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Creating an Asset Protection Plan for Real Estate Investments

One of the big reasons that physicians, and people in general, are nervous about getting into real estate investing is liability. Basically, what if you get sued by a tenant? Well, the way to deal with all that is coming up with an asset protection plan for your real estate investments.

asset protection plan for real estate

To be clear, I am focusing on direct real estate investing here. A great way to avoid liability in real estate investing is just to invest more passively in syndications or funds. The liability risk is taken on by the general sponsors, not you as a limited investor. This is a certain “pro” of passive REI.

But, we all know that direct real estate investing has some huge advantages as well, namely that your ability to grow wealth through cash flow, appreciation, tax advantages, and equity pay down are maximized.

But anyway…

I’d like to share some options for protecting and minimizing the liability of your real estate assets including the plan that Selenid and I have enacted!

Why do you need an asset protection plan for real estate investments?

I alluded to this already.

There are a number of advantages that make this a must:

  • Minimize liability from the properties
  • Separate your real estate business assets from your personal assets
  • Maximize tax advantages

So, let’s talk about some of the options for an asset protection plan for real estate…

Option #1: Going bare…(Please don’t do this)…

Hey…it is an option. But a really bad one.

You could just get the mandatory home insurance on the property and go bare.

No umbrella insurance, no other asset protection legal entities.

Especially as a high income earner, you are putting a huge amount off liability onto yourself and your family. Basically, if you get sued for anything related to your rental property, the courts can come after any of your personal assets, including your home. They can even garner future wages.

No investment is worth losing your home.

Don’t do this!

Option #2: Umbrella insurance

This is an option that many beginner real estate investors get excited about…at first.

Umbrella insurance is basically insurance that covers above and beyond the limits of a home insurance policy or a renter’s policy. You can choose how much you want. Usually you should get at least a few million in coverage.

And the nicest thing about umbrella insurance is that it is SUPER cheap. For example, my $5 million umbrella insurance policy costs about $500/year.

So, an option is to just buy umbrella insurance to cover the liability of your investment property. If a tenant sues, you use the umbrella policy to pay it off…as long as the amount doesn’t supersede the limits of the umbrella policy.

And that is the downside, which I will illustrate more here…

This is from Apartments.com:

Imagine this scenario…A landlord owns a large multifamily property and rents it out to tenants. A fire ignites in the property and injures several people. Prosecutors sue the owner for negligence due to safety hazards.

The owner’s umbrella insurance pays the $3 million to the owner for the fire. However, several families sue the landlord over the fire. The families win a $20 million lawsuit.

Bottom line:

Owner has umbrella insurance policy ($10,000 deductible/$3,000,000 coverage): The landlord goes bankrupt, losing $20 million.

Not a good scenario.

Option #3: Basic LLC Structure

But wait! There are other options.

Let’s go back to that scenario from above. But in this case, the owner of the property had created an LLC and placed the property into that LLC.

Now what happens?

Owner has LLC: The judgement is $20 million. The value of the warehouse is $3 million. The landlord loses the warehouse and insurance payout. The total monetary loss is $6 million.

That is a much, much better outcome.

And yes, this is an extreme example. If the property in question is valued at $250,000 (the median of my properties’ values), the total monetary loss is much less.

But the bottom line is that with an LLC, the loses are limited to whatever is in your LLC i.e. your property or properties.

Now, this is not always 100% fool proof which is what you want a good asset protection lawyer to help you set these things up. I wouldn’t recommend it as a DIY project unless you have some serious experience.

And you certainly can set up your LLC as a single owner, S-corp, or C-corp depending on the size of your operation, your tax goals, and your structure. This is one of a many good reasons again to have a good asset protection and tax advisor helping you with these decisions.

Option #3: More complicated LLC entity structures

I’m just lumping these all together but the big ones that real estate investors tend to use are:

  • Umbrella LLCs and
  • Series LLC
  • Delaware Statutory Trusts (DSTs)

I’m not going to go in depth on all of these but in basic terms:

An umbrella LLC consists of a large, main LLC (the umbrella) with smaller LLCs underneath that umbrella for each rental property that you own. The umbrella LLC is usually in a place like Wyoming and the smaller LLCs can be in the state of the property.

A series LLC is basically a collection of separate LLCs (all within a “series”) that all receive the same liability and asset protection but are all considered separate. Basically just some legal maneuvering to have a bunch of separate LLCs that are actually all considered part of a big “whole LLC.” Similar advantages and disadvantages as above.

As the Darwinian Doctor explains, “To break it down in simple terms, a Delaware Statutory Trust can act almost exactly the same as a series LLC model, without requiring the formation of multiple LLCs.”

These are all valid options. The advantages here are an added layer of anonymity and possibly protection. The downsides are increased complexity and cost.

Oh yeah…last quick thing…

Notice that in all of these asset protection legal entity examples, we are assuming the owner also has umbrella insurance.

Just get both!

The $500 for umbrella insurance (which will cover your personal liability as well) is definitely worth it!

Our asset protection plan for real estate investments

So, this is what Selenid and I did:

  • We bought umbrella insurance to cover us personally and to also cover our invested assets, like real estate
  • We formed a single member LLC into which we placed our 3 properties

That’s it.

We went back and forth a lot about the pros and sons or a more complex structure, notably an umbrella LLC.

In the end, after talking with a lot of more seasoned investors, we just felt the added complexity and cost were not worth it.

For comparison, forming an umbrella LLC would cost us a $10,000 up front fee and a monthly retainer.

Starting our single member LLC cost us about $3,000 as a one time flat fee.

Caveat emptor

Now, mind you, as we acquire more properties, we will divide them up into multiple other LLCs to spread out risk. So the overall cost will be higher. But that would happen regardless of which option we chose.

With the protection afforded by the umbrella insurance AND the LLC, the odds of an above limits claim impacting anything other than our investment properties is very, very low….nothing is ever 0%…but it is very low.

And we feel comfortable with that…

…But you need to make sure you feel comfortable with whatever you choose!

If you are looking to begin investing in real estate or maybe you’re an experienced investor looking for a refresher, this doctor’s guide to real estate investing covered it all!

You can also get an insider look at the analysis of all 3 of our investment properties here:

What do you think? Do you have an asset protection plan for your real estate investments? What is it? Let me know in the comments below!

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    The Prudent Plastic Surgeon

    Jordan Frey MD, a plastic surgeon in Buffalo, NY, is one of the fastest-growing physician finance bloggers in the world. See how he went from financially clueless to increasing his net worth by $1M in 1 year and how you can do the same! Feel free to send Jordan a message at [email protected]

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