"Minimize Business Risk by Using a Limited Liability Company (LLC)"
When managing your rental property business, the 4 most important things you can do to minimize litigation risk are:
- Utilize a real estate LLC (limited liability company)
- Avoid co-mingling of assets
- Get good
- Follow "best practices" when managing your properties
ADVANTAGES OF HOLDING PROPERTY IN A REAL ESTATE LLC
The first step to manage your investments like a true rental property business is to create a single-person limited liability company (disclaimer: if you're in a state that does not allow this, please consult with a
in your area).
The main advantage of a rental property business LLC is that it provides corporation-like liability protection. Thus, your personal assets would be protected if you are successfully sued – the only assets you would have at risk would be those within the LLC.
As an added bonus, a single-person LLC also allows you to file your business
rental tax deductions
on your personal return. So it's very easy to manage.
LLC FORMATION TIPS
You'll want to form your rental property business LLC when you
your first property. Any attorney, or online service such as
LegalZoom, can help you with this and it'll cost anywhere from $200-$350. And, you can form your LLC in any state you wish.
If you plan to acquire only a handful of rental properties (let’s say, 3 or 4), and hold them for only 10-15 years, then it probably makes sense to put all 3-4 properties under the same LLC because it's cheaper to have 1 LLC than several (initial creation costs, plus annual fees). The downside is that a single litigating tenant could theoretically go after all of your properties.
Alternatively, you could put each property into its own LLC to limit your exposure to 1 property at a time. However, as your real estate investing business grows, this can get expensive and cumbersome to manage.
BEST OF BOTH WORLDS: DELAWARE SERIES LLC
The best of both worlds is a Delaware Series LLC, which is what I utilize. With this structure, you have an umbrella limited liability company, with each property held in its own "series" under this umbrella as follows.
Since each series is independent of the others, theoretically your exposure is always limited to a single series even though all of them are under the same umbrella LLC. The advantage is that your cost is essentially the same as if you had 1 LLC, yet each property is singularly protected.
The downside is that this is a relatively new legal structure for a rental property business and so there is not a whole lot of evidence that the limited exposure per series would hold up in court.
In any case, these are just some things to think about. Definitely consult with an attorney to determine the best structure for your real estate investing business.
HOW TO HOLD TITLE IN THE NAME OF YOUR LLC
Ok, let me say that this is not as easy as it would appear, because mortgage companies will typically not make a
in the name of your rental property business LLC (even if you personally guarantee the loan). So your personal name will be on the loan, which means that your personal name must also be on the property's deed / title at the time of acquisition.
This is a major problem because the title must be in the name of your real estate LLC in order for your activity to be deemed as business activity. Otherwise, you could legally be considered an individual instead of an LLC, thereby putting your personal assets at risk. When an attorney tries to discredit your corporate status, it is known as "piercing the corporate veil."
So what you will need to do is transfer the title of the property from your name to the name of your LLC after the
via the filing of a "quitclaim deed" (may be called something different depending on your state). Your attorney can do this for you and it will cost a couple hundred dollars.
You should wait a few months after you close to do this to give enough time for the original deed to be recorded with the municipality. So for a few months immediately after acquisition you will technically not be running the activity as a business.
Luckily, you will have good insurance coverage to close your risk gap in the meantime (make sure you let your insurance company know about the LLC transfer so they can update your policy accordingly).
WORD OF CAUTION WHEN TRANSFERRING TITLE TO YOUR LLC
Now, if you set up your mortgage so that the
investment property taxes
are paid out of an escrow account, there is a tiny risk that your lender will exercise the standard "due on transfer" clause when the title or deed is transferred to the name of your limited liability company. This means that after they get wind of the transfer they could require the entire loan to be paid off in, say, 30 days.
How would they know, you ask? Because after the transfer is made, the property tax bill that your lender receives will now have the name of your LLC on it instead of your personal name. This could throw up a red flag in which your lender may erroneously assume that the transfer was made to an LLC not affiliated with you.
One way to get around this is to pay the property tax on your own, although some lenders may not allow this. That said, I think the risk of your lender balking is very, very small.
And even if they do balk, chances are that you could explain the situation and they would be ok with it. Worst-case, you could simply
refinance investment property
with another lender that understands what you are trying to do. However, I have filed quitclaim deeds for all of my properties, even those with lender-managed escrow accounts, and I have never run into a problem.
"BEST PRACTICES" FOR DAY-TO-DAY PROPERTY MANAGEMENT
So now that you have a rental property business LLC and your property's title has been transferred to it (and your insurance policy updated accordingly), you can focus on the day-to-day aspect of managing your real estate investing business.
The key is to separate all your real estate activity from your personal activity as best you can. That means all documents (except your mortgage docs) should reflect the name of your real estate LLC and not your personal name.
Also, you should not use personal accounts for your real estate activity...this is called co-mingling of assets, and it's a key focus for any litigating attorney attempting to pierce the corporate veil. So, get separate accounts.
Tips for Managing Your Real Estate Investing Business
Beyond that, there are other things you can do throughout the course of running your rental property business that can act as preventive maintenance to avoid getting sued in the first place, for example:
- Minimize the odds that one of your tenants gets hurt by promptly eliminating unsafe conditions such as loose steps or hand railings.
- Disallow tenants to make amateurish repairs for you in order to receive money off the
- Always use licensed, bonded, and fully insured contractors for large and/or potentially hazardous repairs.
to minimize the odds of renting to a frivolous lawsuit predator.
- Maintain as much anonymity as you can in your rental property business. One easy way to do this is to get a P.O. box from your local post office for your business (i.e., have the PO box in the name of your limited liability company). This costs about $60 per year.
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