TO LLC or NOT?

Question

Hello BP community.

My business partner and I are close to purchasing our first rental in New Brunswick NJ. Recently I had a conversation with an established flipper/investor who recommended not worrying about an LLC for asset protection right now as this would be the first property - an instead purchase an umbrella policy on the property to protect against claims etc should they occur. My partner and i have decent 401k and we dont want to be unprotected. I have reached out to an attorney but while i wait for their response i was hoping for some opinions.

my original thought process was that insurance companies are in the business of collecting premums - NOT protecting you, and often look for reasons to not cover. so his comment didnt sound totally correct.

Anyone have experience using an appropriate (if there is such a thing for investors) umbrella policy in lieu of LLC.

Thanks in advance NJ NEWB

David Fink · Answer

Okay...you really need to understand asset protection in NJ to get the best answer.  I live in Florida, so I will give you that perspective, which may or may not be applicable to you (I am guessing it is relevant).  The first consideration is - if there is liability and you are sued, what can they get? (FWIW - I am not an attorney, but I have spent a lot of time looking into creditor protection and taken a number of continuing ed course for attorneys.  Either way - I am just some guy responding to a post on the internet, so verify everything with people you know and trust):

- If you don't have any assets, don't worry about an LLC - there's nothing to get anyway.

- If you have assets, but they are "protected" - don't worry about an LLC - there's nothing to get.  In Florida, "protected" assets include IRAs, 401ks, your homestead, life insurance, annuities, and a couple other items.  I know that other states aren't quite so generous (Florida was a haven for those going into bankruptcy).

- The first line of protection is your homeowner's policy.  It is true that insurance companies don't want to pay, but if you tell the truth and you aren't doing anything really odd, that shouldn't be an issue.

- The next line of protection is an umbrella policy.  If you have potential exposure (i.e., assets) that greatly exceed the coverage provided by the homeowner's policy, get umbrella coverage (excess liability coverage) in the amount of your "at-risk" assets.  Be very honest with the agent to make sure the coverage is appropriate.

- As your net worth gets larger, alternative ownership structures (LLCs, partnerships, etc.) can - and should - be a consideration.  Fair warning - there is a distinct difference in protection between single and multi-member LLCs in a variety of jurisdictions, so make sure you understand what you'll be protected against and what risks are still there.  Warning #2 - multi-member LLCs will require separate tax returns, so understand the legal and accounting ramifications before you dive in.

I tend to own my properties in a variety of LLCs.  The LLCs are single-member LLCs owned by a holding company - a mutli-member LLC.  So, I have 1 extra tax return for the holding company - everything else rolls up into that.  Since the holding company doesn't do anything other than own the other LLCs, nobody will sue it from the "outside".  If anything happens at one of my properties, the liability will be confied to the LLC that holds that property (after insurance takes care of things).  It works for me - it may not work for you.

Good luck.

Steve Vaughan · Answer

I don't personally own little houses inside LLCs.  But I don't have a partner.  A partner would change my whole ownership scheme to at least be TIC with a JV agreement.

For a long-term buy and hold arrangement with a partner I'm not married to, I would have a good op agreement that spells out the Ds and what happens in each case.  Death, divorce, disinterest, default, drug-use, etc.  Put everything in writing @Joe Geist!  Your new partner down the line might be your buddy's po'd x-wife otherwise.

Steve Gordon · Answer

Although someone else may give a better answer, they are two separate beasts.  We have insurance on buildings while they are owned by the LLC.  The insurance is for legal liability, the LLC is to limit the personal loss above the insurance limit.

I believe that if you exceed the umbrella policy limit the owner of the peoperty may be liable for the costs above and beyond.  In this case you may possibly be personally liable for all costs above the umbrella policy limit.  This would, if it's true, include your personal assets.

In the case of the LLC the limit is 'limited' to the assets of the LLC.  Unless you are doing something incorrectly [mixing llc and personal bank accounts, using the llc assets for personal use, etc] the LLC assets won't include your personal assets [personal home, 401k, etc].  In most cases the LLC will contain, other than the property, very lttle assets and therefore you have a safer form of protection.

Of course your accountant and/or your attorney can explain quite a bit more thorough so please check with them before taking action.

Good luck.

Mark Whittaker · Answer

so now its 2 years later... how have you structured your business so far?  did you go with the LLC?

Joe Geist · Answer

@David Fink your post is very helpful and very closely mimics sutton's book on corporation regarding an individual LLC for each property. I think people need to live in reality and understand there is NO full-proof method for protection. an LLC does provide a layer of protection proving that it was setup correctly and is run properly to avoid "piercing" issues. On the flip (pun intended) an umbrella policy may prove sufficient in the early stages of the game where you only have a property or two, are not a millionaire but an average post grad student. Just get one large enough to provide enough coverage.

also looked it up - new jersey doesn't have homestead exemption (chalk another up for NJ not!!!).

appreciate your response!

Ken Teng · Answer

One thing to add:

Your creditor cannot lay hands on your social security and 401k. It is your other properties, like your primary residence, that are at risk.

Steven Stokes · Answer

You have to look at real estate investing as a business. And as a business you want the maximum liability protection for yourself, your family and your partners. And you simple cannot do that as a sole proprietorship or even joint venture.

There are too many things that can go wrong one year, two years or ten years down the road that will make you wish you took set up your business correctly in the beginning.

In my opinion, you should always set your business up as an LLC or S-Corp and the reasons for doing this far out-weighs why you would not want to do it.

The worse part about having an LLC is that it does take a little more paperwork and it's a little more formalized but that's a good thing - not a bad thing for you and your investors.

I hope this helps. Good luck

Joe Geist · Answer

Absolutely!!

Joe Geist · Answer

yes thats my understanding as well. I think its clear there is one option and its not relying on the umbrella coverage to protect personal assets. Thanks for your response!

TO LLC or NOT?

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