|The Importance Of LLC’s To Hold Real Estate|
| One of the American dreams is to own real estate and Arizona is a popular state to own real estate. The smart real estate investor knows that the limited liability company (LLC) is the best entity to hold real estate. When the LLC holds title to the real estate, the personal assets of the investor are protected in the event something happens on the real estate. Whether the investor owns residential or commercial real estate, owning property comes with risks. In the event of a liability on the property, the only asset exposed to satisfy the liability is the asset contained in the LLC, the real estate itself, and not any of the personal assets owned by the investor owner.
The smart investor also knows that as soon as the real estate investor adds a second property to his or her portfolio, then it’s important to set up a separate LLC to hold the new real estate holding. And each time the investor buys a piece of property, a new LLC should be formed. The bottom line, if you, like the investor, want the best asset protection, you need to set up a separate LLC for each piece of property. The following example will explain why this is so important.
Three investors, Tom, Dick and Harry, each buy 3 pieces of real estate: a residential rental home, a duplex and an apartment complex. Tom owned all 3 properties in his personal name. Dick owned and placed all 3 properties into one LLC. Harry formed 3 LLC’s and placed each property into its separate LLC. Tom, Dick and Harry each had a fire on one of their properties, in the residential rental home, and the tenant died. The tenant’s family sued the owner in each case and received a $1.5 million judgment. Consider the result in each situation:
Tom had the property listed in his personal name, so his personal assets were exposed. Tom had insurance on the property, but it was not enough to cover the judgment. He lost his entire savings and all 3 properties.
Dick had all three properties in one LLC. He lost one of the properties and all of his equity in the other two, but his personal assets were safe and protected.
Harry, the smartest of the three, had set up a separate LLC for each property. He lost the equity that he had built up in the residential rental home that he owned in the LLC, but he did not expose his duplex or his apartment complex because they were in separate LLCs. Additionally, he protected his personal assets by strategically placing his real estate in separate LLC’s.
There are several lessons from this example.
First, it’s important that each property has adequate insurance on the property. You should meet with your insurance agent every year and discuss all your holdings and make sure that there is adequate coverage on each property. If the property has $1 million in general liability coverage and the judgment was $1.5 million, then the property owner is exposed for the difference. If the property is owned by an individual, the individual will be responsible for $500,000. If the property is owned by an LLC, then the LLC will be responsible for the $500,000 judgment. The asset of the LLC will be exposed for the judgment, but the personal assets are protected. This leads to the second important lesson.
Form An LLC.
Second, make sure that you form an LLC to hold title to your real estate so you protect your personal assets.
Diversity Your Assets – Form Multiple LLC’s.
Third, as is very well illustrated above, it is important to diversify your assets. It is important to make sure you only have one piece of real estate exposed in each LLC. If disaster occurs on one property, a creditor cannot reach the other properties if they are in separate LLC’s.
Hold Title To Property In The Name Of The LLC.
Fourth, make sure you actually place the property in the LLC. The deed conveying the title to the real estate must be in the name of the LLC and recorded in the county in which the real estate is located. If the title is in the individual’s personal name, the individual remains liable for anything that happens on the property.
Minimize Personal Negligence.
Fifth, you remain responsible for any personal action that you take on the property. Once you place the property in the LLC and make sure the title is in the name of the LLC, it’s important that you minimize the action that you personally take on the property. A person is always responsible for his or her negligence and an LLC cannot be used to protect an individual from personal negligence. In the above example of the fire, if Tom, Dick or Harry was responsible for the fire because he personally installed faulty wiring that caused the fire, then he remains responsible since he was the person who caused the harm. This is important to remember – hire competent contractors to work on and manage your investment properties rather than doing the work yourself.
Prepared by Joan L. Jakel, Business Attorney. For more information about her practice and services, visit her at www.strategicbusinessattorney.com.