When purchasing real estate for investment, you should be concerned about the liability your investment property can create. Often, your biggest worry will be paying the mortgage, but don’t think that’s the extent of your possible liability. A personal injury attorney could turn your retirement investment into a wealth destroying nightmare unless you protect your assets.
The most common way to minimize your potential liabilities would be to have your properties held by and managed by a separate entity with limited liability. While you may consider the property to be separate from your personal assets, unless you proactively create that separation, an attorney will pursue your personal assets in addition to the value of the property itself…
To make your LLC effective, it is usually advisable to have the LLC own the property, rather than just manage the property. If you already own the property, there may be costs associated with transferring the property to the LLC. Further, your lenders will often need to approve the transfer and will request that you personally guarantee their loans. Nonetheless, the risk of owning an investment property in your own name often far outweighs the associated costs.
All property owned by an LLC will still be at risk for any liabilities. Thus, you may consider forming multiple entities if you own several properties, particularly if the properties have significant equity or if one property is very likely to create liabilities. Further, if you flip properties, then you may wish to create new entities. Lingering liability from a former property could affect your current holdings. While allowing the property itself to remain at risk may not sound appealing, the alternative is for all of your personal assets to be subject to claims, including your personal home and your future income.
For tax purposes, the most commonly used entity for real estate investments is the limited liability company, otherwise known as an LLC. A tax benefit of owning real estate through an LLC is that if the LLC is owned by a single member, then the entity is disregarded for tax purposes. This means all income and losses from the property would not need to be reported on a separate return, and the amounts can be directly entered on the owner’s personal income tax return.
In addition to transferring your property to the LLC, it will be necessary for all business of the property to be handled exclusively by the LLC. For instance, tenant leases, the roofer’s contract, and the checkbook should name the LLC as the contracting party, rather than your name. These formalities will make it less likely that an attorney will be able to pierce the LLC veil of protection that prohibits you from being sued personally. One concern for potential personal liability would be for those investing in Baltimore City properties with potential lead paint issues for which an LLC may not be sufficient protection. That issue should be addressed with your attorney.
Often, real estate investors believe their liability insurance will protect them. Unfortunately, you should not assume a jury will limit its sympathy for an injured tenant to the amount covered by your liability insurance. Therefore, the only way to truly be certain that most potential liability from an investment property will not lead to you losing your personal assets is to form an LLC.
In conclusion, holding or managing a property in your own name creates many opportunities to be personally sued. The only way to truly limit your potential personal liability is to form an entity with limited liability protection.
For further information regarding forming an LLC or transferring your real estate, please contact Jeff Rogyom at (410)929-4578. Please review the Disclaimer page regarding use of this website and its information.