Summary: In this article you’ll learn all about real estate asset protection, how to protect real estate assets and avoid lawsuits. Topics include: what is asset protection, the best asset protection strategies for investors, 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.
You’ve worked hard to build your wealth or you are in the process of doing so. Asset protection is a strategy developed to help protect or guard your wealth over the long term. Basically, asset protection and preservation is a legal way of protecting your assets from third-party claims such as creditors or other individuals. It’s one of the most important steps you can take to protect your assets while building your portfolio.
Consider for a moment what would happen if a creditor filed a claim against you or your business. If your business is not structured properly, not only can those assets be used to settle the claim but your personal assets can also be on the line. With proper asset protections in place, you can legally avoid some of the most significant and expensive risks, like creditor claims. It’s can be a complex process, but understanding some of the basics is an essential step for business owners and individuals alike.
What Is Asset Protection?
Asset protection is the development of a strategy that protects your assets from creditors. It is not a tool just used by those that are very wealthy. It is applicable to most people, especially those that own investments, a business, or a portfolio. The goal is to legally protect your assets from creditors. Because any person can be sued for any reason, this strategy helps stop creditors from accessing these assets for payment of settlements, credit card debt, or lawsuits.
There are different methods to asset protection. These include moving funds into an appropriate trust, such as an irrevocable trust or maxing out your IRA contributions. Real estate investors can protect their properties by creating land trusts along with Limited Liability Companies or LLCs. These methods must be legally binding, which is why it is very important to work alongside an experienced professional to create and implement these strategies. Asset protection does not violate any law but rather uses laws to help protect your assets.
What Is Asset Preservation?
Asset preservation is another valuable tool used to help protect your real estate investments. This term can be used in a variety of ways. For example, it is sometimes used to discuss how assets are managed while you are alive, compared to a “will”, which outlines what happens to your assets after you die. Another common use for this term has to do with creating wealth protection strategies, such as asset protection methods.
Asset preservation is often linked to estate planning. How you hold and manage these assets in the time that you own them can impact those assets’ values. For example, depending on whether or not you use a trust, your assets may face tax implications. However, it is possible to structure assets in such a way as to minimize taxation and to gain better protection of those valuables.
The ultimate goal of asset preservation and asset protection is the same. It is to minimize what can be done to these assets to reduce their value. Creditor claims and taxation can create vulnerabilities for property owners. Yet, there are very safe and legal ways to structure and hold these assets that help reduce these risks. Your assets will then maintain their value long term.
Each situation is different. When you work with an expert, you’ll create a customized plan of action that is unique to the types of assets you own, their worth, how you plan to use those assets in the short and long term, and the types of risks they may face.
Best Asset Protection Strategies for Real Estate Investors
Knowing how to protect your 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.
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 of losing everything.
When deciding on an asset protection strategy, you might find that there are many misconceptions that can actually put your assets at a greater risk. To avoid these common misconceptions, we’ll discuss two of the best asset protection strategies for real estate investors: land trusts and LLCs.
Real Estate 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.” Land trusts by themselves do not protect real estate assets.
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.
Think of land trusts as a secure box with the sole purpose of simply 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. Land trusts are appealing to investors because of the dual simplicity and functionality they can provide.
3 Advantages of Using Land Trusts to Protect Real Estate
Land trusts can provide several advantages, which is why they are a useful step in creating and implementing a plan 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. Rather than dealing with a complicated will, the new beneficiary can 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 providing 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 states don’t require the individual to pay transfer taxes. Not only can you avoid transfer taxes, but land trusts ensure that you can still qualify for homestead tax exemptions (if applicable).
2 Disadvantages to Using Land Trusts to Protect 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 an interim step to protecting your assets. As a revocable grantor trust, there are instances when a lawsuit can be filed against a lone beneficiary. Should this occur, 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 find out how the land trust was created. This information will eliminate anonymity and result in the aforementioned legal action against the beneficiary. Additionally, once anonymity is lost so 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 can put your assets at risk during the time it’s held in the trust. 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. Even if you do live in a state that recognizes land trusts, there are still several steps to take in order to take advantage of tax exemptions for all properties held within the 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.
Real Estate Asset Protection Strategy #2: LLCs
As described in the previous section, knowing how to protect real estate assets requires more than just one step or one layer of protection. While land trusts offer the advantages of more easily transferring property, privacy for all parties involved, and avoiding transfer taxes, it should only be used as an interim step. To further protect your real estate assets from a potential law suit, after transferring your assets into a land trust, the next step should be to transfer the trust into Limited Liability Companies or LLCs.
LLCs are a type of legal business formation. They’ve become a very popular way to protect real estate holdings. When property is placed under an LLC, it can reduce personal exposure to risks surrounding that property. There are also serveral tax advantages.
When real estate is placed in an LLC, the property is treated as a business. It is no longer directly linked to the owner’s assets but is a standalone business. As a result, any lawsuits filed against the property, such as someone being hurt on the property, will impact only the business, not the owner’s personal property and assets. On the other hand, if a property owner does not create such a business entity, his or her personal real estate assets can become accessible in a settlement from such a lawsuit.
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.
Additionally, LLCs become separate, taxable entities. Depending on the type of real estate, its use, and its value, this can help reduce some of the taxes the owner pays on that property.
4 Real Estate LLC Recommendations for Investors
The following four recommendations should be carefully considered to ensure that your valuable real estate assets are fully protected should a lawsuit present itself.
- Multiple properties in one LLC is not recommended. — Placing more than one property into an LLC isn’t the best asset protection strategy. That’s because if one of your properties in the LLC faces a lawsuit, then by association the other properties within the LLC might also be at risk. This is especially important for investors that have multiple rental properties. Instead, the best approach is to have multiple LLCs to hold all of your investment properties. In fact, you can have an unlimited number of LLCs. Through the proper setup, LLCs don’t require investors to file taxes on every property, instead they can all succinctly flow down to your personal 1040e. This strategy also has the added benefit of minimizing ongoing costs. In order to know how many LLCs you should have, consider your risk tolerance. If one of your investment properties carries more liability than others, it’s probably best to have that property in its own LLC.
- More insurance versus multiple LLCs? — A common question in asset protection is why you can’t simply take out additional liability insurance to protect yourself in the event of a lawsuit. The main issue is whether or not the insurance company will actually cover you. While more insurance can help reduce risk to an extent it’s not a comprehensive solution. You’ll want to separate real estate assets from personal assets. Business entities like LLCs can shield assets and help prevent losses in nearly every situation, including creditors, lawsuits, and tax implications.
- Should you use Nevada or Wyoming LLCs? — When learning about real estate asset protection and LLCs, many people ask specifically about Nevada and Wyoming. Both of these states offer excellent asset protection. Unfortunately, these two states have also been misused. When you set up an LLC in Nevada or Wyoming, your name is not attached to the LLC, which provides instant privacy and the property 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. 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. You would be charged fees in both states, and the LLC will fall under CA statutes. This means you will lose the benefit of anonymity. It’s best to register the LLC in the state where you are actually doing business in order to avoid paying double the fees. Remember, the land trust portion of the LLC does offer its own privacy benefits.
- Make sure LLC state statutes are up-to-date. — LLCs are a relatively new real estate asset protection strategy in the United States. As such, the laws governing this entity are subject to change. In fact, each state has its own set of statutes regarding LLCs. Land trusts and LLCs together offer the best asset protection strategy. Smart investors should stay up-to-date on their state-specific LLC statutes. Not doing so will leave you and your assets more vulnerable and expose yourself to unnecessary risk, should a renter or creditor try to sue you.
How to Use a Trust as an Asset Protection Strategy
Transferring your assets into a revocable or irrevocable trust can reduce the risk of incurring additional taxes. The trust then becomes the owner of the assets. This can preserve the value of your assets long term.
Real estate asset protection is the process of legally protecting yourself against tax claims, reduce liability, shield property from lawsuits, and minimize creditor and tenant claims. No matter which real estate asset protection strategy you decide to pursue, it’s always a good idea to use an attorney that is experienced and knowledgeable. This individual should have a solid understanding of asset protection statutes in different states. Ask your attorney or CPA if they have other clients that do what you do. Their answer will help determine if they have the expertise and experience needed to safely protect your assets against potential lawsuits. There’s a lot on the line here. Your personal wealth. There’s no reason to risk your money and assets when there are several asset protection strategies available for all types of investors.