Sheltering your real estate investment against Inside Liability with a Limited Liability Company
If you are a real estate investor, chances are you have purchased liability insurance coverage for personal liability for injuries to others or property damage. But what happens when a claim exceeds coverage limits, or an insurer does not cover a claim due to an exclusion clause in the policy?
Inside Liability versus Outside LiabilityAsset 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 landlord. Instead, asset protection centers on formulating a plan to fully insure your property and own such investments in a manner so that they become less vulnerable to the claims of others.
First, it is important to understand the difference between "inside" and "outside" liability. Inside liability is a lawsuit risk that is produced by the property itself. That is, something associated with the property may cause you to be sued. A tenant can be injured on the property or you might have a dispute with a buyer or seller. A lawsuit over these types of claims can put your assets at risk, including other properties and personal savings. The first part of the asset protection planning therefore is to insulate and shield you from any liability arising out of the property itself so that you do not expose your other assets to this lawsuit risk.
Outside liability on the other hand is the risk associated with your other activities unrelated to the property. This can include unrelated business dealings, motor vehicle accidents, and the like. A lawsuit from any one of these sources poses a potential threat to all of your holdings, including the equity in your properties. Therefore the second objective of the planning is to protect the properties from any outside risks.
Protection Against Inside LiabilityIf you own rental property, there is likely a fear in the back of your mind that you will one day be sued by one of your tenants. And if there is not - there probably should be! Real estate investors and landlords are often prime targets for lawsuits, both valid and frivolous.
The law itself 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. Real or alleged injuries to tenants and their guests are regular occurrences, and serious injury to even one person might create a potential liability exceeding the amount of your liability insurance coverage. Other types of problems might not be even covered by insurance at all, such as being sued by a buyer for undisclosed defects in the property.
The good news is that the threat of a lawsuit from a tenant, visitor, buyer, seller or lender, can usually be contained by using the correct legal structure to hold (or shelter) the property. Almost always, this is accomplished with a type of entity known as a Limited Liability Company ("LLC"). Many times, an investor owns real property in his or her personal name. While sole proprietorships (owning assets in your name) are the most common and simplest form of property ownership, they provide no asset protection for property owners. When owning real property in your personal name, all of your assets, even those unrelated to the property, can be used to satisfy a judgment when sued. If structured and managed properly, an LLC entity can provide excellent asset protection 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 LLC's assets will be accessible to satisfy the judgment. This is crucial because it permits 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. With that said however, investors owning multiple investment properties should create separate LLC entities for each property. When an LLC is sued, all of that entity's assets become available to creditors. By placing each property in a separate LLC, an investor can protect his or her other properties from being subject to the judgment related to only one of the properties.