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Updated about 6 years ago on . Most recent reply

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Trevor Finton
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19
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Neither Newbie Nor Pro Asset Protection Experience

Trevor Finton
Posted

I am very much an aspiring investor in Grand Rapids and West Michigan and am checking off my list of needs (CPA, PM, capital, lending etc) but one area that keeps tripping me up is asset protection (i.e. umbrella policy only vs LLC). I have personal assets I want to protect but don't want to have this all slow me down unduly. I'm leaning toward pursuing LLC formation (with advice of both attorney and CPA...and spouse) but am concerned about implications for lending.

I'm wondering if others could share their approach when starting out, particularly those that aren't (or weren't) outright pros (e.g. 4-15 doors), not necessarily working in real estate full-time and  seeking a modest passive income. What were your experiences both positive and potentially disastrous?

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Scott Smith
  • Attorney
  • Austin, TX
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Scott Smith
  • Attorney
  • Austin, TX
Replied

Hey Trevor,

Many real estate investors mistakenly believe that they will be protected from lawsuits by their integrity, their insurance company, or a mistaken belief that they don’t expose themselves to liability. The reality is that real estate investing has many liabilities. As investors we are working in one of the most litigious industries in the most litigious country in the world. 90% of us will be sued in a 20-year investing career. Given that the only ways to lose money in this industry are bad investments and lawsuits, I’m not willing to bet my portfolio that I’ll be in the lucky 10% of people who never have problems. 

Insurance isn’t useless, but it isn’t a substitute for asset protection. You should definitely have insurance for each of your rental properties. Insurance plays an important role as the first line of defense against nuisance lawsuits and common events like slip-and-falls. It does not cover all types of liability or most landlord-tenant issues--that’s where a proper asset protection structure comes in.

Integrity is also great, and is certainly an element of how you do your part to keep your asset protection plan effective. Asset protection won’t protect you from outright fraud, but neither will your integrity alone protect you from lawsuits. You may believe that because you are a generally honest person, you will be safe from lawsuits. However, most lawsuits don’t arise out of intentional, deceptive fraud. There is a legal concept known as the fraud spectrum that accounts for liabilities that can arise out of our words and actions. Intentional deceptive fraud is on the extreme and rare end of the fraud spectrum. In my experience, most lawsuits stem from miscommunications. I wrote about an example for BP of a fairly common type of miscommunication and how asset protection kept my client out of court. The example is typical of most real estate lawsuits: nobody intended to defraud anyone. Both sides had stories that made sense. But insurance would not have saved my client, nor would I recommend that investors rely on it to solve all of their problems. Insurance is your first line of defense, but only an entity like an LLC, or better yet, a network of entities and trusts assembled by an experienced asset protection attorney, can truly eliminate the threat of a lawsuit.

I also discussed this on the BP podcast some time ago, might be worth a listen.

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