Should I Put Rental Property Into a Trust Or LLC? Here’s Your Answer.
When I bought my first property, I knew that I needed some kind of protection. I thought, “well, I’ll just switch over the title to a family trust once I get it established”. Here I am, a financial planner, making the same mistake that a lot of my clients made.
To be fair, at the time of the purchase, my wife and I did not have significant assets and we didn’t have any children. In addition, that purchase was initially intended to be our primary house. But, nevertheless, once it became a rental property, I neglected to get the property into proper protection.
It’s easy to avoid situations that feel complicated. Just like life insurance, however, it’s always better to be protected than sorry.
To be clear, a family trust is incredibly important. But, generally speaking, a family trust is simply a tool to make sure your assets are distributed per your wishes at the time of your death. This is terrific, but it won’t protect you against tenant lawsuits.
The Importance of Creating LLCs for your Rental Investment Properties
When you own rental property, there are all kinds of hidden risks that you may not know about. Your tenant could trip on a loose stairway board. The light switch might have an electrical spark. The sewage could back up and flood the basement causing a health concern.
The point is you don’t know what problems could pop up and create a litigious situation.
You may be thinking, “well, that’s why I have homeowners’ insurance and an umbrella insurance policy to boot”. I think that’s wonderful and kudos to you! But, asset protection insurance doesn’t cover everything!
The risk is exposed in the situation where your tenant makes a claim beyond what your insurance covers. In that situation, your entire life savings could be at risk! Yes, that would mean that your retirement assets, emergency savings, and even your kids college funds could be leveraged to pay for that claim beyond the insurance! Scary, right?!
This is where an LLC comes in. When you establish and hold your rental property inside of an LLC entity, the only exposure is the equity within that property. So, if you have a house worth $500,000 and you owe $400,000 on that same property, you only have $100,000 of equity at risk! In addition, the flip side of that coin is true. If you were sued personally (not dealing with your properties), then your LLC cannot be leveraged in the lawsuit because it’s a separate entity!
In addition, if you have a property manager, your identity is somewhat protected in a lawsuit. When the tenant goes to sue you, they see the LLC name and not necessarily yours. This makes it more anonymous and less risk of the tenant knowing anything about your personal net worth.
So, to recap:
LLCs protect your personal assets
In a lawsuit, the equity in the property is the only thing at risk
What To Do If You Have Multiple Rental Investment Properties
If you are like most of my real estate professional financial planning clients, you have been successful at real estate, so you invest in real estate. Meaning, you have put together a real estate portfolio of investment properties. If this is you, congratulations on setting yourself up for future financial independence!
Now, when it comes to the protection of those properties, it’s important to structure them properly. If you title each property into the same LLC, well, then all of the assets within the LLC are subject to litigation.
The solve? Either, title each property into its own separate LLC, or set up what is called a Series LLC.
The downfall of creating separate LLCs is the costs associating with establishing each and the filing costs annually. A Series LLC is one LLC that covers all of the separate LLCs within the real estate portfolio. The difference is that you are only paying to establish and file for 1 LLC, instead of for each. This is because the Series LLC acts as the parent of the subsidiaries, but still keeps each property protected individually from a lawsuit.
It should be noted that the Series LLC is only allowed in particular states, whereas, California for instance, does not recognize the Series LLC. In this case a Delaware Statutory Trust (DST) might be a better solution that acts in a very similar way. More on the entity structure for another blog post.
A Family Trust does not protect your property from lawsuits, it generally dictates what happens to your property upon death.
By having your rental property in an LLC, it can help protect your personal assets from a tenant lawsuit. On the flip side, by having your rental property in an LLC, a personal lawsuit against you could not be attached to your separate LLC entity.
It’s important to have each of your rental property investments in, either, its own LLC or a more comprehensive entity like a Series LLC or a DST.
For any further questions,
Disclosures: Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.