Fully Protected Real Property: Setting up an LLC and Having Adequate Insurance
This is the fourth and final part in a four-part series aimed toward explaining some of the options available to landlords and business owners when it comes to protecting real property investments. The first discussion in this series addressed the use of a limited-liability company (“LLC”) to protect real property investments (and can be found here). The second post addressed the use of a corporation (available here). The third post addressed the use of liability insurance (available here). Now, this final discussion will focus on detailing a balanced approach to protecting real property investments in order to shield them from potential liabilities.
How to Protect Your Real Property?
To review, owners of real property need liability protection because of liability associated with those on and around the premises of the property. These risks can be unavoidable considering the danger of natural disasters or an appliance malfunction (such as a fire alarm failure or a broken water heater). Moreover, real estate investors and landlords are often prime targets for lawsuits—both valid and frivolous—because of a belief that if they own real property, then they must have deep pockets. Plaintiff’s are more likely to pursue a cause of action because of the knowledge that they may be more likely to collect if they have a judgment in their favor.
The law itself also creates a presumption that property owners become the guarantors of the safety of tenants, employees, vendors, and anyone else that lives, works on, or visits the property. Owners will often be held responsible for injuries sustained on the property, regardless of fault.
Using a shelter company—such as an LLC or a corporation—to protect a real property investment is beneficial because it allows the owner to protect his or her personal assets. If judgment is rendered for a plaintiff against the property owner, only the shelter company’s assets will be accessible to satisfy the judgment. If set up properly, the shelter company will be viewed as the de facto owner. This is crucial because it allows for an individual to hold a series of assets, and compartmentalize those assets without exposing all of the assets to the risk created by any one asset.
A comprehensive asset protection plan may involve holding properties in separate companies so that each asset is insulated from the liabilities associated with the others. This is especially effective where each piece of property is exceedingly valuable. The key herein is to ensure that title to the real property is actually transferred to the holding company. This involves actually signing a deed conveying the real property to the shelter company and recording that deed in the county wherein the real property is located.
While a shelter company can secure personal assets from property liability, it will not be sufficient to protect the property owner from a lawsuit arising out of the owner’s personal dealings. As an example, if the property owner personally undertakes repairs at one of his or her rental properties, and these cause damage or injury to a tenant, the owner can still be held liable as the individual who caused the harm. As an alternative, the owner should hire professionals to deal with the maintenance and repair of the premises whenever practicable, as any costs saved by doing it personally may ultimately create more liability (i.e. expense) in the long term.
Further, there are certain circumstances wherein a court will “pierce” the limited liability veil of a shelter company and allow an owner’s personal assets to be used to satisfy an adverse judgment. For a discussion of “piercing the corporate veil” and when this can occur, refer to a the post available here.
Liability insurance helps to cover any judgments rendered against the owner or the holding company and reduce the amount of loss to the entity’s assets. Even where a holding company protects the owner’s personal assets, a liability insurance policy is valuable for insuring the company assets that a court can reach to satisfy a judgment.
For example, if a real property owner owns three rental properties in his own name and a pipe bursts in one of the properties, severely injuring that property’s tenants, all of his assets could be at risk. Alternately, with a separate holding company for each property, only the property in question is subject to the risk. Then, with a proper liability insurance policy on that property, the amount the holding company will have to pay to cover the injuries will be reduced by the amount covered by the liability insurance policy.
When purchasing liability insurance, the holding company should be the named insured and the owner should obtain written proof of this insurance. If real property is transferred to the holding company through a transfer of title, a liability insurance policy on the property is virtually useless if it does not actually name the holding company as the insured.
The Balanced Approach
Asset protection refers to the way in which your property is arranged such that exposure to lawsuit risk and liability is reduced. This differs from strategies aimed at tax savings or mere disputes about being a slumlord. Instead, asset protection centers on formulating a plan to fully insure your property and own these investments in a manner so that they become less vulnerable to the claims of others. Ultimately, asset protection has emerged as a key component of any sound wealth management strategy.
A balanced approach to real property investment protection is the most advisable. This approach utilizes both a holding company and liability insurance to form a concrete asset protection strategy. When combined with several other prudent measures for managing a real estate investment, this approach can serve to achieve the owner’s goals of reducing potential liabilities and maximizing his or her ability to make a profit on the investment.
ODGERS LAW GROUP specializes in business formation and the development of strategic business plans aimed to help maximize asset protection and reduce liabilities. The firm has experience aiding real property owners in the navigation of the legal environment through the use of both entity formation and liability insurance to create a balanced approach to wealth management. To learn more about Business Law or to schedule your free consultation with Mr. Odgers, contact us by e-mail, call us at (858) 764-2448, or schedule your appointment online here.