Summary: In this article you’ll learn how to protect real estate assets and avoid lawsuits. Topics include: best asset protection strategies, ways to avoid lawsuits and minimize risk, the difference between land trusts and LLCs and the advantages and disadvantages of each.
Making a plan to protect your assets is a valuable step that everyone should take. In fact, the best strategy to protect yourself from a lawsuit, is to come up with a plan before getting sued. However, when the time is right to finalize this plan or to put it into action, you might discover that there are many misconceptions that can actually put your assets at a greater risk. To help you avoid these all too common misconceptions, in the following article, we will discuss two of the best asset protection strategies: land trusts and LLCs.
Why are the Best Asset Protection Strategies for Real Estate Investors?
Knowing how to protect real estate assets starts with the basic understanding that it is hard to predict a lawsuit. In fact, most people who encounter a lawsuit say, “but, I never saw it coming.” While you can’t plan for every single contingency, you can put up several roadblocks and safety measures around your real estate assets to ensure that you have the maximum level of protection, should an unexpected threat materialize. In short, the reason for safeguarding your real estate assets is simple: a failure to do so is like leaving your home’s door open during the holidays and then wondering why a burglar stole everything. If you don’t protect your assets before a lawsuit, then like leaving your home unlocked during the holidays, you are at a heightened risk for losing everything.
Asset Protection Strategy #1: Land Trusts
What is a Land Trust in Real Estate & How Do They Provide Asset Protection
A land trust is designed to hold your real estate assets. It provides several advantages, but only if you follow the necessary steps. In fact, one of the most common misconceptions associated with land trusts is that you can “simply transfer your real estate assets into a land trust, where you are the listed beneficiary, and protect yourself from a potential lawsuit.” The latter misconception is inaccurate. In other words, the answer to the question, “do land trusts provide asset protection,” is no, at least not by themselves.
Land trusts are revocable or grantor trusts, which means that if you leave the property in a land trust and a lawsuit is presented, then you could be held liable. They do, however, provide an interim step in protecting your real estate assets, which is why investors use land trusts. You can think of land trusts as a secure box with the sole purpose of holding real estate. This box includes a set of instructions for the grantor, trustee, and beneficiary. The instructions will include detailed information about who can lease, sell, or encumber the property. Additionally, the instructions will specify how any money earned should be distributed. In this vein, land trusts are appealing to investors because of the dual simplicity and functionality that they provide.
3 Advantages of Using Land Trusts in Real Estate
Land trusts are known for providing several advantages, which is why they are such a valuable step in creating and implementing the pan needed to protect your real estate assets.
- The transfer of property is much easier than a LLC. — As previously mentioned, a land trust is equipped with detailed instructions for the grantor, trustee, and beneficiary. As such, a land trust makes it much easier to transfer property, should something happen to the beneficiary. Instead of being forced to deal with a complicated will, the new beneficiary can instead be easily assigned under the guidelines of a land trust. Once the new beneficiary is in place, the instructions of the land trust will remain; once again proving the usefulness of its simplicity and functionality.
- Offers privacy of ownership and transferring interests. — Many individuals want to keep the value of their real estate assets off of public record. The beauty of a land trust is that it offers privacy ownership, which means that the value of its real estate assets won’t be on the public record. If a lawsuit materializes, then it will be much harder for someone to go after your real estate assets, since they won’t be able to know their true value.
- Avoids transfer taxes. — Unlike transferring a property into an LLC, transferring a property into a land trust can typically be accomplished tax free. In these instances, the federal government often treats the property as if it was owned outright by the beneficiary. As such, many state laws indicate that the transfer of property by a beneficiary to a revocable trust doesn’t require the individual to pay transfer taxes. Not only can you avoid transfer taxes, but the land trust ensures that (if applicable) you will still qualify for homeowner’s or senior citizen’s real estate tax exemptions.
2 Disadvantages to Using Land Trusts in Real Estate
While land trusts offer all the advantages described above, there are several disadvantages of using only a land trust to protect your assets.
- Little protection to offset litigation or taxes. — The biggest disadvantage of land trusts is that they do not provide asset protection. This is why transferring your assets to a land trust is just the interim step to protecting your assets. As a revocable grantor trust, there are instances when a lawsuit can be submitted against a lone beneficiary. Should this occur, then the courts might force the beneficiary to alter the terms of the trust to benefit the claims of a creditor. If a lawsuit is presented, it will be very easy for a legal professional to trace how the land trust was created, which will eliminate anonymity and result in the aforementioned legal action against the beneficiary. Additionally, once anonymity is removed so too is the tax advantage that a land trust can provide.
- Not recognized by statute in many states. — Land trusts are not legally recognized in many states, which means that obscurities can occur, putting you and your assets at a risk. Additionally, state statutes change all the time. If you or the lawyer who is setting up your land trust are not experienced or familiar with up-to-date state statutes, then your assets could very easily be at risk if a lawsuit presents itself. Even if you do live in a homestead state, there are several steps that you will need to take to ensure that you enjoy the full homestead exemption for all properties held within the land trust. To further complicate matters, government personnel in states without the required land trust legislation tend to lack the training or knowledge needed to handle any issues that arise with land trust properties. This lack of knowledge can negatively impact you in the long run.
Asset Protection Strategy #2: LLCs
As seen in the proceeding section, knowing how to protect real estate assets requires more than a one step. In fact, while land trusts offer the advantages of more easily transferring property, privacy for all involved parties, and the avoidance of transfer taxes, it should only be used as the interim step. To further protect your valuable real estate assets from a potential law suit, you will need to complete a vital second step. After transferring your assets into a land trust, you should then transfer the trust into an LLC.
This second step is incredibly important because it is the LLC that will provide the asset protection you need from a lawsuit. By placing your real estate properties into a trust name you can then more easily facilitate the transfer of ownership from your name (i.e. the trust name) into an LLC. This transfer of ownership is important because it avoids informing the banks that you are in fact relinquishing ownership of the property into a business entity.
4 Real Estate LLC Recommendations for Investors
It is important to note that simply transferring a property into a land trust and then transferring the trust into an LLC is a task that requires careful consideration. In fact, the following four recommendations should be carefully heeded if you want to not only enjoy the benefits of this two-step plan, but if you also want to ensure that your valuable real estate assets are properly protected should a lawsuit be presented.
- Multiple properties in one LLC is not recommended. — It is ill advised to place more than one property into an LLC. The reason is simple: should one of your properties in the LLC face a lawsuit, then by association the other properties within the LLC might also be at risk. This is especially important for investors that have rental properties. Instead, the best practice approach is to have multiple LLCs to hold all of your investment properties, including your rental properties. In fact, you can have an unlimited number of LLCs, provided that they have been properly setup. Through the proper setup, you can ensure that the LLCs are disregarded, which means that you wouldn’t have to file tax returns and instead they can all succinctly flow down to your personal 1040e. The latter strategy also has the added benefit of minimizing ongoing costs. In order to know how many LLCs you should have, you must first ask yourself the following question, “what is my risk tolerance level?” The answer to this question will help you to not only determine your acceptable level of risk, but where you want to take these risks within your overarching real estate asset protection plan.
- More insurance versus multiple LLCs. — In the face of setting up several LLCs you might instead be tempted to ask why you can’t simply take out additional insurance to protect yourself in the face of a lawsuit. The primary issue is knowing if the insurance company will actually cover you. While you can read and re-read your insurance policy, the truth is that there are typically several clauses and then sub-clauses that make it difficult to know exactly what is or isn’t covered. The moral of the story is simple, you shouldn’t put all of your eggs into one basket, i.e. insurance may or may not be there when you need it most. While it is a helpful roadblock and safety net, when comparing extra insurance to multiple LLCs, the former should not be mistaken as the should not be mistaken as the ironclad asset security protection that you need.
- Should you use Nevada or Wyoming LLCs? — When learning about real estate asset protection and LLCs, many people automatically ask about Nevada and Wyoming. Both of these states do offer excellent asset protection; unfortunately, these two states have also been misused. It is important to note that when you set up an LLC in Nevada or Wyoming, you can establish privacy whereby your name is not attached to the LLC, which means that it can’t be taken from you. However, if you are not running your business in either of these states, then you will lose your privacy once it’s registered in the state where you are running your business. Additionally, you will also be charged fees each year for creating these entities in both states. For example, let’s say that you are doing business in California, but have an LLC in Nevada. In this instance, you will be charged fees in both states, and then the LLC will fall under CA statutes, which means you will lose the privacy benefit. The moral of the story is simple, you want to register the LLC in the state where you are actually doing business to avoid paying double the fees. Keep in mind, that the land trust portion of the LLC does offer its own privacy benefits.
- Making sure LLC statutes are up-to-date. — The LLC is a fairly new real estate asset option within the United States, as such the laws governing this entity are subject to change. In fact, each state has its own set of statutes concerning LLCs. While using a land trust and a LLC (or multiple LLCs) offers the best asset protection strategy, you must ensure that your advising team is knowledgeable of the most up-to-date statutes. Additionally, it is vital that you stay abreast of any developments within LLC statutes; after all, a failure to do so means that you might leave yourself unprotected should a lawsuit be presented.
Conclusion: Knowing How To Protect Real Estate Assets Starts With The Right Team
No matter how you decide to protect your valuable real estate assets, it is important that you use an attorney who is experienced and knowledgeable in asset protection. Additionally, this individual should have a firm understanding of statutes in different states. In this vein, make sure that you ask your attorney or CPA if they have other clients that do what you do. Their answer will help you to determine if they have the expertise and experience needed to safely protect your assets against potential lawsuits. In conclusion, by following the asset protection strategies described in this article, you can protect yourself and your assets in the event of a foreseeable or unexpected lawsuit.