Imagine a scenario where a tenant is injured on your property and is claiming seven figures in damages. This tenant hires an aggressive attorney who finds out you have deep pockets and wants to sue you for “everything you’re worth.”
What if, instead of finding out that you’ve built an empire, the attorney and his team of forensic accountants come up empty? On paper, it looks like you own practically nothing. As a result, the tenant is limited to going after whatever they can get from your insurance company. Other than a modest rise in premiums, your liability ends there.
The scenario above is typical of a real estate investor who plans ahead and learns how to protect their assets. Asset protection allows you to minimize liability by hiding ownership and minimizing equity positions.
If your assets are not protected, on the other hand, you could find yourself liquidating valuable assets to satisfy a claim. The right asset protection strategy can restrict these parties to the limits of your liability insurance policies. As a result, you can cover the costs of injuries, lawsuits, creditor claims, and other unforeseen circumstances without paying out of pocket or liquidating your portfolio. This article outlines the top asset protection strategies for real estate investors.
Create a Trust to hold Real Estate
Real estate trusts are a multipurpose tool that allows for both asset protection and estate planning. For example, if you place real estate in a trust, you can potentially avoid probate.
From an asset protection standpoint, a real estate trust allows you to designate a trustee, which shields your personal information from the legal public record. You can still maintain indirect ownership and control of the trust as a beneficiary.
Real estate investors can legally hold assets in states or countries other than where the asset is located. For example, you could “move” ownership of real estate into an LLC located in another state or create an offshore trust in the Cook Islands.
As an asset protection strategy, offshoring provides numerous benefits, including making it more difficult for creditors and litigants to seize assets, especially if there are jurisdictional laws outside of your home country that prevent legal enforcement across borders.
An asset protection attorney can help you identify the right offshore opportunities that allow you to achieve maximum asset protection while still complying with tax laws and other legal requirements.
Invest in Landlord Insurance
A homeowner’s insurance policy will only go so far, and it’s not a surefire asset protection strategy. It’s also recommended to invest in landlord insurance, which is designed to protect you in the event that a tenant is injured on your property or suffers another loss.
If a tenant files a claim or sues, you could be on the hook for lost wages, medical bills, court costs, and other fees. With landlord insurance, you’ll have a policy to pay these costs. Some policies even cover the injuries of third parties, like a contractor working on the property.
The key difference between homeowner’s insurance and landlord insurance is that landlord insurance acts like protection for property managers while homeowner’s insurance protects the interests of the personal homeowner. As a real estate investor, both are essential for asset protection.
Use Debt to Your Advantage
While it might be tempting to purchase a property outright with cash, if you finance your properties you can increase your debt ratio. Having debt is like a form of equity stripping that makes it more difficult to liquidate a property because the equity is limited. The underlying value of the assets remains the same, but if you don’t yet “own” the property, there’s nothing to take.
You can also use debt to your advantage by reinvesting the profits from your other properties into new acquisitions. Not only does this shield your assets, but it also helps you build your empire that much faster.
Limited Liability Company
As the name suggests, a Limited Liability Company (LLC) can protect your assets from lawsuits and creditors. It’s recommended to set up a separate LLC for each of your real estate assets so that an issue with one property doesn’t spill over and affect your other assets.
However, without the right asset protection strategy, you could be listed as the organizer, a registered agent, a member, or a manager, meaning that it’s easy to determine you are affiliated with the LLC and have control of the underlying assets. Further, your contact information will also be published on the Secretary of State’s website, making you exceptionally easy to locate.
This can happen when you register your LLC within the state where you reside if it has stringent information requirements. You can, as an alternative, first register your LLC in a state that doesn’t require you to publicly list your information. These states include:
- New Mexico
When setting up an LLC, you’ll need to use a third party because you still have to disclose the identity of the “organizer.” Assigning this role to a third party allows you to keep your identity private. After you set up the LLC in one of the states listed above, you can then create the LLC in the state in which you live.
File a Homestead Exemption
A homestead exemption is a way to protect a residence from creditors, lawsuits, and assessments. The overarching goal of this provision is to allow homeowners to keep their homes in the face of other financial challenges.
The rules for homestead exemptions vary by state. While some states allow for only one property to qualify for a homestead exemption, and it must be your primary residence, other states allow you to file a homestead exemption for multiple properties.
Even with the best asset protection strategies, real estate investors can still be subject to inordinate amounts of risk. Learning how to minimize risk is also essential.
Helpful ways to minimize risk include:
- Thoroughly screen tenants by checking references and performing credit checks
- Carefully screen any contractors who will be doing work on your property by requesting testimonials and verifying license and insurance status
- Diversify your portfolio by investing in different markets
- Consider hiring a professional property manager to ensure timely maintenance and compliance with legal standards
- Conduct regular property inspections to proactively identify any maintenance issues
Risk mitigation strategies can take many forms, including reducing financial, legal, and market risks. Minimizing risk involves being able to identify the most significant threats and implementing strategies to neutralize those threats and ensure financial stability.
In general, the more wealth you have, the more liability exposure you potentially face. This is the crux of asset protection and risk mitigation. Contractual liabilities, business-related liabilities, and tort claims can all expose a real estate investor to significant risk.
An asset protection strategy minimizes both risk and liability exposure by utilizing tools like trusts, insurance policies, and robust financial planning.
If you find yourself over-leveraged and in debt, an impatient creditor may attempt to attach your assets, particularly valuable real estate. A creditor can include an individual, business, financial institution, or even a government entity. The right asset protection strategy can reduce creditor claims or put you in a more favorable negotiating position.
Why do you need real estate asset protection?
Circumstances can change in the blink of an eye, and without asset protection, your entire investment portfolio could be at risk.
Typically, real estate investors tend to think of lawsuits and creditor claims as the most threatening prospects that could erode wealth. However, something that could threaten your wealth could happen at any time, no matter how unexpected or unlikely, so shoring up your real estate (and other) assets with an asset protection strategy is crucial.
In addition to the obvious risks of injuries and creditor claims, other risks include:
- Changing market conditions (the COVID-19 disruption was significant)
- A major commercial tenant closing its doors without paying you
- Contractual disputes that expose you to significant liability
- Environmental hazards that require major cleanup
- Data breaches that expose client information
A well-planned asset protection strategy reduces vulnerabilities, no matter the circumstances. Overall, asset protection is vital for limiting financial liability, preserving your hard-earned wealth, and engaging in estate planning.
It cannot be stressed enough that if you have significant assets that are easily traced back to you, your liability exposure can be massive. A major lawsuit can wipe out everything you, and even previous generations, have worked to amass.
Limiting liability includes forming various legal entities like LLCs, corporations, and trusts, all of which can be used to shield your assets from prying eyes.
If you do face a legal challenge, you can preserve your wealth with a robust asset protection strategy. This can involve segregating assets into separate legal entities. Many of these financial instruments serve multiple purposes beyond limiting liability. For example, forming the legal entities described above may also help reduce tax liabilities.
Much of estate planning centers around ensuring your heirs can take ownership of your estate upon your passing or incapacitation without endless red tape, taxes, fees, and litigation. The same asset protection strategies to minimize risk can also be used to ensure seamless wealth transfers while simultaneously reducing tax burdens and legal complexities.
Contact an Experienced Asset Protection Attorney
When it comes to asset protection for real estate investors, proactive planning is best. If you wait until you are already embroiled in a claim and you make moves to protect your assets, you could be accused of fraudulent transfer. As the proverb goes, “The best time to plant a tree was 20 years ago. The second best time is now.”
To speak with an experienced attorney about your asset protection options, contact Blake Harris Law today.