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Minimize Liability

Submitted by admin_matt on Fri, 2017-07-14 08:21

Worst Practice: Hold Title in Your Own Name

When you buy an investment property, if you buy it in your own name, you are personally liable for bad things that happen there. If somebody sues you and wins, they can take not only the property, but also your personal assets and income.

Better Practice: Hold TItle in an LLC

If you buy the investment property using an LLC then the person sueing you can take the property and any other assets owned by the LLC, but none of your personal assets (if you maintain proper boundaries between the LLC and your personal affairs). Ideally you would want a separate LLC for each property, so that the property in each LLC is protected against problems that occur in the other properties.

LLC's cost $100 to form and $100 per year in New Hampshire. You can form an LLC online in about 15 minutes with a very simple form here: http://www.nh.gov/business/index.html. Your online application for a new LLC should be approved in half an hour or so (during business hours). Upon approval you'll receive a "Certificate of Formation" by email.

Then go to the IRS website and get an employer identification number (EIN): https://www.irs.gov/businesses/small-businesses-self-employed/apply-for-an-employer-identification-number-ein-online. It's called an EIN whether you have employees or not. That takes another 15 minutes and you'll get your "EIN letter" immediately online. Then take the EIN letter from the IRS and the Certificate of Formation and head down to the bank to open a new checking account in the name of the LLC. It's important (for liability purposes) to not mingle personal funds and LLC funds, so you'll definitely need the new checking account.

The LLC protects any assets held outside the LLC. It does not protect your privacy since your ownership of the LLC is in the public record. So if somebody sues you for a reason unrelated to the property, they can probably find out that you own this property. This may convince them that it's worth their while to sue you.

No Liability Protection: Holding the Property in a Trust

A trust can hold title to a property. Public records will reveal that the property is owned by the trust, but they don't reveal who the beneficiary (the owner) of the trust is. The trust protects your privacy. If someone is considering sueing you, they are first going to try to find out what assets you own. If you don't appear to have a lot of assets the lawyer isn't going to waste his/her time sueing you. But if someone gets hurt on your property, that someone is probably going to know (or at least strongly suspect) that you own the property, and you will have to reveal the beneficiary of the trust if you are served with a subpoena. Then you will have full liablity, and all your personal assets will also be at risk. Although the trust protects your privacy, it does not protect you from personal liability.

Best Practice: Combine a Trust with an LLC

When I owned a multi-family property a few years ago, my lawyer set up both a trust and an LLC for me. The property was titled in the name of the trust and the beneficiary of the trust was an LLC of which I was the sole member. With this combined structure you have both the privacy protection of the trust and the liability protection of the LLC. Also, if you already own the property in your personal name and if there is a mortgage on it, most lenders will not object when the title is transferred to your new trust.

Caveats

I'm not a lawyer and this is not legal advice. Get a good real estate lawyer and run these ideas by him/her. This book described in one of my other posts will be a good place to start if you want to do some self-study on the topic: 

Matt