and maintaining insurance on top of your LLC (more on that in a minute).
I Don’t Want the Expense and Don’t Need Asset Protection
Of the 18 million businesses in the U.S. over 70% of them are unincorporated proprietorships. Many small business owners make the mistake of putting real estate property in joint ownership and elect not to form an LLC due to the cost, effort, and time associated. But, as with anything that’s worth the time and money, it’s wise to do this upfront work if you want the ability to accumulate greater wealth. Getting the best start, right from the start, avoids the inevitable consequences of short-sighted thinking that you don’t need real estate asset protection.
Protect your Real Estate Assets with an LLC AND Insurance
If you form an LLC and own real estate within that corporate structure, you must make sure that the LLC is appropriately insured. This means making sure the insurance coverage and policy amounts are adequate to your situation. When the LLC becomes the owner of an apartment building, for example, the LLC must be named the insured on the insurance policy.
The failure to purchase and maintain adequate insurance could mean the court allows a prosecutor to pierce the company veil and hold the owner, or owners, of the LLC liable for the LLC’s debts and liability responsibilities should the company be sued by a plaintiff hurt on your real estate property.