by LawInc Staff
March 10, 2017
Forming an LLC is critical when investing in real estate. Placing assets, like real estate, under your own name can be a disaster in the making. Investors should seriously consider LLC formation.
Unfortunately, many real estate investors realize the consequences of failing to use an LLC when its too late and they’ve lost everything.
Consider the following if you own any real estate investment properties or are thinking of becoming a real estate investor:
There are many situations where having an LLC provides real estate investors with invaluable protection. An LLC is particularly valuable when a lawsuit is commenced against a property owner. The most common scenario is a lawsuit.
If you own property under your own name, instead of via an LLC, your can be held personally liable for lawsuits. Moreover, your other assets would also be vulnerable.
Why unnecessarily put yourself at risk?
Here are some of the more common circumstances leading to lawsuits:
Disgruntled Tenants: These days, it takes disgruntled tenants a few mouse clicks to find an attorney willing to file a lawsuit. If you don’t own the property via an LLC, you will be personally targeted in a lawsuit. This is why it’s always important to form an LLC, hold title via the LLC and execute a lease between the LLC and the tenant.
Extortionists: These days, attorneys will file lawsuits against real estate owners, for any reason. In a sense, these attorneys end up extorting real estate owners into settling lawsuits who are forced to do so in exchange for avoiding hefty attorney fees. Too often, property owners are “bullied” into settling frivolous lawsuits. Examples include suing for violations of the American With Disabilities Act.
Fire: Each year, fires in the U.S. cause thousands of deaths, billions in property damage and countless lawsuits. If a fire starts on your personally owned investment property and spreads elsewhere, your personal assets could be used to pay for damages.
Tenant Guests: You should also be concerned about lawsuits by guests of your tenants. When something happens to a tenant’s guest, the property owners are often the first named in a lawsuit. Remember, plaintiffs are always looking for deep pockets and real estate investors are huge targets.
Insurance Protection is not Enough
Nowadays insurance coverage may not provide enough to cover all damages. Accordingly it’s critical to have an LLC in place to ensure that you are protected if the amount of the judgment exceeds the amount of the insurance coverage.
Also, insurance policies don’t cover everything. Insurance policies often have exclusions.
Protect Your Other Investments
When you hold title to a real estate investment under your own name, everything else you personally own is exposed. Let’s say you own two separate homes that you lease out to two tenants (property 1 and property 2). The tenant in property 1 sues you and is awarded a $500,000 judgement. Since you own both investment properties under your own name, both properties can be used to pay the proceeds of the lawsuit. This is why it’s essential to hold each of your real estate investments in separate LLCs.
Protect Yourself From Co-Investors
Jointly holding real estate investments with others can lead to major and costly complications in case of a partner’s death, incapacity or divorce.
Death and Incapacity: You can end up being at the mercy of disinterested family members who decide to cash out the value of your deceased partner’s ownership. Even worse, you could be caught in the middle of a family dispute, or even litigation, involving how or to whom your partner’s share of the investment is distributed. Such scenarios can be avoided via LLC formation. An LLC operating agreement is essentially an extremely detailed contract which allows co-investors to dictate what happens when a co-investor passes away.
Divorce: With so many marriages ending up in divorce these days, it’s important that you account for what happens if jointly own an investment property with someone who is married. The spouse of a divorcing property co-owner can wreak havoc by effectively becoming an active owner with decision making powers.
Disputes: With so many variables and decisions associated with real estate ownership, it is inevitable that disputes will arise between property co-owners. Having an LLC with an operating agreement in place allows you to dictate the exact protocols that must be followed in case of a dispute or if one owner wants out.
LLCs are great vehicles for estate planning and work great with trusts. Trusts are created to dictate what happens to your assets when you pass away. If you create a trust and have the trust, own an LLC, which owns your investment property, it will be a lot simpler to pass the property to your loved ones.
ALSO SEE: Estate Planning Tool – The LLC
LLCs can help you minimize your estate taxes in connection with passing assets to your family members. Current federal gift tax exemptions allow tax free transfers of up to $14,000 per year. Fractional interests in your LLC can therefore be gifted to your children without having to re-title the property deed. It is important to note that the LLC operating agreement must allow the transferred interest to have immediate value to the recipients to qualify for the gift tax exclusion.
LLCs are the most popular popular investment vehicles when more than one owner is involved since other investors know that they will be protected by the LLC structure.
You are entitled to a certain level of privacy in connection with your real estate investments. This mean that a lease can be between your tenant and your LLC. Not your tenant and you, individually. Also, your LLC name, not your individual name, would appear on the public record and in the chain of title. Although some information can be discovered about LLCs from the public record, it is not extremely readily available. This is why it is important that, when purchasing a new investment property, title is taken under the name of the LLC, not your individual name.
Using an LLC in connection with your real estate investments is a must.
You should treat your real estate investments like a business and make sure to use a proper legal business structure in connection with your holdings. Failure to do so can result in major liability issues.