Top 3 Real Estate LLC Myths: Busted!

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I love that show with the geeks that use science to prove of disprove myths. As a card carrying geek myself, it’s fun to watch what is and isn’t true – common perception versus the physics. The same can be seen in the asset protection arena.

The concept of “asset protection” ranks, to me, almost as important as tax planning in our wealth accumulation plan. Bad things do happen that are outside our control, and how we account for the random bad event like a slip and fall accident can make a major difference in our final score in the wealth game. As always, consult your own lawyer before acting on my opinions.

The Unseen Physics that will Come Into Play in this Field are

1. The desire to encourage risk taking by allowing limited liability. Ever since the British East India Tea Company was formed in 1600 the business alter ego has served a vital part of innovation. If I can set my level of comfort without fear of losing everything – it’s a huge physiological difference, right?
2. The counter force is most often found in a personal or economic injury cases. If our property was negligently maintained and it resulted in harm justice dictates making the person whole as possible.

So with those to forces acting against each other it begs the question: “Is my asset protection plan effective?” To that end, I wanted to bust the myths associated in this arena. If you take thees into consideration you will be armed and ready for all outcomes.

1.) I’m Set up with an Entity, Therefore I am Protected

This one is huge. Most people begin with the idea, “Hey, I’ll just got to LegalZoom or RocketLawyer, get my LLC and am I set!” Wrong.

Be it an LLC, C-Corp or S-Corp the same rules apply. The big problem is that we ask the wrong question. “Should I get an LLC” is not the right question – the right question is “will I keep up with the formalities associated with having an LLC?”

Why?

Aggressive and starving plaintiff’s attorneys are going to attempt to use veil piercing. Veil piercing is a judicial tool used to disregard your entity so they plaintiff can get at YOUR personal assets.

It seems silly to waste time with an entity formation and then not follow up with the rules to all most eliminate the possibility of veil piercing. Aside from fraudulent behavior, if you follow these basic rules your entity should be 99% bullet proof:

• Get insurance and maintain it…not a formal part of the veil piercing framework but it is crucial. Cases where the plaintiff is harmed but has no recovery from insurance results in the invisible hand looking to reach right through your entity. Judges and juries are generally about fairness

Key veil piercing factors:

• Poorly capitalized entity versus the industry standard
• Co-mingled funds where you pay business obligations out of personal bank accounts or vice versa
• Not filing annual reports and filing fee’s

2.) I Don’t Need any Protection Plan

This one is debated often here on BiggerPockets. Many elect NOT to form an entity due to the cost and effort associated. As with anything the cost benefit analysis is always wise, because the amount of equity you start off with real estate investing may make it seem cost inefficient. However to me this is short sighted. Isn’t our goal accumulation of significant wealth through real estate?

So I believe it’s best to set up right at the start, when possible.

3.) I am Set up in a Trust

If anyone asserts that a trust is useful for asset protection become skeptical of why they are saying it. A cottage industry has evolved with this method especially with offshore trust.

They do have some utility in an overall scheme if you employ insurance and or have reserves to pay off a plaintiff. It can be a settlement tool to say, “Hey look, I have a trust” just take the insurance offer.

However, if you are a bad actor, the courts have a lot of tools to compel you to bring those assets to the table for recovery. Complicated layers with LLC’s and offshore trusts are expensive and I am just personally not convinced its worth the effort.

Conclusion

Overall, they are some great ways to use entity to bolster your protection plan. Using a C-Corp as a management entity via a master lease of a property you own in an LLC sounds pretty solid to me.

I am open to learn from your experiences…what do you think?
Photo Credit: zacklur

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.