Rental property as LLC or personal with Umbrella insurance?

Question

Do you recommend purchasing & operating under an LLC or purchasing under my personal name with added umbrella insurance?

Weston Couch · Answer

@Drew Slew  Hello Drew, something from my experience that you might find helpful. When I sit down with clients, I always discuss (1) their personal assets, and (2) what their current investments portfolio and other business ventures are before discussing (3) their future goals. Each of these variables will dramatically change the advice I give the individual asking me this question. Generally though, I break it down into the "five pillars" of protecting your assets.

The first pillar is avoiding unnecessary and risky activities (don't drink and drive, insurance generally won’t cover your poor decisions) and take good care of your investments(maintain your property, etc) - these simple steps will help you prevent lawsuits before they even occur.

The second pillar is a good insurance policy as that cover the majority of your exposure. However, insurance is limited because it only protects you from one type of liability: accidents/negligence. Insurance doesn’t protect you from any part of the sale or acquisition of a property (e.x. Somebody wanting to sue for you backing out of a bad deal or accusing you of selling them a property with defects like unknown termite damage). Insurance also doesn’t protect you from misunderstandings, especially those made in writing and email. What happens in these misunderstandings is that something goes wrong either in the sale or after, and then they sue you for some statement you made that they “misunderstood”. That lawsuit is a claim for fraud, and that’s what fraud typically is...a misunderstanding and someone being “injured” and wanting to hold the other responsible for it. Insurance never protects you from these kinds of claims and they happen all the time.

The third pillar applies after you have good insurance You need to protect yourself from what insurance doesn’t cover by compartmentalizing your assets. Compartmentalization means that if something happens to one property, people suing can’t touch you or the other properties. You should use either LLC’s (the old and expensive way) or a Series LLC (the new and more cost/time effective way). No matter where you live or where you own assets, I personally recommend the Series LLC to be a great tool for the individual investor who is planning to expand their operation, as it allows for you to scale infinitely for FREE. If you’re interested in using an LLC, this article  also further explains the advantages of a Series.

The fourth pillar is somewhat similar - you want to separate your operations from your assets. One company owns everything and does nothing (this is your SLLC a/k/a “asset holding company”) and a completely separate company handles all of your operations (this is a traditional LLC a/k/a “operating company”) For the operating company which serves as your face to the world and through which you do all your business, you establish a Traditional LLC to carry out the operations of your investments. The operating company takes on all of the liability that would otherwise blow back on you including: paying property management, paying contractors, collecting rent, marketing, etc.

The fifth pillar is owning everything anonymously. If people don’t know that you have assets, then they are less likely to sue because there’s no use in suing people that qualify for food stamps. This anonymity can be accomplished for free by using land trusts to own your companies as well as the assets. Trusts create this anonymity by removing your name from public record. Even if they can see you used to own a property, when properly transferred it will look like it was sold to investors. If they somehow guess you are the owner though, it still doesn’t matter because you would not be the owner. The land trust and the LLC are the owner of the asset/real estate, so even in the scenario that potential litigants guess, they would guess wrong.

If you're interested in knowing how you can apply these pillars, please feel free to reach out to me.

Chris Carollo · Answer

I'm not going to get into the LLC vs Personal Name debate but I don't believe you can finance through Freddie, Fannie, FHA, etc through an LLC. Going other routes may lead you to a higher interest rate.

I'd much rather be OVER insured with a large umbrella policy then stay up worrying about it.  Even a couple million dollar policy isn't that terribly expensive.

Joseph Leonard · Answer

@Joe R. from what I have been told, if you have a mortgage on the property from a bank they don't look to fondly on someone holding a property in an LLC and can call for the "due on sale" clause which means you would have to fully pay the mortgage at that time if they decide to do so.

This is a pretty debated topic here on BP. A lot of people say that they've never seen a bank actually use the "due on sale" clause but the question is, do you want to risk it?

Now, if you own a property free and clear, then yeah it would be a good idea to form an LLC to hold that property in if you're wanting it for asset protection reasons. From what I've been told, holding a property in an LLC doesn't really give you any special tax benefits, but rather just protection for your personal assets should you be sued by a renter.

I'm a newer investor and own two rental properties in my name. I have an umbrella policy for $1M to cover everything and I recommend you do the same. It's also a good idea to require your tenants to get renter's insurance.

Hope this info helps.

Steve Rozenberg · Answer

For what it’s worth my experience is that it’s not in or it’s in and conversation I may purchase properties and depending on how I want to cover them if there’s multiple owners I want to stay anonymous asset protection however if you’re doing something wrong and you violate the law an LLC will never protect you so I would recommend you always have an umbrella policy for all your investing needs and an LLC just protect your assets.

Definitely consult with an attorney before you make any decisions

Drew Slew · Answer

@Stewart Miller can you give an attorney or guidance on how to do this in NJ, i got properties in hudson county

Brandon Shewbridge · Answer

An umbrella policy does not cover all potential reasons that you could be sued. If someone slips and falls or gets injured on your property, then the umbrella insurance would be fine. Unfortunately if someone sues you based on some action you took or something you said, the umbrella policy likely will not cover that. At that point they're going to be coming after other personal assets that you own in addition to the rental property because everything is commingled under your name. At a minimum you should have the property held by an LLC with an umbrella policy as well.

The ideal configuration would be to have the property held in a generically named trust with an LLC where you are the managing member named as the trustee.  This gives you control over the property.  Then you can assign the rental rights to a separate management / operating LLC. There are layers of protection here and since a trust document doesn't have to be registered with the state, it's much harder to determine who owns the property.

Rental property as LLC or personal with Umbrella insurance?

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