Ownership of real estate has many benefits from an investment and tax standpoint. There is downside risk, however, since the value of real estate holdings may be significant and can be used to cover damages awarded in a lawsuit. Therefore, it’s important to consider asset protection strategies relating to real estate holdings in order to minimize such risk.
Insurance
Asset protection planning is a way to reduce exposure to future lawsuit risk. It encompasses insurance and how real estate is titled to make it and other assets less vulnerable to the claims of individuals who may sue in the future. It is about pre-emptive planning.
The first place to start is with the property itself. Whether it is a single-family home, a portfolio of apartment buildings, shopping centers, office buildings, an industrial complex, or undeveloped land, make sure the property is adequately insured for its type and its use. Occurrences associated with the property, such as injury to a tenant or delivery person, employees, fires in the building, or breaking and entering, may cause an owner to be sued. Therefore, consult with an insurance professional on possible areas of exposure and insurance needs based on the type of property owned and its current use. Also discuss coverage, costs, and limits for business liability insurance and umbrella business liability insurance. Since real estate investors are easy to identify, easy to sue, and appear to have deep pockets, being adequately insured is a necessity.
Structuring Assets
The second step involves the proper structure in which to hold real estate. For investment properties, it is highly unusual to hold them in an owner’s personal name. Holding property in one’s personal name or jointly with a spouse places personal assets and other investment properties at risk if a lawsuit results in damages being awarded. Thus, investment real estate is typically held in a corporation, a limited partnership, or a limited liability company. Transferring title to one of these entities will provide some insulation from lawsuits.
Since the early 1990s when legislation providing for the formation of LLCs was enacted in all states, the LLC has become the structure of choice for many real estate holdings. The key features of a LLC are that owners are called members and no member is personally liable for the obligations of the LLC. The LLC can elect to be taxed as a partnership with items of income or loss flowing through to the members’ personal tax returns. If it is structured as a single-member LLC, the LLC can be disregarded completely for tax purposes. The income is included on an individual’s personal return.
Another benefit is that an LLC is not required to maintain records such as minutes, bylaws, or shares as is required of a corporation, so there is no chance of piercing the corporate veil for failure to follow prescribed formalities. Each state’s legislation is specific on the required steps to create and use an LLC, so local legal assistance is necessary.
When a property is owned by an LLC, only the assets of that LLC can be used to satisfy a claim. Other assets are protected. This is important as it allows individuals to hold real estate without exposing other assets to risk. When multiple properties are involved, although more costly, it may be worthwhile to hold each property within its own LLC in order to isolate each property from the liability of other properties. In some states it also is possible to establish a series LLC that is designed to protect each property within a single LLC.
Other strategies can be enacted with legal help. For example, property may be titled in a land trust with an LLC, corporation, or limited partnership plus corporation as the beneficiary of the land trust. Thereafter, a living trust may receive the property upon the owner’s death. Use of multiple layers requires the use of an attorney who is an expert in asset protection planning.
Finally, domestic asset protection trusts are currently permitted under the laws of a number of states. These are typically established by wealthy individuals and those in high risk occupations, such as doctors and real estate developers, due to their net worth.
In all cases, investors should consult a personal legal adviser for guidance on asset protection strategies. These strategies should be tailored to their personal situation and needs.
Source: http://www.ccim.com/cire-magazine/articles/323779/2015/03/real-estate-asset-protection
