Alternate Asset Protection Strategy

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Alternate Asset Protection Strategy

Justin K.
Investor · Saxonburg, PA · Member since 2016 · 68 posts · 53 votes

So I am wondering if this is a legitimate asset protection strategy and would highly value any mortgage lenders or attorneys opinions.  I haven't heard this discussed before.

My wife and I own several properties.  I have a fantastic job and she is a stay at home mom to our two beautiful girls.  We own several properties that do pretty well, but I am at the end of my time availability in a given week.  Therefore instead of expanding our portfolio to increase cash flow we are looking at reducing debt to increase cash flow.  I understand that its not mathematically the best solution because we lose tax efficiency, yada yada yada.  We have also looked into hiring property management, but we live in a rural area and although these companies exist near us we have found that their average occupancy rate is in the 70-80% range, where last year my occupancy was 95%.  Charging first months rent and 10% thereafter with a significantly lower occupancy rate doesn't justify the cost for the 'service' (or disservice) to us.  But that is not what this post is about.

As we pay off properties the fear is that all this equity has been created and now we could be sued by an ambulance chaser attorney or anyone that wants to try to become a 'slip and fall millionaire'.  We do carry good liability insurance and we treat our tenants and their guests like they are family.  We dont want any of our properties to be forced to sell for the equity after a potential lawsuit.  So here is my strategy.  

Create a Nevada LLC - (or any state that offers owner anonymity) i.e. "Main St. Loan and Finance LLC"

Pay off a property we currently own and have financed with a bank.

Have a bank that we have a fantastic working relationship with write a new loan with the terms I agree to, knowing that the property will be 'underwater' and the length of the term is crazy long (like 30 or 40 years).

After the bank funds the property loan to my Property Ownership LLC, use the funds to immediately buy the loan from the bank with my "Main St. Loan and Finance LLC". (Our local bank sells all of their loans and collects the origination fee and all the other closing fees, etc).

Now I own the property and the note putting the property underwater.  I would never make a mortgage payment to myself so I wouldn't generate the need to file any IRS tax paperwork, but I would also never file foreclosure on myself either.  In the event that we would be sued the property has no equity, hopefully preventing frivolous lawsuits.  

Please note, in the event of a legitimate lawsuit we do have liability insurance to cover any claims.

This is an attempt to design a lifestyle and not necessarily the best mathematical return.  

Your thoughts are greatly appreciated!

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Don KonipolBusiness Member
Investor · The Woodlands TX / Avon, CT · Member since 2009 · 6k+ posts · 10k+ votes
7y

@Justin K.

Plaintiff attorneys employ asset search specialists who are very good at what they do. They can spot your rather amateurish attempt at hiding loan ownership a mile away. Once you get beyond the basic “exempt assets” you need an experienced attorney who specializes in asset protection.

As example, many states offer LLC with no public record of ownership. However, once a lawsuit is filed, the plaintiffs attorney will depose the Sec of State and he or his rep will have to disclose ownership. Further, the Statute of Fraud may also come into play. Many asset protection devices popular at any given time fail when tested in the real world. About 10 years ago foreign asset protection trusts domiciled in tiny Caribbean or pacific islands where all the rage. When tested in court the judge directed the defendants to direct the trustor to send the money back to U.S. if the defendant said it was out of his control the judge sent him to prison for contempt, until he was mysteriously able to gain control.

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  • Don KonipolBusiness Member
    Investor · The Woodlands TX / Avon, CT · Member since 2009 · 6k+ posts · 10k+ votes
    7y

    @Justin K.

    Plaintiff attorneys employ asset search specialists who are very good at what they do. They can spot your rather amateurish attempt at hiding loan ownership a mile away. Once you get beyond the basic “exempt assets” you need an experienced attorney who specializes in asset protection.

    As example, many states offer LLC with no public record of ownership. However, once a lawsuit is filed, the plaintiffs attorney will depose the Sec of State and he or his rep will have to disclose ownership. Further, the Statute of Fraud may also come into play. Many asset protection devices popular at any given time fail when tested in the real world. About 10 years ago foreign asset protection trusts domiciled in tiny Caribbean or pacific islands where all the rage. When tested in court the judge directed the defendants to direct the trustor to send the money back to U.S. if the defendant said it was out of his control the judge sent him to prison for contempt, until he was mysteriously able to gain control.

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  • Justin K.
    OP
    Investor · Saxonburg, PA · Member since 2016 · 68 posts · 53 votes
    7y

    Thanks for the input @Don Konipol!  I am not talking about avoiding legitimate lawsuits with this strategy.  I am suggesting it as an opportunity to appear 'judgement proof'.  As in, an aggressive attorney would look at my assets and say, 'there is nothing here to gain' and not even file the lawsuit.  In my opinion if I did something that caused legitimate harm to someone else then I would be at the very least morally obligated to make the situation 'right'.  I am suggesting this to avoid frivolous lawsuits.    

    Once a suit is filed the ownership of everything would become public knowledge anyway.

    Currently in my area a few attorneys have been running television ads saying, 'If you slip and fall on someones property we can get you paid!  You may be entitled to thousands of dollars!'

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  • Don KonipolBusiness Member
    Investor · The Woodlands TX / Avon, CT · Member since 2009 · 6k+ posts · 10k+ votes
    7y

    I am very experienced in asset protection, and have been paracticing it for 40 years.  No attorney worth his salt is going to be fooled by your 'hidden' ownership of a lien on your property, and say your judgement proof.  The atty will employ an experienced specialist who will run a search and easily find out the real situation.  My point is that for effective asset protection an atty specializing in asset protection designing a continually changing plans is necessary.  If you will sleep better at night by executing your plan, them by all means do it.  However, if you believe that your plan will actually work to discourage even the most passive plaintiff attorney, you are just fooling yourself.

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  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    7y

    @Don Konipol  comes down to flavor of the month with this stuff.. 

    I just fail to see how small mom and pop landlords that do a very nice job .. and are not slumlords are taking on some huge liability.  although insurance is appropriate that's why they call it liability insurance.. LOL. 

    some of the tools i have seen my clients use are charitable remainder trusts those seem to work pretty good.

    and then i think an irrevocable trust is pretty strong..  

    but not my area of expertise by any means.. but frankly and maybe over the years i have been lucky but like you i have 4 decades at this.. I have owned hundreds of rental houses. and other than deposit or eviction issues.. have not really felt that we were a target.. for one thing the average tenant has little to no money and therefore cant sue you.. and these cases are not taken on contingency UNLESS they think there is insurance money to get.

    But I get the sentiment.. I am Mr. Blue sky others the sky is falling and they are worried about everything.. 

    Its also kind of comical also unless U really been through litigation most of the folks on this site have no clue how it really works.. I have had my share but it was more transaction real estate related for minor partner issues.  Never landlord

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  • Rob K.
    Encinitas, CA · Member since 2011 · 191 posts · 252 votes
    7y

    A frivolous lawsuit is by definition a lawsuit that has no merit. You generally don't need asset protection for protection from frivolous lawsuits since you will win. You need to hire and pay for an attorney even if you are a target of a frivolous lawsuit if you are not going to tender it to your insurance company and you don't want a default taken against you or your entity, the same as if you were the target in a legitimate lawsuit. 

    Sometimes you may want to pay nuisance value to get rid of a frivolous lawsuit. While it is possible that a fancy asset protection set up might give you some negotiation leverage with such a claimant, this ephemeral "benefit"  is probably not worth the cost in most situations.

    The idea that there are unscrupulous attorneys out there that first look for equity and then manufacture reasons to sue you is a fear pitch used by asset protection salespersons, but it is not really based on any kind of reality in my experience. Attorneys who would adopt this approach would not last very long as attorneys.

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  • Costin I.
    Rental Property Investor · Round Rock, TX · Member since 2016 · 1k+ posts · 971 votes
    7y

    @Justin K. Not one thing will give you complete coverage - you'll need to employ several tools. Here are my suggestions (not a CPA, nor lawyer, so take it with a grain of salt):

    You'll need good insurance and umbrella insurance.

    You'll need good property management (yours or outsourced).

    And you'll need asset protection - aka liability insurance. You'll need to separate your assets (either by using a Series-LLC or individual LLC with assessed distribution of assets by LLC) and you'll need to separate your passive (asset holding entities) from active operations (the property management side).

    After you took care of all this you can look into other more complicated/expensive strategies like you describe (equity stripping).

    Here is a diagram to help you on this quest - talk with @Scott Smith for professional advice on this:

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  • Justin K.
    OP
    Investor · Saxonburg, PA · Member since 2016 · 68 posts · 53 votes
    7y

    Thanks for the input guys!  I really appreciate all of your opinions.

    Wondering if @Chris K. or @Scott Smith have any opinions on legality or asset protection?

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  • Chris K.
    Attorney · Nashville, TN · Member since 2015 · 1k+ posts · 1k+ votes
    7y

    @Justin K.

    If there is a claim against you that is actually worth pursuing, the plaintiff lawyers will find you and your assets. After a bit of discovery, they will find out who owns the membership interests in "Main St. Loan and Finance LLC." After that, it's just another target. This particular strategy may also risk what they call "merger" issues --- basically the idea that a mortgage disappears when the mortgagee is also the owner.

    Maybe I need to think about it more, but I honestly can't think of one benefit of doing this. 

    If you have a net worth to protect, I would just work with a proper asset protection attorney to discuss what you need to do. I would say you want to make sure you are not doing anything catastrophically stupid (e.g. unknowingly forming a general partnership with someone you shouldn't). You will also want to take advantage of "free" asset protection features such as tenancy by the entireties. If your wife is willing, you can even look into her working --- even part-time --- to take advantage of 401k protections (some rich housewives do this). At some point, you could look into more restrictive tools like irrevocable trusts. 

    Disclaimer: While I’m an attorney licensed to practice in PA, I’m not your attorney. What I wrote above does not create an attorney/client relationship between us. I wrote the above for informational purposes. Do not rely on it for legal advice. Always consult with your attorney before you rely on the above information.

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  • John Mocker
    Insurance Agent · Norwalk, CT · Member since 2016 · 2k+ posts · 1k+ votes
    7y

    Justin,

    If you decide to go the LLC route, I would suggest speaking to an attorney with experience in these matters. I have been told by several Attorneys that you also have to structure your dealings with regard to the LLC to keep an Arms Length approach. No commingling of funds (ie paying building cost out of your personal check book or personal bill from the LLC checkbook). I'm sure the Atty. will have other things to avoid.

    One risk management piece of advise, do not let anyone (especially a tenant) do work on the property without giving you proof of Liability and Workers Compensation insurance.  A client let a tenant do some work to offset rent owed.  The tenant filed a workers comp. claim and the landlord had to defend it.  Thankfully it turned out to be a non-work related injury and the case was tossed.  had it been legit, the Landlord could have been liable for Medical bills and Lost Earnings that a Workers Comp. policy would have covered. 

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  • Scott SmithPro Member
    Attorney · Austin, TX · Member since 2014 · 1k+ posts · 932 votes
    7y

    Sounds like you are trying to work something very positive into your life! You are approaching the idea of asset protection pretty well, but I want to hit on a couple concepts and explain my personal approach to asset protection. This isn't legal advice and I am not your attorney, this is simply my personal approach to asset protection. The costs of asset protection should scale with your portfolio, so I work with clients on finding the best option for where they sit from a business standpoint - this is how I often break it down. 


    I often break it down into the "four pillars" of protecting your assets. The first pillar is a good insurance policy, as that covers the majority of the claims you face as an investor. However, it only protects you from one type of liability: accidents.

    After that you want to compartmentalize your assets, which is often accomplished through the use of LLCs or corporations. I personally find 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 - check out this article to learn more. The third pillar is somewhat similar - you want to separate your operations from your assets. That means you establish a Traditional LLC to carry out the operations of your investments, in order to separate the highest liability actions from your assets, including: paying property management, paying contractors, collecting rent, marketing, etc. Finally, with the use of Trusts while establishing these structures you can add a level of anonymity by removing your name from public record.

    The second point I want to bring forward is that if you benefit from something, then by law there is always some sort of liability that can be traced back to you. As your assets grow, you goal is to essentially create "stop-gaps" to protect those assets - from the liability of each other and from you personally. When you look at the rich, they don't own anything. They control assets. They do this through the same methods lined out above, and as your wealth grows there are more tools that come with bigger price tags. You are making it as difficult and expensive as possible for anyone to sue you, and most attorneys will look at a well established asset protection plan and drop the case because (A) it takes time and money to discover what is there and (B) there is a lot of uncertainty if they get a payout, or what size that payout might be. They will just move on to the next case with some poor bloke who owns a property in their own name or established an LLC that can be easily pierced. Attorneys have options, and they also make their decisions based from the same business concepts you approach real estate investing from.

    While you have a framework for a good asset protection plan, you want to team up with an attorney who has experience in your investment type who can guide you toward the strongest protection that will also save you money in the long run. It is often better to pay up front to do something right the first time, rather than save a bit of money and lose everything down the road.

    These are just my two cents. Hope this helps!

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